Nuances of NUA
Navigating the Nuances of NUA Strategies
Net Unrealized Appreciation (NUA) can provide a tax-efficient way to handle company stock held in a retirement plan. When executed correctly after a lump sum distribution, this strategy allows qualified individuals to pay long-term capital gains tax on the growth of their company stock, rather than higher ordinary income tax rates. While the core concept is widely known, several lesser-known rules can significantly affect the final tax outcome.
Step-Up in Basis Applies Only to Post-Distribution Growth
When company stock is distributed from a retirement plan through an NUA-eligible transaction, the appreciation that occurred while inside the plan is labeled as NUA. This amount never receives a step-up in basis at death. If the original account holder still owns the stock upon passing, their beneficiary must pay long-term capital gains tax on that original appreciation, regardless of when the shares are sold.
However, any value the stock gains after being distributed from the plan does qualify for a step-up in basis at death. This distinction can make a significant difference in the tax burden for heirs. For example, if a participant named John executed a proper NUA strategy a decade ago, he paid ordinary income tax on the original $100,000 cost basis. The $400,000 in NUA would become subject to capital gains tax upon sale. If the stock appreciated to $750,000 by the time of John’s death, his beneficiary would owe capital gains tax on the $400,000 of NUA but benefit from a full step-up on the $250,000 of post-distribution gains. The $100,000 cost basis is also tax-free, making the outcome far more favorable for heirs.
Using the Specific Identification Method to Lower Taxes
Many retirement plans calculate NUA using an average cost-per-share method. Over time, employees purchase company stock at varying prices through payroll deductions. Instead of tracking each purchase individually, the plan may use total contributions divided by total shares to determine the average cost basis. For instance, if a plan participant has $1,000,000 worth of company stock acquired for $400,000, the resulting $600,000 would count as NUA.
This approach may not always deliver the best tax result. Plan participants who have maintained detailed purchase records can use the “specific identification method.” This strategy allows them to isolate and use only the shares acquired at the lowest cost basis. High-basis shares could be excluded from the NUA strategy and instead rolled into an IRA. This targeted method can increase the portion of gains taxed at long-term capital gains rates, reducing the overall tax liability.
Roth Conversions Can Trigger the NUA Clock
Timing matters when executing an NUA transaction. Once a qualifying event or “trigger” occurs—such as separation from service or reaching age 59 ½—the participant becomes eligible for a lump sum NUA distribution. However, the transaction must take place within the same calendar year as the trigger.
One common oversight involves in-plan Roth conversions. These conversions count as distributions under IRS rules and can unintentionally activate the NUA clock. If the participant does not complete the lump sum NUA withdrawal within that year, the opportunity may be lost. Participants should consult a qualified advisor before initiating any Roth conversion while considering an NUA strategy.
How Early Withdrawal Penalties Work with NUA
Participants under age 55 at the time of separation from service are generally subject to a 10 percent early withdrawal penalty unless they qualify for certain exceptions. In the case of an NUA distribution, this penalty only applies to the cost basis of the company stock—not the appreciated portion.
For someone younger than 59 ½, this rule can be advantageous. If the cost basis is relatively low compared to the NUA, paying a 10 percent penalty on a small portion may be worth it in exchange for paying capital gains taxes on a much larger gain. This trade-off could result in a lower overall tax bill, especially for those with substantial company stock value.
Understanding NUA Means Knowing the Details
NUA is not a one-size-fits-all strategy. It involves multiple rules, timelines, and decision points. From step-up treatment at death to identifying which shares to include, the choices made during this process have lasting implications. Success depends on a combination of recordkeeping, careful planning, and an understanding of how each factor affects the final tax outcome.
Frequently Asked Questions
How does NUA work?
NUA allows company stock distributed from a retirement plan to be taxed at long-term capital gains rates on the appreciation earned inside the plan, rather than ordinary income rates.
What part of NUA qualifies for a step-up in basis at death?
Only appreciation that occurs after the distribution from the retirement plan qualifies for a step-up in basis. The original NUA portion remains taxable to the beneficiary.
Can you choose which shares to include in an NUA transaction?
Yes, if you keep detailed records, you can use the specific identification method to include only low-basis shares in the transaction and roll the rest to an IRA.
Does a Roth conversion affect NUA eligibility?
Yes. An in-plan Roth conversion counts as a distribution and triggers the NUA timeline. You must complete the NUA lump sum within the same year, or the opportunity may be lost.
Is there a penalty for NUA distributions made before age 59 ½?
If you're under age 55 at separation, a 10 percent early withdrawal penalty applies—but only to the cost basis portion of the distribution, not the entire value.
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.