Understanding NUA distributions is important and can give your retirement plans a boost. So, let’s look at how NUA distributions work and how you can take advantage of them.
NUA is the tax-advantaged increase in value of employer stock in an employee retirement plan at the time you take a lump-sum distribution into a taxable brokerage account. The difference in value is taxed at long-term capital gains rates, rather than as ordinary income.
If you have company stock in a retirement plan, it may be wise to roll the plan assets over into an IRA when you retire or leave the company. However, it may be better to distribute the stock out of the plan and take advantage of the lower tax rate on a portion of the distributions.
What is NUA?
Typically, when you leave a company, you can either roll over your retirement account assets into an IRA or distribute the stock into a taxable account under special tax rules. With the rollover option, any distributions you take later the assets will be taxed at your ordinary-income tax rate.
However, this option may not be available, it depends on your plan. Therefore many 401(k) plans liquidate the assets and send a check or wire the funds to your chosen IRA when you request a rollover.
The second option, know as NUA distribution may offer considerable tax savings over the rollover approach. Using this strategy, you only pay ordinary income tax on the cost basis of the stock; you pay the lower capital gains tax rate on the rest of the distribution, and that too only when you sell the stock.
NUA Distribution Tax Implications
To qualify for the favorable tax rules of the NUA distribution strategy, you must:
Have employer securities in a qualified employer-based retirement account. This includes company stock in a profit-sharing plan, stock bonus plan, or pension plan that your employer bought, or you purchased with pretax contributions.
Take a lump-sum distribution from a retirement account because of a separation from the company or reaching age 59 ½. This is a one-time distribution in one year of the entire balance of all qualified retirement accounts of a certain kind. This may also apply if you are the beneficiary of a plan of someone who dies.
Take a direct distribution of stock from the plan. This means you don’t roll over the stock to an IRA first and liquidate it. Instead, you move it directly into a taxable brokerage account.
How NUA Distributions Work
Let’s say you have $60,000 of WIDGET stock in your retirement plan. You can imagine your company stock is composed of three parts. These are:
Cost Basis. This is the price you paid for the shares. Let’s assume the cost basis of your shares is $25,000. When you distribute the stock in kind as a lump sum payment at retirement, you would pay tax on the cost basis at your ordinary income tax rate. So, you would report $25,000 of income on your tax return as a pension distribution.
Net Unrealized Appreciation. If the total value on the day of distribution is $65,000 and your cost basis is $25,000 the net unrealized appreciation would be $40,000. Typically, you do not pay tax on this NUA gain until you sell the stock. And at that time, it will be taxed at the long-term capital gains tax rate, even if you sell it right away.
Additional Appreciation. This refers to capital gains earned after you distribute the stock if it continues to increase in price. This is taxed either at the short or long-term capital gains rate, depending on how long you hold the shares after they are distributed from the plan. You must hold the shares for a minimum of one year to qualify for the lower long-term capital gains tax rate.
Will NUA Distributions Save Me Money?
The best way to determine if the NUA distributions strategy is right for you is to speak to a financial advisor. Otherwise, there are several factors you can look at to help you decide.
The younger you are, the more time there is for assets you roll over to an IRA to grow on a tax-deferred basis. This means there is less benefit in the NUA distribution. The shorter your retirement horizon, the more beneficial the NUA distribution strategy.
Types of Retirement Accounts You Own
If most of your funds are in tax-deferred accounts, NUA distributions may allow you to develop a greater balance between pretax and post-tax retirement assets. This may give you additional tax savings later in your retirement years when required minimum distributions begin. Lowering the amount of money in qualified retirement accounts will lower your RMDs.
Amount of NUA
If the cost basis is low and the current value of the company stock is high, the net unrealized appreciation will be high. This means a larger share of distributions is eligible for the lower capital gains tax rate.
Will your ordinary income tax when you plan to take distributions from retirement accounts be much higher than long-term capital gains tax rates? If so, then the NUA distributions strategy may be more favorable for you.
Is NUA Distributions Right for Me?
To find out if the NUA distributions strategy is right for you, talk to a financial advisor. Contact Argent Bridge Advisors to speak to a knowledgeable, experienced financial advisor today.