Retirement Plan Solutions & Opportunities: Company Stocks

For many people, 2020 has meant leaving a job. Perhaps that job has disappeared or perhaps you are taking early retirement. This may mean you are receiving distributions from your employer retirement plan. For many people, a rollover to an IRA will be a smart decision. However, don’t assume that it 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 better path. How can paying taxes ever be a smart choice?! I hear you. Give me a chance to explain. There is a tax break called Net Unrealized Appreciation (NUA) that may make a lump sum distribution a reasonable choice in 2020.

Is Net Unrealized Appreciation for you?

Ask yourself two questions. First, “Do I own my employer’s stock in my 401(k)?” Second, “Is it highly appreciated?” To determine if the stock is “highly appreciated,” you will want to look at what the cost was when the shares were purchased vs. what the value is today. If it’s greater today, it has appreciated. Determining whether something is “highly appreciated” is definitely subjective, but this is a good starting point. If the answer to both questions is “yes,” you may be a good candidate for the tax break.

How does NUA work?

You withdraw the stock from the company plan, place the stock into a taxable account (no selling yet) and pay regular income tax on it, but only on the original cost to the plan and not on the current market value on the date of the distribution. The NUA is the increase in the value of the employer stock from the time it was acquired in the plan to the date of its distribution to you. You can defer the tax on the NUA until you sell the stock. When you do sell, you will only pay tax at your current long term capital gains rate, not ordinary income tax rates.

You need a triggering event

To qualify for the NUA tax break, the distribution must occur after a triggering event. Triggering events include: death; reaching age 59½; separation from service (this does not apply to the self-employed); or disability (this only applies to the self-employed).

You must take a lump sum

The distribution must also be a lump-sum distribution. This means you must empty the entire account in one tax year. You must be sure there is enough time to complete the transaction. If you are considering this for 2020, note that there are only a few months left: if the account is not distributed by the end of the year, you cannot use NUA.

It is also important to remember that if you roll over the highly appreciated stock to an IRA, you will lose the NUA tax break.

Plan wisely

NUA may sound like a great strategy, but it is not for everyone. Generally, NUA can be a better strategy than a rollover if you are in a high tax bracket with a large portion of your retirement assets in highly appreciated company stock. You must be willing and able to pay an immediate tax bill on the cost basis of your stock.

There are many factors to consider and many pitfalls to avoid with an NUA. Most importantly, you will want to work closely with your CPA or tax advisor to determine if this planning opportunity makes sense for you.

Let's talk about your retirement!