NUA: "Resetting" Cost Basis
The recent market ride has been nuts. It is certainly no fun for anyone who owns stock or stock funds. Many of us are experiencing the same sensation in our gut as when a roller coaster click, click, clicks to its apex and then plummets over the edge. (That’s why I don’t ride roller coasters anymore.) Wild swings in the market result in sleepless nights for many. But for those with a long-term view, there is a potential silver lining in this storm cloud.
Market dips can create positive opportunities with the net unrealized appreciation (NUA) tax strategy…but can also lead stock owners down the wrong path. When executed properly, the NUA strategy allows a person to pay ordinary income tax on the cost basis of company stock from his workplace retirement plan, and long-term capital gains on the appreciation. This could result in tens of thousands of dollars in tax savings. Forward-looking employees could view a dip in the price of the company stock in their 401(k) as an opportunity to “reset their basis.”
Example: Kyle, age 45, participates in the 401(k) offered by his employer, ABC Company. Within his 401(k) account, Kyle owns shares of ABC stock and has a current average cost basis of $40. When the market was at its peak, ABC stock reached $70 per share. However, with the recent downturn, ABC stock has slumped to $30 per share. Kyle sells all his ABC stock within his 401(k) and promptly buys back the shares at $30, thereby “resetting” his cost basis. (The “wash-sale rule” does not apply in this scenario.) If ABC stock rebounds over the next few years, Kyle has set himself up for a more favorable NUA distribution in the future.
Unfortunately, market volatility can also lead to panicked decisions. Others within ABC Company (from the example above) may not have been so level-headed as Kyle. The adage of “buy low, sell high” often gets reversed. A mistake would be to liquidate all 401(k) company stock shares while the markets are tumbling and to sit on the sidelines until conditions improve. But timing the market is impossible. Missing the rebound “bumps” on the way back up could significantly minimize returns (e.g., the Dow Jones spiked 2,963 points on April 9).
Additionally, selling out and buying back company stock at a higher share price could ruin what was previously a solid NUA opportunity.
Example: Nervous Nellie also works at ABC Company and has company stock in her 401(k). Nervous Nellie is a long-time employee with a cost basis of $20 per share. When the ABC stock price dipped to $30, Nellie could not take the volatility anymore. She dumped all her shares and stayed away until the news was more rosy. Ultimately, when ABC stock rebounded and settled in at $60 per share, Nervous Nellie reallocated her 401(k) and bought back into ABC. In her panic, Nervous Nellie reset her cost basis HIGHER, from $20 per share to $60. If an NUA transaction is in her future, Nellie’s actions will prove detrimental.
Before haphazardly panic-selling company stock, be sure to consult with a knowledgeable financial professional to assess your situation. Resetting NUA basis can go both ways.
By Andy Ives, CFP®, AIF®
IRA Analyst
Ed Slott and Company, LLC
Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.