If you have highly appreciated company owned stock, using a net unrealized appreciation (NUA) strategy may be able to save you money on your tax bill.
Assume you have $500,000 in your 401(k). Assume that $400,000 of it is in mutual funds and $100,000 represents your employer’s stock. Also assume that $20,000 of the stock represents the contribution portion and $80,000 represents the appreciation. Under this scenario, your NUA in the employer’s stock is $80,000.
Now assume you have separated from service and you want to rollover your entire 401(k) balance to an IRA. Before doing that, you may want to consider taking advantage of an NUA strategy. Why? Because you have highly appreciated company stock! Under an NUA strategy, you would pay ordinary income tax on the original $20,000 cost of your employer stock shares. However, you would only pay a long-term capital gains rate (15%) on the NUA.
To simply illustrate this example using the numbers above, let’s say 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 cost basis plus 15%, or $12,000, on the $80,000 of NUA.
This would be a total tax bill of $19,000 ($7,000 + $12,000). This translates to a tax savings of $16,000 – without an NUA strategy you would be paying $35,000 instead of $19,000.
Keep in mind that an NUA strategy is not going to be appropriate for everyone. If you are considering an NUA strategy, be sure to first consult your personal advisor, CPA, EA or other tax professional to discuss potential advantages and disadvantages.