Did you get company stock in your 401(k)? You must know about NUD.
In many large publicly traded companies, it is common practice to reward employees with employer shares. Usually through a profit sharing plan or ESOP plan, or at least by allowing employees to purchase stock themselves within their 401(k) plan. The drawback is when you withdraw money from a company plan, it is taxed as ordinary income. However, the IRS – if you can believe it – has two special rules to help: net unrealized appreciation (NUA) and net unrealized depreciation (NUD).
Given today’s stock market volatility, it’s the NUD rule that interests me at the moment.
First things first – Understand the NUA rule
A net unrealized estimate (NUA) is a tricky technical term but an important opportunity for tax savings for those who have company stock in an employer plan. Under NUA, only the cost basis of shares is taxed (and possibly an early withdrawal penalty) at the time of distribution. In simple terms, cost basis is what a person pays for the stock. The net unrealized estimate is the growth of inventory over the cost basis. When you leave your employer and want to withdraw company stock from your retirement plan, if you follow the rules of NUA, there can be significant tax savings. Here’s how:
NUA is not subject to ordinary income tax until the company’s shares are sold and will never be subject to an early withdrawal penalty. When you sell shares, NUA is taxed at capital gains rates — not ordinary income tax rates, which can be much higher, depending on your income and current tax rates. Additionally, NUA is not subject to the 3.8% surcharge on net investment income. The preferential tax treatment of the NUA portion of a company’s stock dividend is what we call the NUA rule.
Why unrealized net depreciation now?
A similar sounding name, but a different strategy together, is Net Unrealized Depreciation, or NUD. Participants who hold company stock in a retirement plan that has fallen sharply in value may wish to consider resetting the cost basis for that stock by selling stock under the plan and repurchasing it shortly thereafter within the plan. Unlike stock transactions outside of a retirement plan, the “laundering sale” rule does not apply. We call this a “concession” of the cost basis – provided the stock is repurchased at a lower price.
Why consider stepping down the foundation? A larger gap between the cost basis – what I paid for the stock – and potential growth from that point onwards creates more opportunities for the application of the NUA rule in the future. The NUD strategy is especially important now given the stock market volatility we’ve seen lately. If you have employer stock in your company’s retirement plan, consider reviewing your cost basis against the current market rate. If the current stock price is below the cost basis, this may be an opportunity to implement the NUD strategy – sell stock and buy back immediately within the plan to step down from the cost basis. (Be sure to check with your plan administrator before implementing a NUA or NUD strategy to make sure your plan allows it.)
There are many considerations for making the choice of a net unrealized estimate. It really depends on the individual’s situation. Meanwhile, the net unrealized depreciation strategy is less complicated: you just reset your cost basis. However, waiving the cost basis may give you a greater chance of applying the NUA rule in the future if you choose to opt for NUA in retirement. Most of all, investors must weigh the benefits (and risks) of owning their company’s stock in the first place. A high concentration – more than 10% of the portfolio in one stock – is risky in my opinion.
There is a lot to consider when evaluating a NUA or NUD strategy. I advise clients not to go alone. NUA calculators are a useful tool for determining potential tax benefits. But it’s not just about NUA and NUD; It’s about taking a comprehensive look at the parts about your retirement and financial plan. An experienced professional can help you see the big picture, explain the advantages and disadvantages, and help you make the right decision.
If you would like to learn more or discuss your financial planning, feel free to email me for a free consultation.
Disclaimer: Investment advisory and financial planning services are provided by Summit Financial LLC, an investment advisory firm registered with the SEC, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. These materials are for your information and guidance and are not intended to be legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with independent tax or legal advisors. Individual investor portfolios should be created on the basis of an individual’s financial resources, investment objectives, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is no guarantee of future results. The opinions and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Summit is not responsible for the hyperlinks and any external reference information contained in this article.
CFP®, Summit Financial, LLC
Michael Alloy is a Certified Financial Practitioner™ and Certified Wealth Management Consultant with Summit Financial, LLC. With 21 years of experience, Michael specializes in working with CEOs, professionals, and retirees. Since joining Summit Financial, LLC, Michael has built a process that emphasizes the integration of various aspects of financial planning. Backed by a team of real estate and income tax professionals, Michael provides its clients with coordinated solutions to discrete problems.
Investment advisory and financial planning services are provided by Summit Financial LLC, an investment advisory firm registered with the SEC, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. These materials are for your information and guidance and are not intended to be legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with independent tax or legal advisors. Individual investor portfolios should be created on the basis of an individual’s financial resources, investment objectives, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is no guarantee of future results. The opinions and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third party websites are provided for your convenience and informational purposes only. Qimma is not responsible for the information contained on third party websites. The Summit financial planning design team has approved attorneys and/or chartered accountants, working exclusively in a non-representative capacity with respect to Summit clients. They neither provide tax nor legal advice to clients. Any tax information contained here was It is not intended or written for use, and cannot be used for the purpose of US federal, state, or local tax avoidance.