The Little Known NUA Tax Break For 401k Owners

Not knowing about this little known tax break could cost you dearly.  If you are close to retiring, have recently left your company & own a significant amount of company stock you can’t afford to not know about this tax break.

Taking a lump sum distribution means withdrawing all the assets from your retirement plan in one fell swoop-typically at retirement.  If you participate in a 401k, taking a lump-sum distribution could net you a couple of big tax breaks you may not have considered, or perhaps, never even heard about: NUA (Net Unrealized Appreciation) on company stock in your plan, and 10- year averaging on on your distribution.  Not everyone with a 401k qualifies for these breaks, but if you do, either or both of them can make a big, big dent in your tax bill by helping you get funds out of your plan at bargain-basement tax rates, & maybe even for free.

These breaks do not apply to lump-sum distributions from 403b or 457 plans or from IRAs (including SEP & SIMPLE IRAs.)  And a triggering event must occur for 401k owners to qualify for a lump sum distribution.  For the lump-sum distribution NUA tax break, the triggering events are:  (1) Separation from service (not for self-employed individuals)  (2) Reaching age 591/2  (3) Death (4) Disability (for self-employed individuals only.)  Triggering events for 10-year averaging qualification are the same, plus these extras:  You must have participated in the plan for a minimum of 5 years (2) You must have been born before 1936 (3) You cannot have elected 10-year averaging anytime since 1986.

The NUA tax break allows you to withdraw employer stock (stock of the company you work for) from your 401k as part of a lump-sum distribution & pay tax only on the original cost of the stock, not its appreciated value over your years of service.  So, let’s say you have $1,000,000 worth of company stock in your 401k & the original cost of that stock when purchased for your plan is $100,000.   The NUA amount is $900,000 (the difference between the $1,000,000 value of the company stock at the date of the lump-sum distribution & the $100,000 original cost of the stock.)  That $900,000 is not taxed until you sell the stock, at which time you pay just long-term capital gains tax, no matter how long you have held the stock.  The rule requiring you to hold stock for more than one year to receive long-term capital gains rates does not apply to NUA stock, so you can sell the stock one day after your lump-sum distribution & still pay only long-term capital gains tax (currently at 15%.)

What’s In It For Me?

You won’t know until you run the numbers, but there is the potential for huge tax savings here depending on the amount of company stock in your 401k.  For example, if you have company stock in your plan, the longer you worked for your company, the more likely it is that your stock has appreciated in value.  The greater the appreciation in the value of your company stock, the greater your NUA tax break.

Once you get the numbers for NUA and/or 10-year averaging, contact your tax advisor to determine what the tax benefit for you will be & whether the strategy is right for you in terms of your overall tax-planning goals.  Remember that with either break, you will have to pay some tax up front (whereas with an IRA rollover you will have to pay no tax but IRREVOCABLY lose both tax breaks.)  The idea is to see how much less that tax can be.  (There’s a good chance your current CPA or tax advisor, etc. has never heard about this…in that case let me know & we can consult with the CPA that works closely with me on this little known legal tax break.)