Save Taxes On Your 401K Through Net Unrealized Appreciation (NUA), #195
Do you own stock in the company that you work for in your 401K? Net unrealized appreciation could potentially save you a significant amount of money on your taxes when you start making withdrawals. I’ll share how to take advantage of the process as well as mistakes to avoid making in this episode of Retire with Ryan.
You will want to hear this episode if you are interested in...
[1:00] Sign up for my Retirement Readiness Review!
[1:26] What is net unrealized appreciation?
[3:31] How net unrealized appreciation works
[5:05] How to process the distribution
[7:41] Where people run into problems
[10:09] Net unrealized appreciation when you aren’t retired
[12:23] Reminder: Sell the stock in a lower tax bracket
What is net unrealized appreciation?
The net unrealized appreciation (NUA) is the difference in value between the cost basis of the shares of employer stock that you own and the market value of the shares when you distribute them. For example, if you bought $10,000 worth of company stock and they’re now worth $100,000, the difference between them is the net unrealized appreciation ($90,000).
The goal is to pay long-term capital gain rates (as opposed to taking it out as a distribution of cash and paying ordinary income tax brackets). Why? Because our current tax code makes it possible to pay 0% tax on long-term capital gains rates for those in the lowest two tax brackets. How do you take advantage of this? Via a triggering event: death, disability, separation from service (leave the employer), or reaching age 59 ½.
How net unrealized appreciation works
Let’s say you’ve been working for CVS and purchasing CVS stock for several years. $100,000 of your $500,000 portfolio is CVS stock that you paid $10,000 to buy over time. That’s a $90,000 gain. That $90,000 is what is eligible to be taxed under long-term gain rates.
If you have to pay the 22% federal income tax on the $90,000, that’s $19,800. If you’re living in a state with a state income tax of 5%, that’s another $4,500. That’s about $24,000 in taxes that you’d pay if you took the $90,000 out and it was taxed as ordinary income vs. as a long-term capital gain. How do you get it taxed as a capital gain instead?
Let’s say your “triggering event” is retirement. At that point, you’d need to roll over your 401K to an IRA. While you’re doing that, you have to separate the company stock from the rollover. That stock gets sent to a brokerage account.
The basis in the stock is going to be taxed as ordinary income in the year you process the rollover. In my earlier example, the basis was $10,000. Going forward, the company stock you’ll maintain will be taxed when you liquidate the stock. The difference between the basis ($10,000) and the price when you transfer the stock out ($100,000) will be taxed as a long-term gain.
How does it work if you aren’t yet retired but qualify for a triggering event? What mistakes should you avoid making? What wouldn’t make it worth it? I explain more in this episode of Retire with Ryan!
Resources Mentioned
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