An employee who has highly appreciated employer stock in their employer sponsored retirement plan and has either recently changed jobs, or otherwise separated from employment (i.e. retired), may be able to take advantage of the NUA strategy.
Each share of employer stock is comprised of two components, its initial cost and its appreciation. When you continue to hold an appreciated stock, you have not realized the appreciation. Thus, the difference between the stock’s cost and its current value is its “net unrealized appreciation.”
The Income Tax Benefits of NUA Strategy:
If the appreciated employer stock that is held in your employer’s retirement plan is rolled over into an IRA, the current fair market value of the stock (or its proceeds) are taxed as ordinary income as they are withdrawn by you during your lifetime, or by your heirs in the event of your death.
The alternative to consider is taking an in-kind distribution of this appreciated employer stock directly from your employer’s retirement plan. This distribution will be immediately subject to ordinary income tax, but the amount taxed will be the cost of the shares, and not their current fair market value. Furthermore, if you elect to sell the shares in the future, the net unrealized appreciation is taxed at the reduced long-term capital gain rate of 15%.
For example, if you have $100,000.00 in employer stock with a cost of $10,000.00, you could roll that stock into an IRA and when you withdraw the $100,000.00 you would end up paying about $30,000.00 in ordinary income taxes. On the other hand, if you took an in-kind distribution of stock you would pay $3,000.00 in ordinary income taxes since you would only be paying income taxes on the cost. You could then sell the stock at a later date and pay capital gains taxes of $13,500.00 (15% on the $90,000.00 of net unrealized appreciation). In the second scenario you paid $16,500.00 in taxes, as opposed to $30,000.00 under the traditional IRA rollover approach.
The Estate Planning Benefits of NUA Strategy:
By taking an in-kind distribution of your employer’s appreciated stock you will have greater flexibility in your estate planning. First, using an IRA to fund charitable gifts or to establish trust funds for young or irresponsible heirs can be complicated and have negative income tax consequences, such as accelerated IRA distributions and the payment of high trust income tax rates.
Alternatively, by taking an in-kind distribution of employer stock that is held in either your individual name or titled to your Trust, this stock is easily managed and distributed to your charities or held in trust for your heirs without any negative income tax consequences.
During your lifetime the tax on the NUA portion of the stock is deferred until you sell the stock. In the event of your death, your heirs are responsible for capital gain tax on the NUA that occurred while the stock was in your employer’s retirement plan, but any further appreciation that occurred during your lifetime will receive a steeped-up cost basis and can pass to your beneficiaries free of income or capital gains taxes.
Important Things to Consider:
- The in-kind distribution of employer stock must come directly from employer’s retirement plan. If your plan is rolled over into an IRA the NUA strategy is no longer available.
- You must have the ability to pay the current income taxes due on the in-kind distribution.
- Verify you qualify to avoid the 10% early distribution penalty on the in-kind distribution.
- Make certain you talk to your tax and financial advisor, as well as your attorney, before making any final decisions.
Paul Kellogg is a lawyer with Phillips Law Firm, Inc., whose practice focuses on estate planning, probate and representing entrepreneurs and business owners. He can be reached at (513) 985-2500 or via email at PJK@PhillipsLawFirm.com.