Remember our friend Lucas who has the charm and looks to be a tuxedo model? Well, after escaping NYC to beat the heat, I met up with him at the beach over the weekend. We talked a bit about finance and he asked me about Net Unrealized Appreciation (“NUA”). It’s another one of those funny finance terms. And like all complicated definitions, it has an acronym too – NUA. So what is it?
Net Unrealized Appreciation Overview
NUA is the difference between the original cost and the current market value of company stock.
Believe it or not, the IRS gives you a tax break on NUA. As long as there are certain qualifying events upon distribution of the stock, you pay the favorable long term capital gains tax rate.
It’s a way to save on taxes as long as you meet certain criteria. The requirements are:
- Own company stock in a tax deferred account, such as a 401(k) plan
- When you leave the employer you move the plan over to a non-IRA investment account
- You get a tax break on the company shares when moving the 401(k)
And like most things in life, there is a catch. You must pay ordinary income taxes on the cost basis of the company shares.
Keep in mind that you get the favorable long term capital gains rate on the stock price appreciation. In comparison, when you don’t use NUA, you pay the ordinary income tax rate on the distribution.
Potential Tax Savings
Lucas owns $250,000 of employer stock in his 401(k) and he is considering leaving and moving to another company. NUA is a topic that is on his mind. Let’s look at some numbers to illustrate the NUA argument.
NUA Comparison
| Market Value | Taxed as Ordinary Income | Taxed as Capital Gains | Ordinary Income Tax (35%) | Capital Gains Tax (15%) | Total Tax | |
|---|---|---|---|---|---|---|
| No NUA | $250,000 | $250,000 | $0 | $87,500 | $0 | $87,500 |
| NUA | $250,000 | $50,000 | $200,000 | $17,500 | $30,000 | $47,500 |
In the no NUA scenario, Lucas will pay ordinary income taxes of 35% on the entire $250,000 distribution. The tax due is $87,500.
With the NUA scenario, he will pay $47,500, assuming that the employer stock is sold when received from the 401(k) plan. The tally is $17,500 – 35% ordinary income tax rate on the $50,000 cost basis and long term capital gains tax – $30,000 – 15% on the $200,000 of NUA.
When comparing the two scenarios, the total tax savings are $40,000! NUA is a great technique for Lucas, and it could be for you as well.
When NUA Could Work for You
Going further than our example, here are some specific scenarios when using NUA can make sense for you.
- Highly appreciated company stock in 401(k) plan
- Tax bracket spread
- Tax diversification
When your company stock price has increased substantially, you may want to consider NUA. The greater the difference between the cost basis and the market value, the more incentive you have to pay the lower capital gains rate tax.
Your tax brackets for ordinary income and capital gains taxes are based on your income. The higher the difference between ordinary income and capital gains, the better your tax treatment – and a stronger reason for using Net Unrealized Appreciation.
When you think down the road to retirement, NUA can be beneficial. The company stock will be removed from your 401(k) plan and into a taxable account. When in retirement, your Required Minimum Distributions (RMD’s) will be lower because the NUA stock won’t be in your 401(k) account.
There are many scenarios to consider with NUA, and they may fit into your overall financial system.
It would be awesome to chat with you about NUA.