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) – $400,000 of it is in mutual funds and $100,000 represents your employer’s stock. $20,000 of the stock represents the contribution and $80,000 represents the appreciation so $80,000 is your NUA in the employer stock in this example.
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 because highly appreciated company stock is involved. Under an NUA strategy, you would pay ordinary income tax on the original $20,000 cost of your employer stock shares and you would pay a long-term capital gains rate (15%) on the NUA.
To simply illustrate 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 cost basis plus 15%, or $12,000 on the $80,000 of NUA. This is a total tax bill of $19,000, which 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. If you are considering an NUA strategy, be sure to first consult your personal tax professional to discuss potential advantages and disadvantages.