It is not uncommon to be awarded company stock in your retirement account. When this happens and it becomes time for you to retire, there are certain moves you can make to achieve better tax outcomes. This is often referred to as “net unrealized appreciation” planning. Here’s how it works.
When you are awarded company stock in your 401(k) it tends to appreciate over time. Let’s say you were awarded stock when it was $7/share 30 years ago and now it is worth $40/share. The normal way of taking money out of your retirement account is to take monthly distributions and pay income tax on them, but with company stock, you have the option to pay long-term capital gains (LTCG) tax instead of ordinary income tax. This could be very advantageous because your LTCG rate may be significantly less than your income tax rate. In some years and for some marginal income tax brackets, the LTCG tax rate was as low as 0%!
In order to take advantage of this special tax law, you have to make a one-time distribution from your employer plan to a brokerage account. During this tax year you will pay ordinary income tax only on the basis of the stock. The tax basis of the stock is the original value of the stock. For example, the original $7/share value. Now you have the stock in a brokerage account and it can continue to grow and you won’t pay the LTCG tax on it until you sell it.
The “net unrealized appreciation” (NUA) refers to the appreciation of the shares; in other words, the difference between the original $7 value and the $40 price today. This $33/share is the net unrealized appreciation portion, which can avoid the ordinary income rate altogether and only pay the LTCG rate.
This is a very wise tax move to make if you have company stock in a retirement account. If you need help doing something like this, consult with our advisors at American Financial Planning. We have helped a number of clients plan for this and we are very familiar with the process which can seem daunting to the average investor.