Who Can Benefit from the Net Unrealized Appreciation Strategy?

March 14, 2017

Do you have clients who own appreciated stock in a 401(k) or other employer-sponsored retirement plan?

Are they separated from service or about to retire and would be interested in minimizing taxes?

There is a strategy that may help. It's called net unrealized appreciation, or NUA for short.
 

What Is Net Unrealized Appreciation?

When a participant needs to decide between a distribution of company stock or taking its cash value from a 401(k) plan, a choice must be made: roll it into an IRA, or distribute the company stock into a taxable account and roll the remaining assets into an IRA.

Participants who elect a lump-sum distribution of the company stock to a taxable account pay only ordinary income tax on the stock’s cost basis: that is, the price paid for the stock. If the participant is younger than age 59½, he or she also may be subject to an additional 10% federal tax.

When shares of the stock are eventually sold, the participant will pay long-term capital gains (LTCG) tax on the stock's NUA: that is, the difference between the price initially paid for the stock (cost basis) and its current market value. Any post-distribution growth will also be taxed then, as either short-term capital gains (STCG) or long-term capital gains, depending on the holding period after the distribution.
 

What Is a Lump-Sum Distribution?

A participant must meet all the following conditions to qualify for NUA:

  • Experience a triggering event
    • Separation from service
    • Attainment of age 59½
    • Permanently disabled
    • Death
  • Distribute the company stock from the 401(k) or qualified plan in-kind to a taxable account
  • Distribute all remaining assets from the 401(k) or qualified plan with that employer within one tax year


Who Can Benefit from the Net Unrealized Appreciation Strategy?

The NUA strategy primarily benefits individuals who own appreciated employer stock in a 401(k) or other employer-sponsored retirement plan. The higher the income-tax bracket and the more the stock has appreciated, the more a participant may benefit from this strategy.


Net Unrealized Appreciation Example

The NUA will be taxed at favorable long-term capital gains rates when the stock is sold. Any post-distribution growth also will be taxed then, as either short-term or long-term capital gains, depending on the holding period after the distribution.

In the following example, the $5,000 of appreciation accrued after the lump-sum distribution will be taxed as either short-term or long-term capital gains, depending on the holding period.

For more information on NUA rules as well as situations that trigger additional tax restrictions, review IRS publication 575, Pension and Annuity Income.

As always, participants should seek guidance and consult their personal tax advisors to help determine whether the NUA strategy is an appropriate course of action based on their specific situations.

If you have additional questions, please feel free to contact the Retirement Strategies Group at (800) 722-2333, ext. 3939, or send an email to RSG@PacificLife.com.

Picture of Steve Chmelka

Steve is a Senior Retirement Strategies Consultant with the Retirement Solutions Division at Pacific Life. He brings more than 25 years of industry experience in financial planning and wealth management, including detailed knowledge of both employer-sponsored retirement plans and retirement-planning strategies.

Pacific Life, its distributors, and respective representatives do not provide tax, accounting, or legal advice. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor or attorney.

Pacific Life is a product provider. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

Pacific Life refers to Pacific Life Insurance Company and its affiliates, including Pacific Life & Annuity Company. Insurance products are issued by Pacific Life Insurance Company in all states except New York and in New York by Pacific Life & Annuity Company. Product availability and features may vary by state. Each insurance company is solely responsible for the financial obligations accruing under the products it issues. 

Variable insurance products are distributed by Pacific Select Distributors, LLC (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company (Newport Beach, CA) and an affiliate of Pacific Life & Annuity Company. Variable and fixed annuity products are available through licensed third parties.

No bank guarantee • Not a deposit • Not FDIC/NCUA insured • May lose value • Not insured by any federal government agency