The unrecognized gain in value (NUA) is the increase in the value of an employee retirement plan at the time you transfer a large amount to a taxable account. The value difference is calculated at long-term capital gains rates instead of ordinary income.
Definitions and Examples of NUA
NUA is the difference between the cost of employer stock and its fair market value when you take a distribution. This difference is taxed at capital gains rates, which are lower than the tax rates applicable to ordinary income.
How Unrecognized Gain in Value Works
When you leave a job where you have a retirement account, you can either roll over the assets to an IRA or distribute the stock into a taxable account. With the first option, any distributions you make later on the assets will be taxed at your ordinary income tax rate. These options may not be available, depending on whether there are specific accounts that match your employee account. This is why many 401(k) plans sell the assets in your account and send a check or direct cash transfer to the specific IRA you choose when rolling over funds.
Requirements for Unrecognized Gain in Value
To qualify for the preferred tax treatment of the NUA strategy, you must do the following:
- You must own employer securities in a qualified employer-sponsored retirement plan. This includes company stock in a profit-sharing plan, stock bonus plan, or retirement plan contributed or purchased by the employer with pre-tax dollars.
- You must receive a lump-sum distribution from the retirement account as a result of leaving your job or reaching age 59 and 1/2. A lump sum distribution is a one-time distribution in one year of the full balance from all eligible retirement accounts of a certain type. Profit-sharing plans are one type of these plans.
- You must receive a direct contribution of stock from the plan. In other words, do not roll over the stock into an IRA first and then liquidate it. Transfer it directly to a taxable account.
What This Means for Individual Investors
Deciding whether the NUA strategy is the right choice for you involves considering a number of factors.
- Your age: The younger you are, the more time there is for the assets you roll over to an IRA to grow tax-deferred. If you have many years before retirement, there is less benefit in executing the NUA tax treatment, as years of growth may outpace the long-term capital gains tax rates. The shorter the time frame, the more beneficial the NUA tax treatment will be.
- The types of retirement accounts you have: If the majority of your funds are in tax-exempt accounts, receiving stock distributions with NUA treatment may provide you an opportunity to develop a balance between pre-tax and post-tax assets in retirement. This could lead to additional tax savings when required minimum distributions (RMDs) begin. By lowering the amount of money in qualified retirement accounts, you will reduce your RMD requirements.
- The amount of NUA: If the cost basis is low and the current value of the company is high, the NUA will be substantial. This makes a larger portion of distributions eligible for long-term capital gains tax rates.
- Your current and future tax rates: If the ordinary income tax rate when you intend to take distributions from retirement accounts is expected to be much higher than long-term capital gains tax rates, the NUA strategy may be the best option.
- Risk
Your own: A single stock in a brokerage account is a riskier investment than a diversified portfolio. If one company’s stock represents a large portion of your financial assets, and you intend to hold it for a long time after distributing it from the plan, you should consider the investment risk.
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Sources:
Internal Revenue Service. “Publication 575 (2020), Pension and Annuity Income.”
Internal Revenue Service. “Topic No. 409 Capital Gains and Losses.”
Internal Revenue Service. “Net Unrealized Appreciation in Employer Securities.”
Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.”
Source: https://www.thebalancemoney.com/when-does-using-net-unrealized-appreciation-make-sense-2388276
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