Individuals nearing retirement have many timely decisions to navigate. For those who hold shares of their employer’s stock in an employer-sponsored retirement plan, such as a profit-sharing plan or an employee stock ownership plan (ESOP), it’s an opportune time to determine how to best leverage the appreciated stock by exploring net unrealized appreciation (NUA) tax strategies to support your long-term financial goals.
Qualifying Events
When certain qualifying events and triggers are met, the IRS allows for a more favorable capital gains tax rate on the NUA of the employer stock you hold in your retirement plan when the sale of the stock is in a brokerage account.1 Qualifying events include retirement (separation from service), attainment of age 59½, death, or disability. In addition, it must be a complete distribution from the employer-sponsored retirement plan and the shares must be distributed in-kind. Due to the unique rules and triggers around NUA, it is important to discuss this strategy before taking any action to avoid disqualifying yourself from taking advantage of NUA.
Determining Net Unrealized Appreciation
To determine the cost basis of your employer stock, you can reference your annual statement or call your plan administrator. The cost basis is the purchase price of the stock within the plan; the net unrealized appreciation is the gain on the stock.
A Layered Tax Strategy
For many of our clients, we find it most beneficial to distribute their shares of company stock to a brokerage account and non-employer stock to an IRA. The key to understanding the benefits to this strategy lies in the difference in taxation between brokerage accounts and IRA accounts. This NUA strategy can help optimize your tax and retirement cash flow situation because the sale of company stock in a brokerage account will be subject to long term capital gains rates of either 0%, 15%, or 20% on the federal side, which is lower than the ordinary rate on the same level of income on similar amounts distributed from an IRA. Furthermore, it will reduce future required minimum distributions (RMDs) at age 72, which are based on balances in your IRA account.
Additional Planning Strategies
Recognizing the opportunity for an NUA strategy is only one aspect of consideration when making a decision to execute on it. The following factors can help determine whether or not to pursue it:
Other Sources of Income and Retirement Timeline
If you retire with few other sources of income, it can be an opportunity to utilize the 0% federal capital gains tax bracket, especially if there is a longer timeline before starting Social Security or RMDs.
Risk Tolerance and Concentration
The amount of employer stock relative to your other assets and your risk tolerance regarding this stock can help inform whether or not to pursue NUA. A large percentage of your overall assets in company stock in a brokerage account may take a few tax years to fully diversify away from at an attractive tax rate.
Amount of Unrealized Gain
Due to the tax treatment of the basis of the stock on distribution, NUA tends to work well in situations of highly appreciated employer stock.
Charitable Intent
Highly appreciated and highly concentrated stock can open some charitable planning strategies with charitable remainder trusts (CRTs) and donor advised funds (DAFs).
Access to Funds
Since separation from service is one of the triggers for NUA, this can be a strategy to gain access to funds for things like education, early retirement, or real estate purchases prior to age 59½ with potentially less tax implication and early withdrawal penalties compared to an IRA.
When to Speak With Your Advisor
Each NUA situation is unique and requires careful consideration alongside your individual financial planning goals. To better understand your options when it comes to pursuing NUA, speak with your CCM advisor any time. The optimal time to review this strategy is in the year leading up to retirement or age 59½.
NOTE: The information provided in this article is intended for clients of Carlson Capital Management. We recommend that individuals consult with a professional adviser familiar with their particular situation for advice concerning specific investment, accounting, tax, and legal matters before taking any action.
