If you’re considering retirement and have purchased stock of the company you work for within your retirement plan, you have an opportunity to manage the income taxes you pay on any plan distributions by taking advantage of an IRS-approved policy referred to as Net Unrealized Appreciation.
Net Unrealized Appreciation or “NUA” Explained:
The net unrealized appreciation (NUA) is the difference in value between the amount you paid for the stock shares and the current market value of those shares held in your retirement plan. Upon the distribution of stock, the NUA is not subject to ordinary income tax. As a result, if your company stock has gained significant value over what you have paid, it could be better to transfer that stock to a regular (non-IRA) brokerage account instead of rolling the stock over to a tax‑deferred IRA. If rolled over to an IRA, the company stock’s NUA would eventually be taxed at your ordinary income tax rate (not the lower, long-term capital gain rate) when you sell the shares to take a distribution.
EXAMPLE:
John has a $2 million 401(k) plan balance. The plan consists of $1 million in stock of the company he’s worked for many years. Through years of salary deferrals, John has only paid $100,000 for that stock. The additional $900,000 is attributed to the appreciation in value of the stock. The remaining $1 million in assets in his 401(k) is a mixture of mutual funds and cash. How would the NUA Rules apply here?
When John retires, he can take the $1 million worth of company stock and transfer the shares to a “non-IRA” brokerage account. At this point, the $100,000 cost basis of the shares will be taxed as ordinary income, but the remaining $900,000 is now considered capital gain and will be taxed at favorable capital gain rates (which are likely lower than his tax rate on ordinary income) only when he decides to sell shares. The remaining $1 million in mutual funds and cash will be rolled over to an IRA and distributions from that IRA will be taxed at ordinary income rates (no tax is incurred on the rollover).
ADDITIONAL QUALIFICATIONS
Keep in mind that NUA is only applicable to the stock of the company for which you are (or were) employed. The stock distributions must be taken as shares and cannot be converted to cash at the time of the distribution. To qualify for NUA tax treatment, you must have either separated from the company, reached the minimum age for distribution or suffered an injury resulting in total disability (if you are a self-employed worker).