Company Stock and NUA: An Opportunity to Reduce Your Taxes

If you have highly appreciated company stock in your 401(k) plan, you may be able to reduce the eventual taxes on that stock by moving it to a taxable account rather than an IRA when you retire or change employers.

YOU MAY SAVE A BUNDLE IN TAXES

If you transfer your hares of appreciated company stock to a taxable investment account instead of an IRA. When the stock is transferred to a taxable account, its cost basis (the price originally paid for the stock0 will be taxed as ordinary income, but the increase in the stock’s value (known as its net unrealized appreciation, or NUA) will not be taxed until you sell the stock, And when it is sold, the NUA will be taxed as a long-term capital gain rather than ordinary income.

If you transfer company stock to a traditional IRA instead, you will not owe tax on it immediately, but the money you eventually withdraw from the IRA will be taxed as ordinary income, at a rate that may be significantly higher than the rate you’d pay on long-term capital gains.

The NUA strategy can only be used with employer securities held in a qualified retirement plan, such as a 401(k) plan, that allows the actual securities to be transferred. If you decided to use the strategy, your entire balance must be distributed in a single year, but not necessarily to the same account. You can transfer all or part of your company stock to a taxable account and the rest of your 401(k) account to an IRA so that it maintains its tax deferral.

Whether or not to use the NUA strategy is a complex decision.

HYPOTHETICAL EXAMPLE

Let’s say Jessica has company stock in her 401(k) account that she purchased for $10,000 and that is now valued at $100,000, making the NUA $90,000-. Let’s also say that Jessica is age 64, retired, in the 25% federal income tax bracket, eligible for the 15% long-term capital gains tax rate, and wondering what to do with her company stock.

IF THE COMPANY STOCK IS TRANSFERRED DIRECTLY TO A TRADITIONAL IRA

Current federal tax: $0. There is no tax on the transfer of the company stock ($100,000) to a traditional IRA.

Future federal tax: $25,000. Cash ($100,000) is taxed as ordinary income (25%) when it is withdrawn from a traditional IRA.

Total federal tax: $25,000

IF THE COMPANY STOCK IS TRANSFERRED DIRECTLY TO A TAXABLE ACCOUNT

Current federal tax: $2,500. The stock’s cost basis ($10,000) is taxed as ordinary income (25%) when the stock is transferred to the taxable account.

Future federal tax: $13,500. The NUA ($90,000) is taxed as a long-term capital gain (15%) when the stock is sold.
Total federal tax $16,000

This is a highly simplified example for illustrative purposes only. It assumes that the value of the company stock does not take into account any state or local taxes.

Copper Leaf Financial is a fee-only, fiduciary financial advisor firm with offices in the Burlington and Rutland Vermont marketplaces. We develop a customized wealth management plan designed to integrate every aspect of your financial life. This is "true wealth management" - a holistic, all-encompassing approach that goes beyond just investment advice. Call our office at 802.878.3731 to set up a time to meet and discuss your specific situation.