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Net Unrealized Appreciation: Company Retirement Plans with Company Stock


Net Unrealized Appreciation: Company Retirement Plans with Company Stock

Many employees who work for publicly traded companies have the option of purchasing their company stock within their retirement plan. This turns out to be a win-win scenario for the employee and the company. The employee gets ownership in their employer stock and is connected to, in a sense, the profits and losses of the company, and the employer gets employees who have a personal stake in the company.

Over time, consistent and ongoing purchases of company stock can lead to a significant investment in your employer. Often, the employee will simply roll this stock position over from their retirement plan to an IRA at retirement and make periodic sales in the stock over time. As you have surmised by now, all the withdrawals of the proceeds from the sale of the company stock from the IRA are taxable at your marginal income tax rate. However, there potentially is a better way to still maintain an investment in your company stock once retired while also reducing your tax liability.

Called a Net Unrealized Appreciation (NUA) transaction, an employee who utilizes this strategy can potentially save thousands of dollars in taxes. Here is how the strategy works:

  • An employee of a publicly traded company makes purchases of company stock over the length of their career inside the company retirement plan with pre-tax dollars.
  • After what is known as a “triggering event”, the employee rolls his company retirement plan balance out to a combination of an IRA and a taxable account (e.g. – individual, joint, or trust account). There are 3 different triggering events when it comes to NUA:
    • Attainment of age 59 ½ years
    • Separation from service
    • Death of retirement plan participant (participant’s beneficiary could then employ this strategy)
  • The company stock or some portion of the stock position is transferred, in-kind, to the taxable account while the remaining balance of the company retirement plan is rolled over to an IRA. Importantly, if this strategy is to be used properly, the entire balance of the company retirement plan must be emptied within one calendar year. Notably, the calendar year does not have to be the same calendar year as the triggering event.
  • For the company stock transferred to the taxable account, the employee pays income tax on the stock’s cost basis at the employee’s marginal tax rate in the year of the rollover.
  • Thereafter, any sale of the company stock in the taxable account is taxed at capital gains rates and not ordinary income tax rates.

An NUA transaction is most often employed in the case of highly appreciated company shares but can also be used in cases where the appreciation is more modest. Here is an example of the benefits of this type of transaction:

Glen has been an employee of a publicly traded company for 30 years. Over that time, Glen has purchased $227,000 of company stock inside his 401(k) plan. Glen is now considering retirement. The shares are now worth $954,000 hence his net unrealized appreciation is $727,000. Assuming Glen is in the 24% income tax bracket in retirement and his capital gains rate is 15% and not accounting for any future growth, you can see how much in taxes Glen can save by transferring his company shares to a taxable account:

Rollover IRA:

$954,000 x .24% ordinary income tax rates = $228,960.

Net Unrealized Appreciation:

$227,000 x .24% = $54,480 (this tax bill would be due in the year of the transfer of the shares to the taxable account)

$727,000 x .15% = $109,050 (this tax liability would not be due until the shares were sold)

Total tax bill = $54,480 + $109,050 = $163,530 for a total tax savings of $65,430.

So, you can see that in the case of highly appreciated securities, employing a net unrealized appreciation transaction can be beneficial.

One issue we have found to be problematic through the years when it comes to net unrealized appreciation is that many employers do not keep track of an employee’s individual purchases of company stock and only provide an average cost per share for the total purchases. Ideally, because you can cherry-pick which shares to transfer to the taxable account, it would be well worth your time as an employee to keep track of the cost basis of each lot that is purchased inside your 401(k) plan. Then, when it comes time to consider the benefits of an NUA transaction, you can select only the shares with the associated cost basis that you want to pay tax on in the year of the transaction. All other shares can then be rolled over to your IRA.

If you have any questions about Net Unrealized Appreciation or any other financial questions, please contact us at 513-271-6777.

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Written by

Mark F. Kleespies, CFP®

Mark joined THOR in January of 1997, and is the head of the Wealth Management team. His primary duties include working directly with clients and strategically planning the direction of the firm. Mark is a member of the Financial Planning Association and is a Certified Financial Planner.

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