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WHAT TO DO IF YOU HAVE COMPANY STOCK WITHIN YOUR 401(K)
NET UNREALIZED APPRECIATION (NUA) TAX STRATEGY The question often comes up when talking with my clients who have the option to rollover or remove money from their qualified retirement account: “What do I do with my employer’s stock that has appreciated in value when it is held inside my 401(k) plan?” Not many people realize that they have options to help reduce their tax burden relating to the sale of employer stock held inside a qualified retirement plan. One of those options is Net Unrealized Appreciation.
WHAT IS NET UNREALIZED APPRECIATION (NUA)? Net Unrealized Appreciation is a tax-‐deferred strategy to be used when an individual has made contributions to an employer-‐sponsored retirement plan, KURT K. SCHUSTER, CFP®, CHFC, EA A LPL financial planner with nearly fifteen years of experience within the finance industry, Kurt advises clients around the country, concentrating on comprehensive retirement planning, portfolio management and tax planning.
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and also has company stock within the qualified plan. This strategy enables the company shares to be taxed at two separate rates.
WHO DOES IT BENEFIT? Individuals with appreciated company stock in their 401(k), or any other employer-‐retirement plan, as well as individuals in a higher tax bracket. page 1 of 3
HOW THE STRATEGY WORKS Once eligible to rollover or remove funds from a qualified retirement account (i.e. individual no longer works at the company, meets age requirements, etc.), an individual can rollover their entire 401(k), splitting ordinary funds from company stock so they can be processed separately. An individual would rollover ordinary funds into an IRA at no immediate tax consequence. The individual would then put their shares of company stock into a taxable account and immediately pay ordinary income tax at their current tax rate on the cost basis of the stock. Once the stock is sold, the individual would then pay capital gains tax on the appreciated value. Since capital gains tax is less than most income tax rates, the individual would realize a tax savings.
EXAMPLE:
INDIVIDUAL IN THE 28% FEDERAL TAX BRACKET
SELLING STOCK HELD IN 401(k) WITH A COST BASIS OF $100,000 AND CURRENT MARKET VALUE OF $200,000 WITH NUA STRATEGY
$100,000 x 28% = $28,000 $100,000 x 15% = $15,000
TOTAL TAX = $43,000 WITHOUT NUA STRATEGY
$200,000 x 28% = $56,000
TOTAL TAX = $56,000 TAX SAVINGS UTILIZING NUA STRATEGY = $13,000
For example, suppose over an individual’s tenure at a company they purchased 10,000 shares of company stock at an average price of $10 a share. Their total cost basis would be $100,000 (10,000 shares x $10). Now, let’s suppose the company stock has a market value of $200,000, or $20 per share, after removing the stock from the retirement plan. The appreciated value of the stock would be current market value ($200,000), less the cost basis ($100,000), equaling $100,000. Using the NUA strategy, the individual would pay ordinary income tax on $100,000, the cost basis of their 10,000 shares. Once that individual elects to sell the shares, he or she is assessed a 15% capital gains tax on the appreciated value of $100,000. Assuming the individual was in the 28% income tax bracket, upon moving the money from the retirement account, he or she would owe $28,000 in taxes on the $100,000 cost basis. Once that individual decides to sell the stock, they would then owe capital gains tax on the appreciated value of the stock, an additional $15,000. The NUA strategy would bring this individual’s federal income tax owed to $43,000. page 2 of 3
On the other hand, if that individual were to sell the stock and put the proceeds in their IRA, the entire $200,000 sale would be taxed at 28%, resulting in a $56,000 federal income tax bill. Use of the NUA strategy would thereby save the individual $13,000 in federal taxes. IMPACT ON BENEFICIARIES Making use of the NUA strategy can also benefit those who would inherit the individual’s taxable account upon their death. When the beneficiaries sell the stock they have inherited, they receive as step up in cost basis as of the date of death, effectively eliminating all capital gains tax on the appreciation from the original owners purchase price. However, if any additional appreciation occurs after the original owner’s death, beneficiaries would be responsible for the capital gains tax on those profits. NUA VS. ENTIRE ACCOUNT ROLLOVER TO AN IRA The NUA strategy might be beneficial to an individual if he or she meets any of the following criteria: 1. Realized significant market appreciation in company stock QOLity Financial is an independent financial services firm based in Utica, Michigan and is licensed to discuss and/or transact securities business with residents of the following states: Michigan, California, Connecticut, Florida, Illinois, Massachusetts, North Carolina, New Jersey, Oregon, New York, Ohio, Pennsylvania, Tennessee, Virginia, and Wisconsin. Securities and Advisory services offered through LPL Financial. A registered investment advisor. Member FINRA/SIPC.
2. Resides in a tax bracket of 25% or higher 3. Considering an immediate distribution 4. Planning to leave stock to their heir(s) An IRA Rollover might be beneficial to an individual is he or she meets any of the following criteria: 1. Wants to defer taxes as long as possible 2. Wishes to diversify holdings out of company stock IM POR TANT D ISC LOSURES
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Stock investing involves risk including loss of principal.
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