Why NUA is the Tax Break You Don’t Want to Miss

By Sarah Brenner, IRA Analyst
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When you leave an employer, you may assume that the right move is to roll over your retirement funds to an IRA. Not so fast! For many people, a rollover will be a smart decision. However, don’t assume that is always the way to go. In some cases, as strange as it may sound, taking a lump sum distribution and paying taxes is a smart choice. You may be wondering how that could be possible. A tax break called Net Unrealized Appreciation (NUA) may make taking that distribution a good choice.

Are You a Candidate?
Can you benefit from NUA? Ask yourself two questions. The first question is, “Do I have company stock in my 401(k)?” and the second question is, “Is it highly appreciated?” To determine if the stock is highly appreciated look at what the cost was when the shares were put in the plan and what today’s value is of those shares. If the answer to both question is “yes,” you may be a good candidate for the NUA tax break.

How the NUA Tax Break Works
You withdraw the stock from the company plan and pay regular income tax on it, but only on the original cost to the plan and not on the market value, i.e., what the shares are worth on the date of the distribution. In addition, if you are under age 55 at the time of separation of service, you would generally owe a 10% penalty on the cost basis of shares distributed.

The difference (the appreciation) is the NUA. NUA is the increase in the value of the employer stock from the time it was acquired by a plan to the date of the distribution to you. You can elect to defer the tax on the NUA until you sell the stock. When you do sell, you will only pay tax at your current capital gains rate.

To qualify for the NUA tax break, the distribution must be a lump sum distribution. This means you must empty the entire account in one tax year. The distribution must also occur after a triggering event. Triggering events may include: death; reaching age 59 ½; separation from service (not for self-employed); or, disability (only for self-employed).

If you roll over the highly appreciated stock to an IRA, you will lose the NUA tax break. Any distribution from your IRA will be taxed as ordinary income.

Our team of experts breaks down this strategy in more detail and outlines 10 NUA mistakes financial advisors can’t afford to make in this month’s IRA Focus (which was posted on June 27, 2016). You can sign up for IRA Focus today – and get the first month free!