NUA strategy gets most out of company stocks

|tab|

It's common for employees with company stock in their retirement plans to roll that stock over into an individual retirement account when they change employers or retire. That can be a costly mistake, according to an increasing number of retirement specialists.|ret||ret||tab|

What workers may be overlooking is a little-known company stock benefit called net unrealized appreciation. Here's how it works, and how it can save you money if company stock makes up a chunk of your retirement plan at work.|ret||ret||tab|

Say you own $400,000 in company stock in your 401(k) plan and you plan to retire at age 65. The average cost basis for each share is $20 and the stock is currently worth $70 a share. Typically, you would roll over the stock, along with any cash or other investments in the account, into an IRA and let it continue to grow tax-deferred. |ret||ret||tab|

However, when you begin withdrawing funds, they will be subject to ordinary income taxes. You will have lost any chance of paying lower, long-term capital gains rates on the stock.|ret||ret||tab|

The other downside is that when you die, your heirs won't receive the company stock with a step-up in basis that is, they'll pay ordinary income taxes on the value of the stock at the time the IRA owner dies.|ret||ret||tab|

An alternative is to roll over the cash and other investments into an IRA, but have the stock distributed directly to you. This must be done before any post-retirement distributions are made, and it must be part of a single lump-sum distribution. It can't be part of a partial distribution.|ret||ret||tab|

Yikes! you may protest that means it's going to be taxed immediately. Yes, it will, but not as much as you think. And the long-term tax benefits could be substantial.|ret||ret||tab|

You will be taxed at your ordinary income tax rates on the cost basis of the stock $20 in the example. If you hold on to the stock for a while, that's the only immediate tax you'll pay, with the exception of a 10 percent early withdrawal penalty if you are younger than age 59 1/2. But that, too, is paid only on the cost basis of the stock. |ret||ret||tab|

On the other hand, you may want to sell some or all of the stock immediately, perhaps to diversify your portfolio so it's not so heavily steeped in a single stock or because the stock's future prospects aren't good.|ret||ret||tab|

Whenever you sell it, you'll pay long-term capital gains rate 20 percent maximum on what is called the net unrealized appreciation or NUA. That's the difference between the cost basis and the value of the stock when you received the distribution. In this example, that's $50 ($70 - $20). |ret||ret||tab|

The long-term capital gains rate applies on the NUA regardless of the holding period following distribution. Say you hold on to the stock for a while before selling it at $90 a share. That additional $20 gain will be subject to capital gains tax at your ordinary income tax rate if you sell the stock within a year of distribution, or the long-term capital gains rate if held longer than a year.|ret||ret||tab|

When it comes to the estate planning implications of this strategy, things get a bit more complicated, and sometimes they've been misreported in the press. It's not true that if you hold the stock until death that the heirs will receive it on a step-up in basis. There is no step-up in basis on the NUA portion the $50 gain in our example. However, any appreciation above the NUA portion $20 in our example does receive a step-up in basis at death.|ret||ret||tab|

Before committing to the net unrealized appreciation strategy, run it by your certified financial planner professional |ret||ret||tab|

The decision to do it or roll it over into an IRA or other strategy will depend on several factors, such the amount of the NUA, whether other investment alternatives are more likely to appreciate better than the company stock, whether you want to sell quickly to pay for retirement or whether you want to bequeath the shares to you heirs. |ret||ret||tab|

Also, check with your benefits department at work well in advance. Some plans don't allow separate distribution of company stock, and some departments are not familiar with the NUA strategy.|ret||ret||tab|

|bold_on|(The preceding article was produced by the Financial Planning Association and provided by William O. Woody, CLU, ChFC, CFP, of Stovall Woody Associates.)|ret||ret||tab|

[[In-content Ad]]