Hi Reader,
Consider a 401(k) worth $250,000, consisting of $50,000 in mutual funds and $200,000 in employer stock. The stock has a $30,000 cost basis, resulting in $170,000 of Net Unrealized Appreciation (NUA).
Scenario 1: Typical 401(k) Rollover
In a traditional rollover, the mutual funds and employer stock are sold and the full $250,000 is transferred to an IRA tax free.
However, when those IRA funds are eventually distributed, the entire amount is generally subject to ordinary income tax rates.
Scenario 2: Rollover Using an NUA Strategy
With an NUA strategy, the mutual funds are sold and transferred as cash to an IRA. The employer stock is transferred in kind to a taxable brokerage account.
The $30,000 cost basis is immediately taxable as ordinary income, but the $170,000 of NUA is not taxed until the stock is sold.
At that time, the NUA is generally taxed at long term capital gains rates rather than ordinary income tax rates.
For highly appreciated employer stock, this difference in tax treatment can create a meaningful planning opportunity.
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David N. Waldrop, CFP®
Owner of Bridgeview Capital Advisors, Inc. a Registered Investment Advisor.
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