What is net unrealized appreciation?
Net Unrealized Appreciation (NUA) applies to people who own company stock through their employer 401k plans. NUA applies only when you leave your company and you need to decide how to distribute the assets in your 401k. Ordinarily, when you leave your company, you would rollover your 401k into an IRA (Individual Retirement Account); the money in the IRA would then continue to grow tax-deferred and would be subject to ordinary income tax once you begin making withdrawals at retirement. However, with NUA, you have the option to separate the money in your 401k between your company stock and your diversified investments (usually mutual funds). The mutual funds (non-company stock) would rollover into an IRA whereas the company stock would transfer into a taxable brokerage account. You would owe ordinary income tax on the cost basis (the amount you paid for the stock) when you make the distribution and a 10 percent penalty if you are under 59.5 years old; however, appreciation (market value less cost basis) would be taxed at the lower capital gains tax rate. If you have a substantial amount of unrealized gains in your company stock within your 401k, pursuing the NUA option could amount to a significant tax savings.
NUA is not appropriate for all situations. You must calculate your unrealized gain, estimated tax liability from the distribution, factor in your 10 percent penalty (if you take an early distribution), and decide whether it is the right decision for your financial position and goals.
There are many nuances related to NUA – stay tuned for a more indepth article describing the mechanics behind NUA and how to evaluate your specific situation.