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NUA Mini-Series - Part 3 - Digging Deeper with Taxes

Welcome to part three of the NUA mini-series. There are two previous segments you may want to listen to, or you can jump in right here. So far in previous episodes, we've covered distribution options for NUA and when it does and does not make sense to do an NUA. As a reminder, NUA stands for Net Unrealized Appreciation. This is an advanced financial planning technique for people who own company stock within tax-deferred workplace retirement plans. The key here is that the stock has appreciated since acquiring it. NUA is a way to potentially save significant amounts in taxes and I’m going to tell you how in this episode.

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

  • Tax basics for Net Unrealized Appreciation [1:49]
  • A few rules to know about the NUA [5:23]
  • The difference between public and private stock [7:50]
  • This week’s FLASHBACK [9:12] 

Net Unrealized Appreciation basics

How about we start with the basics of taxes for Net Unrealized Appreciation. If you've listened to the other episodes, you will recall the whole concept of NUA is to reduce your taxes so you keep more of the gains of the stock in your pockets. Again, it’s not what you make, but what you keep. 

As a basic example, let's say you acquired company stock in a tax-deferred retirement plan over the years that has a cost basis of $200,000. Fortunately, the company has done well and the stock has grown. The stock is now worth a million dollars. You retire from the company and have to decide what to do with this highly appreciated stock. One option is to take a lump sum, which would cause the entire one million to be taxed at ordinary income levels. Another option is to roll that money into an individual retirement account, a rollover IRA. This is what most advisors recommend. You avoid taxes for now but as you take money out the distributions are taxed at ordinary income levels. So when RMDs kick in, you are dealing with mandatory taxes. 

Savings scenarios going the NUA route

When you go to the NUA route, the $200,000 basis is taxed at ordinary income levels. Right now the highest ordinary income tax level for individuals is 37%. The stock growth of $800,000 is then taxed at a long-term capital gains rate. Currently, the highest long-term capital gains rate is 20%. 

So if you did the standard lump-sum distribution of one million dollars, you could be looking at a tax bill of $370,000 based on ordinary income. If you take the NUA route, you're looking at $200,000 being taxed at ordinary income rates, and the $800,000 of growth being taxed at the long-term capital gains rates. This could result in maximum taxes of $74,000 of ordinary income and another $160,000 of long-term capital gains. I don't know about you, but paying $234,000 of taxes seems more palatable than paying $370,000 of taxes. There are several other details I cover in the episode so be sure to listen!

This week’s FLASHBACK: Student Crossing Guards

A million years ago when I was in the 7/8th grade it was a normal practice to have students be crossing guards for the younger children. Only the most responsible kids got the job even still I’m sure this is no longer a thing. Can you imagine what all the Karen’s would say about 12 and 13-year-old crossing guards? 

We wore a bright orange vest-like thing and it even came with a badge. Sure, we had to stay a few minutes after school and stand outside in bad weather but the reward was worth the sacrifice! At the end of the year, those who did their duty were given a summer pass to the municipal swimming pools. This was key for those of us in eighth grade, who would be in high school in a few short months. My group of friends and I all had bikes and we were allowed to ride from our homes to the two town pools. One of which was on the other side of town. This gave us a greater sense of freedom and we had a chance to meet other kids our age. Good times!

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.