facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause
Nuances of NUA Thumbnail

Nuances of NUA

We have written about the net unrealized appreciation (NUA) tax strategy many times. Generally, after a lump sum distribution from the plan, the NUA tactic enables an eligible person to pay long term capital gains (LTCG) tax on the growth of company stock that occurred while the stock was in the plan. But there are finer points to NUA. Here are some more nuanced details:

Nuances of NUA

Step-Up in Basis

NUA (meaning the appreciation that occurred in the plan prior to the lump sum distribution) never receives a step-up in basis. If the company stock is still held by the former plan participant upon his death, the beneficiary of that account will pay LTCG tax on the NUA no matter when the shares are sold. But what about any appreciation of the stock AFTER it was distributed from the plan? Appreciation after the lump sum plan distribution DOES receive a step-up in basis.

Example: John completed a proper NUA distribution 10 years ago of his company stock that was valued at $500,000. At that time, John paid ordinary income tax on the cost basis of his shares ($100,000) and he anticipated paying LTCG tax on the NUA of $400,000 when he sold the shares. John held all the shares until his death, when the total value had increased to $750,000. John’s beneficiary (his daughter Susan) immediately sells the shares. She will pay LTCG tax on the $400,000 of NUA. However, Susan will get a step-up in basis on the $250,000 of additional appreciation and owe no tax on that part of the transaction. (The original $100,000 is also tax-free as a return of basis.)

“Specific Identification Method”

Retirement plans will typically use an “average cost per share” to determine the NUA. Over the years, as the company stock price goes up and down, a plan participant will acquire shares at different price points with each salary deferral. However, the plan may not track all these different purchase prices. Instead, the plan could use the total purchase amount (the cost basis) vs. the current value of the stock. For example, if the current value of the stock within a 401(k) is $1,000,000, and if the total amount used to purchase the stock was $400,000, the NUA is $600,000. Average cost per share is cost basis ($400,000) divided by the total number of shares owned within the plan.

If a plan participant maintains detailed records and documents the specific historical stock purchase prices, the person could decide to only include the low-cost-basis shares in an NUA transaction. The high-cost-basis shares would be rolled to an IRA and excluded from the NUA calculation. By following the “specific identification method” and targeting the low-basis shares, a person could further maximize the NUA tax strategy.

In-Plan Roth Conversions: Caution!

When an NUA “trigger” is hit, a plan participant does NOT have to act immediately on an NUA distribution. However, if the trigger is “activated” by certain transactions – like a normal distribution – the NUA lump sum withdrawal must occur within that same calendar year. If not, the trigger will be lost. Be careful! An in-plan Roth conversion is considered a distribution and WILL activate an NUA trigger.

10% Penalty for Those Under 55 Years Old

Assume a plan participant was under 55 at the time of separation of service. As such, she could not leverage the age-55 exception to avoid a 10% early withdrawal penalty. But there is a silver NUA lining. If she pursued an NUA transaction before age 59 ½ (and rolled over her non-stock plan funds), she would owe a 10% penalty ONLY ON THE COST BASIS of shares. If the appreciation is high enough, it could be advantageous to pay the 10% penalty on the cost basis to preserve the LTCG tax break on the NUA.

The NUA tax strategy is part art and part science. To maximize the benefits, understanding the different nuances is essential.

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.

Copyright © 2024, Ed Slott and Company, LLC Reprinted from The Slott Report, 10/14/24, with permission. https://irahelp.com/slottreport/nuances-of-nua/, Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article. 
Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment advisor. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. This content is developed from sources believed to be providing accurate information and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional.