By S. Joseph DiSalvo, ChFC, and Marie Madarasz, AIF
For many, the 2020 pandemic meant quitting their jobs or early retirement. For others, it meant a renewed interest in getting their financial “ducks” in a row, which means they focus more on one of their greatest assets: their employer-provided retirement plans.
Marie Madarasz, Joe DiSalvo
If you have company stock on your 401 (k) plan, there may be a tax planning option that you may not be familiar with. Read this before making any decisions about your 401 (k) after retirement or 59 ½ years of age; We would like to share with you a tax saving opportunity that is often missed!
When you retire or quit your job, many assume the right step is to transfer your retirement funds to an IRA. Not so fast! For many people, rollover is a wise decision. However, don’t assume that this is always the way to go. In some cases, another option may be the smart choice; If you have company shares in your 401 (k), a tax break called Unrealized net increase (NUA) can make another route a good choice.
Are you a candidate for NUA?
Can you benefit from NUA? Well, ask yourself two questions. The first question is, “Do I have any company stock in my 401 (k)?” The second question is, “Is it highly valued?” To determine if the stock is “highly valued” (which is a subjective term), look how high the price was when the shares were purchased and what the current value of these shares is. If the answer to both questions is yes, you could be a good candidate for NUA tax relief.
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This is how the NUA tax break works
This is how the NUA tax break works: You pull the stock out of the business plan and pay regular income tax on it, however only on the original cost of the plan and not on the market value, which is the value of the shares at the time of distribution.
The difference (the appreciation) is the NUA. NUA is the increase in value of the employer stock from the time it was purchased in the plan to the date it was distributed to you. You can defer tax on the NUA until you sell the stock. When you sell, you only pay your current long-term capital gain interest rate. (Had you acted too quickly and transferred the planned balance to an IRA, you would have lost the NUA tax break and ultimately paid the ordinary income tax on the appreciation when it was withdrawn from the IRA.)
Now is the time to act – the triggering event
To qualify for the NUA tax break, the distribution must take place after a triggering event. Triggering events are: death, reaching the age of 59½, separation from work (not for self-employed) or disability (only for self-employed).
The distribution must also be a flat-rate distribution. This means You must empty the entire 401 (k) account in one tax year. You can transfer all funds that are not in the company’s portfolio to your IRA and distribute the company’s assets in kind to a non-pension brokerage account. You pay normal income tax on that Cost basis only the inventory now and defer long-term capital gains tax on the NUA until you sell the stock. Depending on your current and future tax bracket, this can mean significant tax savings. Any additional earnings from the date you transfer the stock from the 401 (k) until they are sold will be used for either the short-term (if the stock is held for less than a year after the transfer) or the long-term cap earnings- Taxed rate (for a period of one year or more).
Be careful! Remember, if you transfer the highly esteemed stock to an IRA, you will lose the NUA tax break.
Is NUA Right For You?
NUA sounds like a great strategy. However, it is not for everyone. Is it for you Well, in general, NUA can be a better strategy than rollover if you are in a high tax bracket and have a good chunk of your retirement savings in highly valued company stocks. You need to be willing and able to pay an immediate tax bill based on the cost of your inventory. There are many factors to consider and many pitfalls to avoid.
With NUA, you can’t afford to go wrong
You may not know that what appears to be a minor breach of the rules can lead to the loss of the NUA strategy. The devil is in the details here! Many taxpayers have learned this lesson the hard way. You mistakenly transferred company stock from your plan to an IRA or missed a lump sum distribution. They discovered that these mistakes were irreversible and the NUA hiatus was over forever. Since the consequences are so severe, you cannot afford to make a mistake with the NUA rules.
If you are interested in learning more about NUA and how you can benefit from it now or in the future, it is a good idea to reach out to a knowledgeable tax or financial advisor.
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About the authors: S. Joseph DiSalvo, ChFC® and Marie L. Madarasz, AIF®
S. Joseph DiSalvo, ChFC and Marie L. Madarasz, AIF, authors of Income for Life, a Retiree’s Guide to Creating Income from Savings, specialize in coordinating retirees’ income, investment and tax planning. They are members of Ed Slott’s Elite IRA Advisor Group, a prestigious study group that is expanding their knowledge of IRA distribution planning. Both are strong advocates of financial literacy and seek to teach others how to achieve sustainable success and lifelong prosperity. www.IncomeForLifeBook.com
Do you have questions about your taxes, personal finances, and investments? Get answers!
Email Jeffrey Levine, CPA / PFS, Chief Planning Officer at Buckingham Wealth Partners to: [email protected].
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