Company Stock in Your 401(k)? Consider Net Unrealized Appreciation.

June 1, 2024

If you are currently holding company stock in your pre-tax retirement account, you may want to consider a tax planning strategy called Net Unrealized Appreciation (NUA). The NUA strategy primarily aims to reduce your overall tax burden when distributing employer stock from a retirement account, such as a 401(k) or ESOP. Here are some of the key features of the NUA strategy:

• Distribution: When you retire or leave a company (known as a “triggering event”), you generally have the option to roll over your pre-tax 401(k) into a Traditional IRA (tax-free rollover) or take a lump-sum distribution (taxed as ordinary income). If you choose the latter, you can transfer the stock directly to a taxable brokerage account. The NUA strategy combines these options by allowing you to take a lump-sum distribution ONLY on your employer stock via an in-kind transfer to a taxable account, and then rolling over the remainder of your 401(k) into an IRA.
• Tax Treatment: The NUA strategy involves paying ordinary income tax on the cost basis of the stock (the price at which it was purchased within the retirement account), not on the entire distribution amount. The appreciation of the stock (difference between your cost basis and the fair market value), also known as the unrealized appreciation, is then taxed at the long-term capital gains rate when you sell the stock. Note that if you continue to hold the stock, any additional gain or loss may be short or long-term depending on how long you hold it post-distribution.
• Qualifications: There are certain requirements for utilizing the NUA strategy, such as distributing the entire vested balance of your 401(k) in one tax year, distributing all the employer’s qualified plans of the same kind (even if only one holds company stock), transferring the employer stock in-kind, and incurring a qualifying event such as separating from service, becoming disabled, or obtaining age 59 1/2. There are strict rules enforced by the IRS regarding the criteria to qualify for the NUA election, so it is best to consult with your tax professional before implementing this strategy, or your entire company stock distribution could become subject to ordinary income taxes.
• Considerations: While the NUA strategy can potentially result in tax savings, it’s important to consider your individual financial situation, including your current and future projected tax brackets, investment goals, and overall portfolio diversification before deciding to implement it. There are certain situations in which an NUA strategy may not be favorable (i.e. the cost basis of your employer stock is high relative to its fair market value, your projected tax rate in the future is lower than it is today, you will lose out on the tax-deferral of keeping it in your 401(k) and the  ability to rebalance tax-free, etc.), which is why your long-term outlook must be carefully evaluated.

As always, be sure to consult with your financial advisor and tax professional to ensure the NUA strategy aligns with your specific circumstances and goals.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.

Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.