Net Unrealized Appreciation (NUA)
Net unrealized appreciation (NUA) is the increase in value of company stock held in a retirement plan. It measures the difference between the original purchase price and the current market value. NUA can help you save on taxes when withdrawing company stock from certain retirement accounts, such as 401(k) plans.
When you retire or leave a company, you may take a lump-sum distribution of your 401(k) in company stock. Instead of paying ordinary income tax on the full value, you only pay income tax on the stock’s cost basis (what you paid for it). The unrealized gain, or NUA, is taxed at the lower long-term capital gains rate when you sell the stock.
Key Takeaways
- NUA applies to company stock in retirement accounts.
- It offers potential tax savings when distributing stock.
- You pay lower capital gains taxes on the NUA when selling the stock.
How NUA Saves on Taxes
The main advantage of NUA is the tax break on unrealized gains. Normally, withdrawals from a 401(k) are taxed as ordinary income. But with NUA, the increase in stock value is taxed as long-term capital gains instead.
Let’s say you bought company stock for $10,000 in your 401(k), and the current value is $50,000. The NUA is $40,000. If you take a lump-sum distribution, you only pay ordinary income tax on the $10,000 (cost basis). When you sell the stock, the $40,000 is taxed at the capital gains rate, which is lower than ordinary income tax rates.
NUA and Retirement Planning
NUA can play a key role in your retirement strategy. By leveraging the tax savings, you can stretch your retirement funds. When planning distributions from your 401(k), it’s essential to consider the cost basis of your stock and how much you can save on taxes.
Consulting with a financial planner or tax advisor is helpful when determining the best strategy for your stock. NUA is only available for company stock, so it’s not an option for other assets in your retirement account.
Example Calculation of NUA
Imagine you worked for a company and bought stock through your 401(k) plan at $20,000. Now that stock is worth $100,000.
- Cost basis: $20,000
- Market value: $100,000
- NUA: $80,000
When you retire, you decide to take a lump-sum distribution of your stock. You pay ordinary income tax on the $20,000 cost basis. If your tax rate is 24%, you owe $4,800 in income tax.
When you sell the stock, you will pay capital gains tax on the $80,000 NUA. If the capital gains tax rate is 15%, you owe $12,000. Without NUA, the entire $100,000 would be taxed as ordinary income, costing you much more.
Tax Rules for Net Unrealized Appreciation
To take advantage of NUA, you must meet certain conditions. First, the stock must be part of a lump-sum distribution. You also need to take the distribution after a triggering event like retirement, leaving the company, or becoming disabled.
NUA does not apply to stocks rolled over into an IRA or Roth IRA. If you roll the stock into an IRA, you will pay taxes as you withdraw, and the entire amount will be taxed as ordinary income.
When NUA Is Not Beneficial
NUA is not always the best option. If your stock has not appreciated much or if you need the funds soon, it may be better to roll the stock into an IRA. Rolling it over allows you to defer taxes until withdrawal and possibly gives you more time for the stock to grow.
If the difference between the stock’s cost basis and market value is small, the tax savings might not be significant. In such cases, other retirement withdrawal strategies might be more effective.