If you have company owned stock, net unrealized appreciation (NUA) may be able to save you a lot of money on your tax bill. To illustrate, assume you have $500,000 in your 401(k) and $400,000 of it is placed in a variety of mutual funds and $100,000 is in your employer’s stock. Assume that $20,000 of the stock represents the contribution and $80,000 represents the appreciation. That $80,000 represents your NUA in the employer stock.
Assume you have separated from service and you decide to rollover your entire 401(k) balance to an IRA. The $500,000 balance will continue to grow tax deferred until you begin to make withdrawals. Those withdrawals will be taxed at ordinary income tax rates, presently as high as 39.6%. However, you may consider taking advantage of an NUA strategy in this type of circumstance where there is highly appreciated company stock involved.
Using an NUA strategy, you would pay ordinary income tax rates on the original $20,000 cost of your employer stock shares. The tax you would then pay on the NUA would be taxed at long-term capital gains rate – 15%.
In this example, assume your income tax rate is 35%. Instead of owing 35% or $35,000 on the total $100,000 of your company stock, the most you would be on the hook for is 35%, or $7,000, on the $20,000 original cost plus 15%, or $12,000 on the $80,000 of NUA, for a total tax tab of $19,000. That translates to a tax savings of $16,000 ($35,000 vs. $19,000)!
Of course, using an NUA strategy is not going to be appropriate for everyone. All relevant factors must be considered before making this decision to avoid any potential downsides. Consult your personal tax advisor to determine whether this option may be available and advantageous for you.