It might surprise you to learn that nearly 40% of Americans started saving for their retirement in their 20s. Even knowing retirement was decades away, they started.
No matter when you start to save for the big life even of retirement, you want to do everything you can to protect that money you worked so hard to save and grow over time.
For the 60 million Americans who’ve spent years socking money away into their company 401k, you might want to consider a net unrealized appreciation strategy available to save you some tax money.
Are you wondering what net unrealized appreciation (NUA) is and if it’s something you’re eligible for? Read on to learn more about this NUA strategy.
What Is Net Unrealized Appreciation?
Net unrealized appreciation offers investors who have money put away into a 401k to take advantage of a lower tax rate by using IRS Code Section 402.
Once retired, some people will opt to take a lump-sum payment from their 401k from the employer stock that’s a part of their 401k.
The problem with this, of course, is that once you do that you’ll pay taxes on that lump at your current taxable rate. Remember, money put into a 401k is not taxed yet.
A net unrealized strategy allows you to roll over this stock in-kind to avoid paying the full taxable rate and then it’s taxed at the long-term capital gains rate.
Understanding How Net Unrealized Appreciation Works
Many employers, as you invest into their company 401k plans, allow employees to own stock from the company as part of the 401k. The goal for many employers when they do this is that employees take on an owner mentality in the company.
Yet, when retirement rolls around, often the employee wants their value out of the stock. The net unrealized appreciation is the difference between the average cost basis of employer stock shares and the current market value of those shares.
The difference in those two amounts is where the net unrealized appreciation strategy comes into play. It’s an option available for some scenarios to avoid paying that full taxable amount on that amount.
It’s important to note that this NUA option is only available when:
- The stock is placed into a tax-deferred account, like a traditional IRA or 401k
- It only applies to the stock of the company for which you are or were employed
You’re unable to use the NUA strategy with a Roth IRA because the Roths are not tax-deferred. A brokerage account also won’t qualify because they already have the capital gains tax in place.
Advantages of Net Unrealized Appreciation
While taking advantage of an NUA strategy might not be right for everyone, there are some benefits to consider.
Using net unrealized appreciation allows you to avoid paying a full income tax rate and instead take advantage of paying tax at a more favorable long-term capital gains tax rate.
When you reach age 72, you will face the required minimum distribution rules. This can reduce the assets that are subject to these rules.
This also allows you to sell the company stock on your terms when it works best for you. The NUA strategy might also be used to accomplish some charitable donation goals.
Disadvantages of Net Unrealized Appreciation
There are some times when using net unrealized appreciation may not be the right choice.
If you own a large amount of company stock, you want to talk over the implication of selling with your financial advisor.
Remember, anytime you make a move during retirement, it can have a ripple effect. Using the NUA strategy could impact your tax situation in other ways.
It’s important you have someone who understands not just NUA strategy but can also consider your whole wealth management plan.
Should you say no thanks to an NUA strategy? It really depends on your individual circumstances. Often it makes sense to take advantage of those tax savings.
Yet, it can really depend on a host of factors that are a part of your financial picture overall. Be sure you discuss this with your financial advisor or tax attorney.
Rules for Net Unrealized Appreciation
There are some specific rules to the net unrealized appreciation for you to know about. These include:
- Company stock you have must be distributed in-kind. This means they don’t have cash value to you at the time, but instead must be transferred to a brokerage account.
- The transfer must happen when: you reach age 59½, when you leave the company, or when you die or have a permanent disability.
- You have one calendar year to distribute the entire vested balance.
Remember, there are penalties for early withdrawals.
Who Is Eligible for NUA?
You are eligible for the net unrealized appreciation if you’re eligible to take a lump-sum distribution from the 401k. You’re usually eligible because:
- You’ve separated employment from the company
- Reaching 59½ years of age
The distribution has to come right from the workplace plan. You couldn’t take advantage of an NUA if the distribution was rolled into an IRA and you liquidated it.
You also have to be prepared to pay taxes on the cost bases of the stock distribution in kind from the year you took it out.
Who Benefits From Taking Advantage of NUA?
So, when should a person opt to take advantage of an NUA strategy?
You would benefit if you had just separated your service from an employer. If the stock you own from the employer in your employer-sponsored retirement plan is highly appreciated.
If you expect your tax bracket to be high when you sell the stock, you should also consider the NUA strategy.
Understanding the Role of Net Unrealized Appreciation in Wealth Management
Understanding net unrealized appreciation can be complex. You need to know if you qualify and if it’s financially advantageous for you. Before you make any moves you should talk with your financial advisor about what’s best for your situation.
If you need someone to discuss net unrealized appreciation with or need other wealth management assistance, we can help. Contact us today to get the advice you need.