Understanding Net Unrealized Appreciation (NUA)

Written by Carson Hamill CIM®, CRPC®, FCSI® Associate Portfolio Manager and Assistant Branch Manager & Dean Moro BComm, CIM®, Associate Portfolio Manager

When it comes to planning for retirement, there are various strategies that can help you make the most of your assets. If you are leaving current U.S. employer or approaching retirement, and you hold company stock within your 401(k) or other employer-sponsored retirement plan, it may be worthwhile to contemplate the net unrealized appreciation (NUA) strategy.

• What Is The Net Unrealized Appreciation (NUA)
• Key Benefits of Net Unrealized Appreciation (NUA)
• Who should consider The New Unrealized Appreciation (NUA) strategy
• How a New Unrealized Appreciation (NUA) Strategy Works
• Early Withdrawal Penalties
• Important Factors To Consider

What is Net Unrealized Appreciation (NUA)
In simple terms, net unrealized appreciation refers to the increase in the value of your employer’s publicly traded stock in an employee retirement plan when you elect to take a lump-sum distribution into a taxable account. The key advantage of NUA is that the appreciation in value is taxed as long-term capital gains instead of being treated as ordinary income.

Let's break down the essential points about net unrealized appreciation (NUA):

• NUA is the increase in value on a lump-sum in-kind distribution of employer stock from an employee retirement plan into a taxable investment account.
• The employee's Adjusted Cost Basis (ACB) in the stock is taxed as ordinary income at the time of distribution.
• The growth portion is taxed at the long-term capital gains rate only when the stock is sold.

Key Benefits of Net Unrealized Appreciation (NUA)
Utilizing the NUA strategy can offer several advantages, including:

• Potentially reducing the overall tax burden on your investments by allowing long-term capital gains treatment on NUA instead of ordinary income tax rates.
• Providing tax benefits for your beneficiaries, as inherited NUA may be eligible for favorable tax treatment.
• Preserving the tax-deferred status of other assets in your employer-sponsored plan by rolling them into an IRA.

While the NUA strategy has benefits, it also comes with potential drawbacks, including:

• Incurring immediate tax liability on the cost basis of employer stock when distributed from the plan.
• Limiting flexibility, as NUA benefits apply only to employer stock and not to other investments in the plan.
• Losing the ability to convert employer stock to a Roth IRA, which could provide long-term tax advantages.

Who should consider the Net Unrealized Appreciation (NUA) strategy
The NUA strategy might be suitable for individuals who:

• Are approaching retirement age and possess company stock in their 401(k) or another employer plan such as a profit-sharing plan, stock bonus plan, or pension plan.
• Hold highly appreciated company stock in a former employer's retirement plan while being in a low tax bracket.
• Are on the brink of retirement and require an income distribution strategy.
• Have inherited an employer plan that contains company stock.

How does the Net Unrealized Appreciation (NUA) strategy work
The NUA strategy can be initiated as follows:

1. Initiate a lump sum distribution of the employer stock from your existing plan.
2. Direct the distribution to a taxable investment account.

When you receive the distribution, you will be liable to pay ordinary federal income tax on the adjusted cost base (ACB), or average cost, of the stock as provided by your plan. Keep in mind, if the plan record keeper has maintained individual cost basis records and not merely average cost basis, it may be possible to cherry pick the lowest cost basis shares for the NUA distribution.

Upon selling the shares of company stock, you are not obligated to pay ordinary federal income taxes on the Net Unrealized Appreciation (NUA) at the time of distribution. However, you will be subject to long-term capital gain tax on the NUA, along with any additional appreciation, when you eventually sell the shares.

We recommend consulting with your cross-border accountant to determine the suitability of the NUA strategy for your specific situation.

Early Withdrawal Penalties
It's important to note that when utilizing the NUA strategy, the standard age-distribution regulations for 401(k)s apply, and early withdrawal penalty taxes might be applicable to the distributed portion related to the adjusted cost basis (ACB). Should the participant be below 59.5 years old or separated from employment before the year reaching age 55, withdrawing the ACB component of the distribution will incur the early withdrawal penalty. As mentioned above, the ACB portion will also be subject to taxation as regular income.

To summarize, if the participant is below the age of 59.5 years or separated from employment before age 55:

• they will incur a 10% penalty on the withdrawn ACB portion of the company stock.

  If the participant is above the age of 59.5 years or separated from the employer’s service during or after the year, they reach age 55:

• the ACB portion would not be subject to the 10% penalty.

It's important to consult with an experienced cross border financial advisor and tax professional to assess your specific situation and determine if the NUA strategy aligns with your retirement goals.

Important Factors to Consider
When deciding whether the NUA strategy is suitable for you, several factors come into play. Your age plays a significant role, as the longer you have until retirement, the more time there is for assets in an IRA to grow on a tax-deferred basis. If retirement is still far off, the benefits of NUA may be outweighed by the potential tax-deferred growth within an IRA.

On the other hand, if you are closer to retirement, hold highly appreciated company stock, and expect higher future tax rates, the NUA strategy could be advantageous.

Net unrealized appreciation presents a valuable opportunity to optimize your retirement savings by taking advantage of the favorable tax treatment of appreciated employer stock. Understanding the concept and considering the relevant factors can help you make informed decisions to unlock the benefits of NUA in your retirement plan.

Summary
Recognizing the significance of net unrealized appreciation (NUA) as a tax strategy is crucial, as it provides investors with the opportunity to potentially reduce their tax obligations. This is achieved by leveraging the advantageous tax rates for long-term capital gains on appreciated company stock within qualified retirement plans. Since each person's circumstances are distinct, seeking advice from a cross-border accountant and your financial advisor is not only important but also recommended. This will ensure you receive tailored advice and can ascertain whether this strategy aligns with your individual situation.

Next Steps
If you’re planning on moving to Canada and need assistance with your investments, estate planning, and portfolio management, please call or email Snowbirds Wealth Management, as we specialize in cross-border financial planning and wealth management. We work closely with experienced cross-border lawyers and accountants to ensure you have a qualified team behind you.


About Snowbirds Wealth Management
Gerry Scott is a Portfolio Manager and founder of Snowbirds Wealth Management, an advisory firm focussed on the cross-border market. Together with Dean Moro and Carson Hamill, Associate Portfolio Managers with Snowbirds Wealth Management, they provide investment solutions for Americans living in Canada and Canadians residing in the United States. Licensed in both Canada and the US, they provide tailored investment solutions to minimize the tax burden when moving assets across borders.

To schedule an introductory call, please click here.

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