Do you have company stock in your 401(k)?
Are you no longer working for that employer?
Are you 59 ½ or older?
Would you like to potentially pay less in taxes?
And do you want to enjoy as much of that ice cream cone as you can?
Okay, the last one was just to see if you are with me.
If you answered YES, then read on → You may be eligible to take advantage of a tax deferral strategy called Net Unrealized Appreciation (NUA).
What is Net Unrealized Appreciation (NUA)?
Normally, any distribution from a qualified plan is taxed at ordinary income tax rates, but NUA allows you to distribute employer’s stock to a taxable account and pay ordinary income tax on your cost basis only. The “net unrealized appreciation” portion of the distribution (the difference between the fair market value of the stock at the time of distribution and the cost basis) is tax deferred until the shares are sold. And when sold the NUA portion will be taxed at long-term capital gains rates, which are typically much lower than ordinary income tax rates. The remaining portion of the 401(k) is rolled to an IRA and retains its tax deferred status.
Here is an Example:
We recently helped a client, who had $4.2M in their Microsoft 401(k), learn about NUA. In this case, $1.7M of that balance was in Microsoft stock. But the really impressive thing is that the basis (what they paid for that stock over the many years of employment) was only $150k. So, the Net Unrealized Appreciation on the stock was $1.55M. Through our work, we helped to educate this client on their options in regard to this 401(k). They could have kept it with the employer plan, they could roll to an IRA, or they could initiate the NUA strategy. Ultimately the client chose to take advantage of the tax benefits of the NUA strategy, and they rolled over their 401(k) and distributed the large portion of Microsoft stock to be held in their brokerage account.
Due to the low cost basis of the stock along with the client’s low income tax bracket, distributing the stock out from the 401(k) resulted in only ~$40k in income tax. Going forward, any sales of the Microsoft stock will have long-term capital gains treatment as opposed to ordinary income. And furthermore, the Required Minimum Distribution (RMD) that would be applied at age 72 will be dramatically less because the large stock portion is not held in the new IRA. The lower RMD amount equates to lower taxes when the client starts to take their RMD. And given this client’s other investable assets, they certainly would not have needed the higher RMD amount for their lifestyle. The lower RMD and resulting lower income tax will be meaningful to them and will outweigh the initial tax paid on the distribution.
And for yet another benefit of this advanced planning strategy, this client can now consider gifting some of their large concentration of this highly appreciated stock to charity or family. They could not have done this if the stock was maintained in the 410(k). And by gifting a portion of the stock, they not only reduce some risk of a high concentration, but they also avoid capital gains taxes had they sold the stock.
This may be confusing, and hard to fully describe in this format. But if you have company stock in your 401(k), are no longer employed at that employer, and ideally over 59 ½, and like ideas that can save you on taxes, then please reach out to us at