Do you have employer stock in your 401(k)?
Don’t take your first withdrawal until you learn more about Net Unrealized Appreciation (NUA).
If you have employer stock in your 401(k), you might have an NUA distribution opportunity.
NUA is the difference in value between what you or your employer paid for the stock (cost basis) and the current market value of stock held in your 401(k). If there is a large gain on the stock upon your retirement, it may be more sensible for you to distribute the stock to a brokerage account.
How is an NUA distribution taxed?
Initially, you may have thought you would be paying ordinary income taxes on distributions from your 401(k). If so, you were partially correct. Most distributions from 401(k)s are taxed at ordinary income rates. However, you have some flexibility on taxes with the employer stock in your 401(k). If you distribute the stock to a brokerage account as the first withdrawal utilizing the NUA strategy, you will pay ordinary income taxes on the cost-based portion. When you eventually sell the stock, you will pay long-term capital gains taxes on the gain of the stock.
Below is an example of how the tax savings could work if you have $300,000 of employer stock with a cost basis of $50,000:
If you utilized the NUA strategy in this scenario, you would save $50,000 in income taxes.
Who can take NUA distributions?
It’s pertinent to understand how NUA withdrawals work. One of the following must apply to you:
- (1) you are separated from service of the company whose plan holds the stock,
- (2) you are age 59 ½,
- (3) you are disabled, or
- (4) you have passed away and your spouse is permitted to utilize the NUA strategy
The distribution of stock MUST be the first withdrawal from your 401(k) and you also must distribute all the assets in your 401(k) within one year, either by a rollover to an IRA or directly to yourself.
However, there are additional elements to consider. For example, are you under age 59 ½?
If so, you may be subject to a 10% penalty for early withdrawal. Additionally, assets outside retirement plans do not enjoy the same creditor protection. Finally, NUA may not always be the most tax-efficient strategy, especially if the price of the stock declines or tax rates change.
Often, NUA may only make sense when you have a large gain and you can pay taxes on the majority of the value of the stock at long-term capital gains rates. It is also important to think about the timing of the NUA solution and how that may best fit your personal tax situation over the next few years. Expert advice can help you identify the discrepancies and limits of your company stock plans, and leverage a strategy that minimizes your tax burden. Before you make a final decision, consult your financial advisor for advice, or meet with one of our financial professionals to get a second opinion.