Upticks: Net Unrealized Appreciation (NUA)

By Jake Falcon on November 4, 2021

On this episode of Upticks, Jake highlights a topic that is not widely talked about by CPAs and financial advisors, much less everyday investors. The concept is called Net Unrealized Appreciation (NUA) and is relevant for people who are still working, participate in a 401(k) plan through their employer, and own stock of the company they work for in that plan.

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In today’s post, I want to discuss a topic that is not widely talked about by CPAs and financial advisors, much less everyday investors. The concept is called Net Unrealized Appreciation (NUA) and is relevant for people who are still working, participate in a 401(k) plan through their employer, and own stock of the company they work for in that plan.

If you’ve worked at a company for decades and bought and received shares of its stock during that time, hopefully you’ve seen its share price rise while you collect more shares. When this happens, you have what is called an “unrealized gain.”

Let’s say your average cost basis on one share of your company’s stock is $10 and today it’s trading for $70 a share. If you decide to leave your job at, say, age 60, you could simply roll over all of this company stock into a traditional IRA. Or you could take advantage of the NUA strategy, which involves transferring that stock into a traditional brokerage account in kind.

As part of the NUA strategy, whatever you paid for that stock – $10 a share in this example – will be subject to ordinary income taxes in the year you transfer the stock into a brokerage account. The benefit of the NUA strategy is it allows for the gains you’ve earned – $60 a share in this example, after we deduct the average cost basis from the stock price – to be taxed as long term capital gains rather than ordinary income.

As of October 2021, capital gains tax rates are between 0 percent and 20 percent, based on your tax bracket. These rates can be lower than ordinary income tax rates, which is what you will have to pay when you make withdrawals from a traditional IRA. The NUA can lower the amount of taxes you have to pay on company stock you accumulated over the years.

While long term capital gains tax rates may rise in the near future, at this moment, they’re lower than the ordinary income tax rate for nearly all our clients at Falcon Wealth Advisors. If you’re in the 35 percent tax bracket and your long term capital gains rate is 20 percent, that 15 percent you’re saving on taxes is going to have a sizable impact on that $60 a share gain – especially if you own hundreds or thousands of shares of your company’s stock.

And that’s why we discuss NUA with clients as they approach retirement or have a career transition.

It’s worth noting that when you move your company stock from a 401(k) plan into a brokerage account, you don’t have to sell it that day; though, again, you will have to pay ordinary income taxes on the cost basis for the stock ($10 in our example). You can hold on to the stock in the brokerage account as long as you would like and don’t have to pay long term capital gains taxes until you sell it.

As you can see, this is a fairly complex strategy and I don’t recommend an investor attempt to execute the NUA strategy without the help of a professional wealth advisor. And you should consult with your CPA before you execute the NUA strategy, just to make sure they don’t have any concerns. Your CPA will be able to tell you exactly how much NUA will save you in taxes.

At Falcon Wealth Advisors, we are familiar with NUA and have helped many clients take advantage of its benefits.

Reasons to consider NUA

There are two primary reasons someone should consider NUA. The first is tax diversification. Let’s say you have $2 million in your 401(k) account and it’s all pretax dollars, meaning you or your beneficiaries will eventually have to pay income taxes on it. And let’s say $1 million of that 401(k) account is comprised of your company’s stock.

If we execute the NUA and move that $1 million to a brokerage account, while rolling over the other $1 million into a traditional IRA, half of your 401(k) account will be taxed as ordinary income (when you withdraw it) and half of it will be taxed under capital gains.

This is what we call tax diversification and it’s important for clients in retirement. You ideally don’t want to have a significant percentage of your retirement savings in one pretax bucket. While it’s obviously still possible and common for retirees to have all their savings in pretax accounts, if you want a portfolio that can adapt to changes in the tax code, it’s prudent to have money in several different places. I love when clients have money in Roth IRAs, brokerage accounts, pretax retirement accounts (like traditional IRAs), and other accounts. This allows clients to pull from whichever bucket is preferable at the time, based on the current tax code and their unique tax situation.

The second reason clients should consider the NUA strategy is it allows you to borrow against the stock on margin. This can be a risky way to leverage your money, but it’s nice to have the option. You can’t borrow on margin inside an IRA, but you can in a brokerage account.

What is borrowing on margin? If you have that $1 million in a brokerage account, you may be able to borrow against the stock and access money from the stock without having to sell it. To go back to our first example, the average cost basis of a share of the stock was $10 and it’s now worth $70. If you would prefer to sell the stock when it hits $90 a share, but you’re retired and need income now, a short term solution is to take a low-interest loan against the stock you own.

Borrowing on margin allows you to access money while holding on to an asset you believe will appreciate. Where borrowing on margin gets risky is if the stock doesn’t appreciate as you anticipate. But the overall key message is you have more options when stock you own is in a brokerage account, rather than a pretax retirement account like a traditional IRA.

If you would like to learn more about if you’re eligible to take advantage of the NUA strategy, I recommend you contact Falcon Wealth Advisors today. Again, we help clients with strategies like this everyday and pride ourselves on using our knowledge to impact our clients’ financial plans. If you want to get in touch, you can email me directly at Jake@falconwealthadvisors.con.

Clients choose to work with us to enhance their financial literacy and explain exactly what their financial plan means to them.

-Jake Falcon, CRPC®

Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.