It works like this, a company security consist of two parts: (1) cost or basis of the security (2) appreciation or the increase in the security’s value. The appreciation portion is the NUA. Why is that important? When you retire, if you choose to receive the company stock “In Kind” meaning you transfer the shares into your individual name you may save taxes.
Let’s say you own 1000 shares of ABC Inc. stock in your pension plan that you paid $20,000 for and the security is now worth $100,000, this equates to $80,000 in NUA. If you roll that stock into an IRA to avoid current tax, you will eventually pay ordinary income tax when you withdraw this money. However, if you choose to withdraw the stock you would pay ordinary income tax on the $20,000 (cost) while the remainder of the gain $80,000 (NUA) when sold will be taxed at the more favorable long term capital gain rate. The take away is that the greater the disparity between what you paid and what it is now worth the more advantageous this strategy will be.
In summary, there are numerous important decisions to make as you near retirement NUA, 10 year averaging, rollover and 72(t) calculation among other strategies can all affect the amount of tax you pay. So make sure that you have considered all the variables as you approach this important milestone.
Please check with your tax advisor for details on any of the above mentioned strategies.
In addition, the IRS publication covers NUA in greater detail.
Christopher C. Freeman is a Certified Financial Planner Professional and has a Masters of Science Degree in Financial Planning with 23 years of investment experience. He is employed with Janney Montgomery Scott LLC. Member NYSE, FINRA, SIPC.