The first thing to know about NUA—even before knowing what the initials stand for—is that it is a tax trick for reducing the tax you pay in retirement. While it does not work for everyone, it can be particularly useful for ExxonMobil retirees.
NUA stands for “Net Unrealized Appreciation”. If that means nothing at all to you, don’t worry. The title isn’t important. How it works is.
How does NUA work?
In order to understand NUA, you must start with fundamental differences between a qualified retirement plan, such as a 401(k), and a normal (taxable) investment account.
Let’s start with the tax perks that come with a qualified retirement plan like a 401(k):
- You put part of your salary into the account pre-tax, and the IRS doesn’t count it as income for the year.
- You reduce your taxable income, and therefore your tax burden, every year you contribute to a 401(k).
- In addition, you pay no tax on any investment returns until you start to withdraw money from the account.
- You may also receive matching contributions from your company.
In exchange for these tax benefits, qualified retirement plans come with a few restrictions:
- You cannot withdraw the money until you are 59½ without paying a potential 10% penalty.
- You promise to withdraw the money during retirement; the government requires minimum distributions from the account once you reach a certain age and penalizes you if you fail to do so.
- Every dollar you withdraw, whether it’s from your initial contribution or an investment gain, is taxed as ordinary income in retirement.
That last bullet will be important going forward. Ordinary income tax rates are higher than the capital gains tax rate.
Now, let’s consider the benefits and restrictions on a standard investment account. Imagine you open a brokerage account where you buy and hold Exxon shares ($XOM). You will:
- Pay income tax on the money you put in the account to buy Exxon shares.
- Pay tax quarterly dividends.
- Not get a company match.
You don’t pay any tax if the value of Exxon stock increases so long as you hold the shares. When you sell the shares, you are realizing the gain; it’s not a taxable event. However, as long as you’ve held the shares for longer than a year, any appreciation is taxed as a capital gain, not as ordinary income. Capital gains tax has other intricacies that may benefit you beyond the tax rate itself.
These accounts also have fewer restrictions: You can withdraw the money at any time and there are no required minimum distributions down the road.
All things considered, the tax benefits of a qualified retirement plan generally outweigh the benefits of a brokerage account, and we would encourage you to use the the Exxon Savings Plan as your primary retirement account.
Now, imagine that you’re checking your 401(k) statement and see your Exxon shares trading much higher than when you purchased them. Suddenly, you wish you’d purchased those Exxon shares in a brokerage account instead, so you could pay a lower tax rate on the gains. Imagine you write a letter to the IRS saying as much on a whim—you tell them you’d like a do-over, and would like to pay income tax on the money you used to purchase the shares initially if you can move them to a brokerage account instead of your Savings Plan.
To your utter surprise, the IRS says, “Yes, go ahead.” That answer is courtesy of a specific section of tax code: net unrealized appreciation, or NUA.
How to successfully use NUA
You might be asking: What’s the catch? Here are some of the terms and conditions the IRS applies to NUA.
- It only applies to your employer’s stock.
- It can be stock you purchase in your retirement plan OR a company match.
- You must withdraw all of your money from your 401(k) when executing NUA. You can simply roll those funds to a traditional IRA to preserve the tax benefits for any non-Exxon assets.
- To do this, you must “qualify” by either turning 59½ or leaving the company after you turn 55.
Should I use NUA?
The details involved in net unrealized appreciation (NUA) can feel complicated, and you may be wondering whether the tax savings are worth the hassle.
First, Bogart Wealth can handle the logistics of executing an NUA for you. So to really assess whether NUA is worth it, consider how much your company shares have appreciated since you purchased them. If that appreciation is considerable, then it’s absolutely worth it to take advantage of the significantly lower tax rate on those gains.
You’ll also receive secondary benefits. For instance, you no longer need to take required minimum distributions from any shares you’ve moved to a taxable brokerage account.
NUA mistakes to avoid
One important thing to remember? You do NOT have to sell your company shares to complete an NUA transfer. You can simply move those shares from the qualified account to a non-qualified account. The important number is the price you paid for the shares, since that’s the amount the IRS will tax as part of the transfer. Their current value doesn’t matter until you’re ready to sell.
You also don’t need to make a decision immediately upon retirement. The best time to execute an NUA transfer will likely depend on your personal goals and circumstances, company share prices, the overall market, and more. A financial advisor can help you assess the many competing factors to help you come up with the best plan for your personal circumstances.
If you think you might qualify for, or benefit from, and NUA transfer in retirement, set up a call with a Bogart Wealth financial advisor to discuss your options.
