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NUA Mini-Series - Part 2 - When To Do and Not Do NUA, Ep 30

Welcome to Part 2 of the NUA (net unrealized appreciation) mini-series. If this is the first episode in the series that you're listening to it may be worth it to go back and have a quick listen to the last episode just to get a little background. However, you're more than welcome to jump in right here. 

I promised in the last episode to spend some time talking about when it makes sense to use net realized appreciation. I can't stress this enough NUA is an advanced financial planning technique. It is designed for people with company stock in a tax-deferred employer retirement plan. But, just because you fall into this category does not mean you should use an NUA. Listen to this episode of the Equity Compensation Guidebook to learn more about whether it’s right for you.

You will want to hear this episode if you are interested in...

  • When it may NOT make sense for you to us NUA [1:12]
  • When it DOES make sense to use the NUA [2:42]
  • Is the gap between ordinary income and capital gains rates enough? [4:49]
  • The time frame until you have a qualifying event [6:56]
  • This week’s FLASHBACK [8:09] 

When an NUA does not make sense

Let's talk quickly about when it may not make sense to use NUA. The simplest example is if your company stock has what a client of mine refers to as “pooper stock”. Yes. Pooper stock, his words not mine. I've been in financial services for a long time and I'd never heard that term before. His “highly technical term” is just a funny way to say that the company's stock has not appreciated. 

The advantage with NUA is that it allows you to divide up the tax treatment of company stock that's never been taxed before. The basis— or what was paid for the company stock— gets taxed at ordinary income rates. However, and this is key, the appreciated portion gets taxed at long-term capital gains rates. If you have stock that is not appreciated— “pooper stock”— then NUA most likely does not make sense for you. There are various reasons, but the main one is there is not enough appreciation to take advantage of lower capital gains rates on the current appreciation. Additionally, if the stock has not grown, what are the odds that it's going to start growing after you do NUA?

When NUA does make sense

 If your stock is the complete 180 of "pooper stock", you know, highly appreciated, it could easily make sense to go the NUA route. An example is if your stock is worth a million dollars now but had a basis of $200,000, there’s absolute growth of $800,000. This is a highly appreciated stock since it has grown tremendously over your time with the company. 

Without going the NUA route your company stock is subject to ordinary income tax rates upon distribution. These currently top out at 37%. I doubt these rates are going to go down. The top rate for long-term capital gains is 20%. As I mentioned earlier, the basis for a company's stock is subject to ordinary income, which could be 37%. That absolute appreciation of $800,000 in my example is subject to a maximum tax of 20% of long-term capital gains. This is not a tax conclusion, but 37% of $800,000 is $296,000. And 20% of $800,000 is $160,000. I don't know anyone who would turn their nose up at keeping an extra $136,000 in their accounts growing for themselves. Do you? Check out the episode for a few other ways to determine if the NUA makes sense for you. 

This week’s FLASHBACK: Senior class trip

Today we are taking a trip back to my high school senior class trip! Did your school have a senior trip? My class was one of the last classes to enjoy this trip and I was reminded of it as my younger son is about to finish high school and there is no school trip for him. I don't think it's a COVID-related thing either. I think high schools have done away with them. It's probably a good thing since I’m not sure if I could convince my wife—or myself— to let him do a trip like the one I did. 

For years my high school sponsored a senior class trip. The destination... New Orleans. Yes. You read that correctly, the school allowed a bunch of teenagers to go to New Orleans. There were well over a hundred 17-18-year-old students taken by bus to a town with a rather casual attitude toward underage drinking. We stayed in a hotel outside of the French Quarter. Mornings and early afternoons were usually spent around the pool but evenings were spent venturing into The Quarter. There was a strict curfew for us though. A few years ago an old classmate posted an itinerary for our New Orleans trip, I didn't recognize a single thing on it. My comment was “we had an itinerary?” 

As I mentioned, they stopped doing the trip right after we went. I think they realized taking underage students to a place known for drinking may not be a great idea. Regardless, it was a great trip. So great that two of my friends and I headed back down there a few years later. Once we were all legal of course.

Resources & People Mentioned

I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.