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Make The Most Of Net Unrealized Appreciation (NUA)

by , | Updated: Jan 8, 2024 | Published: Feb 27, 2023 | Insights

NUA treatment The Woodlands, TX

Make The Most Of Net Unrealized Appreciation (NUA)

A Strategy to Substantially Reduce Taxes When Owning Company Stock in Your 401(k)

 

As modifications to the tax code become more prevalent, maximizing after-tax wealth through every avenue afforded to taxpayers is critical to retirement planning.

For many individuals, diligent savings through a 401(k) plan allows them to build ownership in their company’s stock and take advantage of special tax treatment on the shares.

Some individuals may remember investing in their company’s stock over decades of gains and stock splits. Even after the turmoil in 2008, employees may have substantial gains in company stock and a very low cost basis. Once withdrawn from the plan, taxes on these assets during retirement can be staggering with marginal tax brackets as high as 37% and the potential to increase in the future.

 

 

A little known rule in the Internal Revenue Code (IRC) may offer tax advantages on a distribution of highly appreciated company stock. The appreciation above the price that you paid for your stock within qualified plans like a 401(k) is known as Net Unrealized Appreciation or NUA.

 

WHEN AN EMPLOYEE QUALIFIES FOR A DISTRIBUTION THEY HAVE 3 OPTIONS

NUA options The Woodlands, TX

How Does the Net Unrealized Appreciation Rule Work?

First, an employee must be eligible for a distribution from their qualified plan; generally at retirement or age 59.5. The employee takes a “lump-sum” distribution from the plan, distributing all assets from the plan during a 1 year period. The portion of the plan that is made up of mutual funds and other investments can be rolled into an IRA for further tax deferral. The highly appreciated company stock is then transferred to a non-retirement account.

The tax benefit comes when you transfer the company stock from a tax-deferred account to a taxable account. At this time you apply the NUA Rule and incur an ordinary income tax liability on only the cost basis of your stock.

The appreciated value of the stock above its basis is not taxed at the higher ordinary income rate but at the lower long-term capital gains rate, typically 15% but in some instances as low as 0%. This could mean a potential savings of >20%.

Let’s look at an example:

We will assume the value of the stock within an account is $500,000. The price paid for this stock is $75,000.

If one rolled the entire amount to an IRA they will owe nothing in taxes presently. Over time, if they were in the 24% federal tax bracket they would pay $120,000 in taxes for distributions.

If one were to take advantage of the NUA Rule, they will pay ordinary income tax on the cost basis at the time of distribution. This totals $18,000 in tax today. The tax on the Net Unrealized Appreciation would be 15% of the gain, or $63,750. Your total tax liability is $81,750.

Neat Unrealized Appreciation (NUA) Explained

In this example, the NUA Rule saved nearly $40k on the tax bill

 

A few things to keep in mind:

  • Employees taking a distribution prior to age 59.5 may be subject to a 10% penalty.
  • NUA makes more sense when employees have a low-cost basis.
  • It is important to take advantage of the NUA Rule prior to a rollover. Once you roll retirement assets into an IRA, it is too late to take advantage of the potential savings.
  • To qualify, you must be eligible for a Lump-sum distribution of your entire qualified account.
  • Stock shares must transfer “in-kind” to a taxable account, this means that the shares must not sell but must move from your qualified account into your new taxable account.

 

Need Some Help?

The NUA Rule can be used in certain circumstances to save a substantial amount in taxes. If you’d like some help from a CPA or CERTIFIED FINANCIAL PLANNER (CFP®) professional regarding this strategy and how it applies to you, the Rhame & Gorrell Wealth Management team is here to help.

Our experienced Wealth Managers can help you review your financial and tax situation and come up with a custom tax optimization strategy going forward.

Feel free to contact us at (832) 789-1100, [email protected], or click one of the buttons below to ask a question or schedule your complimentary strategy session today.

 

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JEFFREY G RHAME, CFP®

Partner & Senior Wealth Manager
As a Wealth Manager, Kyle McClain serves on the Investment Committee, interfaces with clients, and coordinates ongoing financial planning initiatives. He also facilitates many marketing and business development functions for the firm.

Prior to joining RG Wealth, Kyle spent time with Fidelity Institutional Asset Management as an Investment Consultant and with Merrill Lynch as a Wealth Advisor. He graduated Magna Cum Laude with a dual degree in Finance and Economics from the University of Alabama. He also completed his CERTIFIED FINANCIAL PLANNER™ program at Texas A&M University, holds the CFP® designation, and has completed his Certified Investment Management Analyst (CIMA®) designation from the Yale School of Management.


JEFFREY G RHAME, CFP®

Managing Director & Senior Wealth Manager

Jeff Rhame is one of the founders and President of Rhame & Gorrell Wealth Management. Jeff’s vision for starting Rhame & Gorrell was to deliver wealth management services and investment strategies typically available at the highest levels of wealth. Today, clients benefit from these sophisticated financial services, targeted to meet their unique needs.

Jeff leads a team of investment specialists that develop asset allocation strategies for high-net worth families. They seek out the most appropriate investment ingredients and then construct portfolios to meet our clients’ goals from income generation and capital preservation to tax-efficiency and growth.

Jeff has been honored with Top Professional’s Five Star Wealth Managers, recognized by The Wall Street Journal and Texas Monthly, for the last 10 years in a row and twice as Best of The Woodlands – Top Financial Advisors and Planners by Woodlands Online. For over 15 years, Jeff served as an adjunct professor for the University of Houston and Lone Star College Systems, teaching classes on Investment Management and Estate & Insurance Planning. As a member of the Financial Planning Association, he has also taught, and continues to teach, on & off-site retirement workshops for the employees of many Fortune 500 companies, such as ExxonMobil, Chevron.

Jeff is proudly serving as a member of three organizations: Memorial Hermann Hospital’s Advisory Board in The Woodlands, The Nelson Rusche College of Business Executive Advisory Board at Stephen F. Austin State University, and as the Vice-Chairman of the Tall Timbers District of The Boy Scouts of America.

Jeff received a degree in Accounting from Stephen F. Austin State University, and through post graduate work at The University of Houston, achieved his status as a CERTIFIED FINANCIAL PLANNER™ practitioner.


 

IMPORTANT DISCLOSURES:

Rhame & Gorrell Wealth Management, LLC (“RGWM”) is an SEC-registered investment adviser with its principal place of business in the State of Texas. Registration as an investment adviser is not an endorsement by securities regulators and does not imply that RGWM has attained a certain level of skill, training, or ability.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own CPA or tax professional before engaging in any transaction.  The effectiveness of any of the strategies described will depend on your individual situation and should not be construed as personalized investment advice.

For additional information about RGWM, including fees and services, send for our Firm Disclosure Brochures as set forth on Form ADV Part 2A and Part 3 by contacting the Firm directly. You can also access our Firm Brochures at www.adviserinfo.sec.gov. Please read the disclosure brochures carefully before you invest or send money.

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