NUAs, or net unrealized appreciation, is a special tax strategy available for those with company stock in a 401(k) plan.
The strategy uses a lesser known tax rule that under certain circumstances allows for company stock in an employer retirement plan to be taxed differently than other investments, such as mutual funds, in the account.
Typically, when money is withdrawn from a 401(k), or an IRA after a 401(k) has been rolled over, it is taxed at income tax rates. But the special NUA rule allows for shares of company stock within a 401(k) to be taxed differently.
Instead of the entire value of the stock holding being taxed as income, an employee may elect to transfer the company shares from their 401(k) into a taxable brokerage account, and only pay income tax on the cost basis, or what they paid for the stock originally, and not the appreciated value.
Then, when the shares are sold at a later date, the appreciation of the shares is taxed at long term capital gains rates, which are lower than income tax rates.
For example, lets say your employer paid a $10,000 profit sharing bonus to you by giving you $10,000 in company stock 10 years ago. Fast forward to today, and let’s say that company stock is now worth $50,000.
If you are in the 22% tax bracket and rolled this $50,000 into your IRA, you would be subject to $11,000 in taxes at the time you withdrawal the investment.
Instead, you may be able to take advantage of the NUA rule and transfer the shares to a brokerage account. This would require you to pay income tax on only the $10,000 initial value, or cost basis of the shares, and long term capital gains tax rates on the remaining $40,000 in appreciation. Depending on your income, this strategy could save you between $2,800 and $7,800 in taxes during your retirement.
Determining whether the strategy makes sense for you requires an analysis of your tax liability through retirement. And executing the strategy can be complex and take coordination between you, your retirement plan, and another custodian. The strategy can be complex, but we find that for those with highly appreciated company stock in their 401(k), it can significantly reduce your tax bill later in retirement.