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What is net unrealized appreciation on company stock in a 401(k)?
Net unrealized appreciation, or NUA, is the growth on your employer's stock while it sat in your 401(k). Take that stock out as shares in a qualifying lump sum distribution and you pay ordinary income tax only on what the shares cost the plan. The growth is taxed later, at long term capital gains rates, when you sell. Roll the stock into an IRA and that treatment is gone for good.
The tax break is on the growth, not on the whole account.
Every dollar that comes out of a 401(k) or an IRA is normally taxed as ordinary income. It does not matter whether it started as a contribution or as twenty years of growth. All of it lands on your return at your regular rate.
Employer stock held inside the plan can be the exception. The plan keeps a record of what it paid for those shares, called the cost basis. The difference between that cost and what the shares are worth today is the net unrealized appreciation.
If the shares leave the plan as shares, under the right conditions, the tax splits in two. The cost basis is ordinary income in the year the shares come out. The appreciation is not taxed until you sell, and then it is taxed as a long term capital gain, no matter how long you hold the shares after they leave the plan.
A simple example shows where the money is.
Say you hold 200,000 dollars of your employer's stock in the plan, and the plan's cost basis is 30,000. This is arithmetic for illustration, not a projection.
Take the shares out to a regular brokerage account and 30,000 is ordinary income this year. The other 170,000 waits until you sell. Federal long term capital gains rates top out at 20 percent, while ordinary income rates go up to 37 percent.
Roll the same shares into an IRA and all 200,000 becomes ordinary income whenever you withdraw it. For someone in the 24 percent bracket who would pay 15 percent on the gain, that 9 point gap on 170,000 is about 15,300 dollars of federal tax.
If you are under 59 and a half, the 10 percent early withdrawal penalty can apply to the 30,000 of basis unless an exception fits, such as leaving that employer in or after the year you turned 55. It does not apply to the appreciation.
The rules are strict, and one wrong move can end it.
NUA treatment generally needs a lump sum distribution. That means the entire balance of all that employer's plans of the same type leaves within one calendar year. It also has to follow a triggering event: separating from service, reaching 59 and a half, disability, or death.
The stock has to come out as shares, moved in kind to a taxable account. Sell it inside the plan and take cash and the break is gone. Everything else in the account can go to an IRA in the same year.
Timing is where people trip. Taking a partial distribution after a triggering event, then finishing the job in a later year, can spoil that event. A later one, such as turning 59 and a half, may open the door again.
So get the cost basis from the plan in writing before anything moves. Every number in the decision runs off it.
In California, the break is smaller than most articles say.
California taxes capital gains as ordinary income. The state part of the advantage mostly disappears, and what is left is the federal difference.
You also pay tax on the basis now instead of later. When the basis is a large share of the stock's value, the savings shrink, and they can flip into a cost. NUA works best when the shares cost very little compared to what they are worth.
Then there is the stock itself. Keeping a big piece of your net worth in the company that also writes your paycheck is a bet on one business. A tax break is a poor reason to hold more than you otherwise would.
Heirs get a different deal too. NUA shares do not get a step up in basis on the appreciation at death, so whoever inherits them still owes capital gains tax on it when they sell.
Rolling everything into one IRA is the easy sale, and it is how this gets lost.
The standard pitch is to roll the whole account into one IRA. It is one statement, and it puts every dollar where it can be charged a fee or placed in a product. Once the employer stock lands in that IRA, the NUA treatment is gone permanently.
We have the same kind of incentive, so here it is out loud. opfinances.com is a licensed insurance agency. We are not a financial advisor and not a fiduciary, and we are paid a commission by the insurance company when somebody buys a product through us. This is general education, not tax, investment or legal advice.
NUA belongs with a CPA, and the stock decision comes first. If it is in play, settle what happens to the shares before anyone talks to you about where the rest of the money goes.
Before you decide
Questions worth asking.
What is the plan's cost basis for my employer stock, and can I get that figure in writing?
Have I taken any distribution from this plan since I left the job or turned 59 and a half?
If I roll the whole account into an IRA, how many dollars of tax treatment am I giving up on the stock?
How are you paid if I roll everything over, and how are you paid if the stock goes to a brokerage account instead?
How much of my net worth would sit in one company's stock if I keep these shares?
What does the comparison look like after California tax, not just federal?
Related
Is NUA worth it?
It depends mostly on how low the cost basis is compared to the stock's current value. A low basis and a large gain can save real federal tax. A high basis can make it a wash or a loss, because you pay ordinary income tax on the basis right away. In California the state tax advantage mostly disappears. Run the numbers with a CPA.
Do I have to sell the stock right away to get NUA treatment?
No. The appreciation that built up inside the plan is taxed as a long term capital gain whenever you sell, even the next day. Any growth after the shares leave the plan is a separate gain, and it is long term only if you hold the shares more than a year after the distribution.
Can I roll the rest of my 401(k) into an IRA and still use NUA?
Generally yes. The employer stock moves in kind to a taxable brokerage account, and the rest of the balance can go to an IRA as a direct rollover in the same calendar year. Both pieces have to leave the plan within that year for the lump sum rule.
Do I pay the 10 percent penalty on NUA?
The penalty can apply to the cost basis, which is the taxable part of the distribution, if you are under 59 and a half and no exception fits. Leaving that employer in or after the year you turned 55 is one exception. The appreciation itself is not hit by the penalty.
What happens to NUA stock when I die?
The appreciation from inside the plan does not get a step up in basis. Your heirs owe long term capital gains tax on it when they sell. Growth after the shares left the plan is treated differently and generally does get a step up.
Where this fits.
This question sits inside a bigger one. 401(k) Rollover walks through the whole decision rather than this one piece of it.
On Point Finances is a licensed insurance agency, not a tax, legal, or investment adviser. This page is general education, not a recommendation, and reading it does not create a client relationship.