Net Unrealized Appreciation (NUA) – Worth It?
Happy New Year to you and your families! That is, if it is still appropriate to wish people a Happy New Year this far into January. I always enjoy the debate around how far into the year you can still say that. I tend to land on through the end of January. I think Seinfeld agrees with that sentiment! 😊
As we enter the new year and are doing our best to stick with resolutions (see Kira’s most recent post!), maybe one of yours was to finally consolidate all of those old company retirement plans that you have left behind at previous jobs into one IRA. Generally, this can be a good idea, because it can help you better manage the investments and distributions, usually gain access to a wider array of investments, and get centralized reporting of performance and activity among many other benefits. I will also add a note here to make sure your beneficiaries are up to date regardless of whether or not you consolidate plans. We have seen situations where ex-spouses were left on old accounts unintentionally, and needless to say, that can result in a less than desirable outcome at your passing.
However, there are some things to weigh when considering a rollover to an IRA. There are a few benefits to leaving money in a company plan, but the focus of this post is whether or not to utilize the Net Unrealized Appreciation strategy. If you have a significant amount of company stock in your 401(k), you may want to look into electing this option with your first distribution. The shortest explanation of the benefits is that it could save you some tax dollars.
Please see the decision tree below should you be facing this issue:
If you do elect NUA, you will be taxed on just the cost basis of the stock (the amount you paid for it, or the cost when you received it) and it will be reported as ordinary income at the time of the distribution. So, timing will be important here. Ideally, you have stopped working, so your income tax rate will be lower, and you can better handle the additional income tax. If you do not elect the NUA option, the entire amount of the company stock will be taxed as ordinary income at the time of distribution.
The strategy here is to have the appreciation of the stock be taxed as long-term capital gains (a more favorable rate) when you do eventually sell the stock. The logistics are that you instruct the plan to move the company stock out of your plan into a brokerage account where it can be held until it is sold. Usually there are other investments in the plan that can be rolled into an IRA.
Note that this is not always advisable even if you have appreciated stock. It might mean that you are forced to hold a large portion of your funds in one stock, which may prevent you from achieving a properly diversified portfolio. And, of course, the stock price could always go down, in which case the strategy would not have been worth it. Most plan administrators will at least make you aware of the option when you attempt to initiate the rollover, but do keep this in mind when consolidating our plans.
Here at Meridian, we try to help our clients find ways to avoid the tax bite, especially when it comes to retirement plan distributions. Most are willing to pay their fair share, but no one wants to pay more than they are required to. Unfortunately, the fish we caught on a fishing trip last year definitely did not avoid the bite of a shark that took his share while we had it hooked on the line!
Once again, Happy New Year (?) to you and yours!