February 2016
Looking to Lower Your Tax Bill?
Consider NUA
Andrew Salak
Associate Director
It’s no secret that the financial world we live in is complex. Markets are changing constantly, and it is crucial
to stay on top of market trends, concepts and strategies. It’s also as important as ever for investors to be
aware of certain rules, regulations and special provisions that could help or hinder their ability to achieve
their financial goals.
One important factor to be familiar with is a special tax code provision that applies to company stock held
within an employer sponsored retirement plan. Many individuals own shares of their company’s stock within
their retirement plan; however, not many are aware of net unrealized appreciation, or NUA. NUA is defined
as “the difference in value between the average cost basis of shares and the
current market value of the shares held in a tax-deferred account.”1 NUA
“Choosing the
deals specifically with company stock held within an employer’s qualified
right option
plan. The strategy of how to distribute the shares of company stock becomes
can result in
increasingly important if an individual holds highly appreciated shares. In
thousands, if not
some cases, choosing the right option can result in thousands, if not tens of
thousands, of dollars in tax savings. This is because instead of being taxed at
tens of thousands,
ordinary income tax rates, distributions that fall under the category of NUA
of dollars in tax
allow for favorable long-term capital gains tax rates (provided the stock is
savings.”
held for longer than one year).
To qualify for NUA, an individual must have a “triggering event.” Such events include separating from service
from an employer, being over age 59 ½, disability, or death. In order to qualify for NUA, all shares of
employer stock must have been purchased with pre-tax contributions. Additionally, the shares must be
transferred in-kind, via lump sum, in the same tax year, into a taxable brokerage account. Regarding the
transfer strategy, an expert clarifies:
By doing so, the employee only reports the cost basis of the securities (from inside the plan) in
income for tax purposes, with the remaining “unrealized appreciation” deferred until the stock is
sold… and when the stock is sold, all of that unrealized appreciation that built up inside the plan
is eligible for long-term capital gains treatment. By contrast, if the funds had remained inside the
account, the growth would have (someday, upon withdrawal) been subject to ordinary income
treatment.2
This is, in a nutshell, the concept of NUA.
Strategic thinking. Customized solutions.
Using an example to illustrate the potential benefits, let’s consider an individual with $400,000 of employer
stock in his or her 401(k), with a cost basis of $100,000. If the stock is sold within the plan, and the cash proceeds
are rolled out of the 401(k) into an IRA, there is no immediate taxable implication. However, when distributed
from the IRA, the funds would be taxed as ordinary income. Conversely, if the individual chooses to transfer the
stock using NUA tax rules to a taxable account, the $100,000 basis is taxed that year as ordinary income, but the
$300,000 NUA is taxed at a preferential long-term capital gains tax rate later, when it is actually sold. This, again,
assumes that the stock is held for longer than one year. In this example, let’s assume the individual’s ordinary
income tax rate is 25%, and the long-term capital gains rate is 15%. If the individual does not employ the NUA
strategy, the transaction would result in $100,000 of taxes (25% of $400,000), whereas using the NUA strategy
would result in $70,000 of taxes (25% of $100,000 + 15% of $300,000). Employing the NUA strategy results in tax
savings of $30,000. I don’t think anyone would be opposed to that!
Of course, there are scenarios where the outcome would not be as favorable. One question to consider is: What
is the difference between the cost basis of the stock and the current market value? The more highly appreciated
the stock is against the cost basis, the better the case for using NUA. If cost basis and market value of the stock
are the same, or, if the cost basis is actually higher than market value, then NUA would not be advantageous to
the investor. Running the numbers ahead of time is key.
Clearly, there are many factors to take into account when evaluating if NUA is the right strategy to use. By doing
the calculations ahead of time, investors may find that they can significantly lower their taxes in retirement.
Now, if we could only find the fountain of youth, then avoiding both death and taxes may just be possible!
Sources:
1.
“Net Unrealized Appreciation.” Investopedia.com. Web. 12 Jan. 2016
2.
Kitces, Michael. “Repeal The Exclusion For Net Unrealized Appreciation (NUA).” 18 Feb. 2015. Kitces.com. Web. 12 Jan. 2016
Strategic thinking. Customized solutions.
Fiduciary Investment Advisors, LLC (“FIA”)
FIA is an independent institutional consulting group with over 20 years of investment consulting experience.
FIA is an employee owned firm with 100% of the firm’s revenue derived from fees clients pay for investment
advice. Our mission is to provide customized investment consulting services to assist our clients in achieving
their investment and financial objectives, while fulfilling their fiduciary obligations. Our clients include corporate
retirement plans, endowments & foundations, public plans and private clients. Our consulting services include:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Investment Policy Statement Review/Creation;
Retirement Service Provider Search (RFI/RFP);
Plan Benchmarking;
Investment Menu Analysis and Design;
Total Plan Fee Analysis (full fee disclosure);
Fiduciary Governance Consulting;
Investment Fund Performance Measurement, Analysis and Reporting;
Risk-Based Model Portfolio Construction;
Employee Communication and Education;
Asset Allocation Analysis;
Investment Manager Searches;
Liability Driven Investment (“LDI”) Strategies for Pension Plans;
Quarterly In-Person Meetings with Finance/Investment Committees;
Strategic Guidance on Relevant Topics of Interest;
For More Information Please Contact:
Andrew Salak
Associate Director
Fiduciary Investment Advisors, LLC
100 Northfield Drive
Windsor, CT 06095
Direct: (860) 697-7425
Email: [email protected]
Please remember that past performance may not be indicative of future results. Different types of investments involve varying
degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product
(including the investments and/or investment strategies recommended or undertaken by Fiduciary Investment Advisors, LLC), or any
non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding
indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors,
including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a
substitute for, personalized investment advice from Fiduciary Investment Advisors, LLC. To the extent that a reader has any questions
regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with
the professional advisor of his/her choosing. Fiduciary Investment Advisors, LLC is neither a law firm nor a certified public accounting
firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Fiduciary Investment
Advisors, LLC’s current written disclosure statement discussing our advisory services and fees is available for review upon request.
Strategic thinking. Customized solutions.