NAVIGATING CONCENTRATED POSITIONS + NET UNREALIZED APPRECIATION (NUA)

If one does not know to which port one is sailing, no wind is favorable.

SENECA

A LIFETIME OF ACCOMPLISHMENT

Perhaps you sought out your company as a young professional specifically for the benefits package. Owning a piece of the company and personally experiencing the benefits of growth have made you feel invested in your company's success. Your company has done well, and so have you.

Retirement is approaching. Decisions need to be made, but questions remain.

Exploring Your Employer Stock Options When Leaving a Company

  • What’s right for your situation?

  • I’ve heard about NUA, but what does it entail?

  • How do taxes affect my bottom line?

  • Will I incur penalties if I retire before a certain age and start drawing funds from the account?

OPTION NO. 1

Leave stock in the company plan
(if permissible by your former employer)

OPTION NO. 2

Sell the stock, pay the ordinary income tax due on the proceeds, and pay penalties if you are under the age of 59 ½.

OPTION NO. 3

Complete a direct rollover to an Individual Retirement Account (IRA) and defer your tax.

OPTION NO. 4

Implement a tax strategy known as Net Unrealized Appreciation (NUA)

HOW DOES NET UNREALIZED APPRECIATION (NUA) WORK?

NUA is an often overlooked tax strategy that could have significant tax savings if utilized correctly.

NUA by definition is the difference between the cost basis (purchase price) and the current fair market value (FMV) of the stock.

Upon electing the NUA strategy, the employee receives the stock, pays ordinary income tax (and penalty if under age 59 ½) on the average cost basis of the stock. The shares can then be sold any time and will be taxed at (typically more favorable) long term capital gains rates.

When NUA Makes Sense

It may be the right strategy if…

  • There is a significant difference in the stock value over the cost basis.

  • You’ll need access to your funds within a shorter time horizon.

  • If you’re in a higher tax bracket, you may benefit from the favorable long-term capital gains treatment.

Case Study No. 1 ⭢

  • Lynn is a 52-year-old executive and retiring.

    Lynn needs a few moments to sit and think through her ESOP options, but the time is elusive.  At 52, retirement is looking attractive, especially given the enormous amount of travel required by her job. She finds herself brainstorming about retirement on the back of cocktail napkins as she crosses the country. Her confidence in her ability to complete complex real estate transactions serves her very little when it comes to tax rollover strategies. She can envision retirement in her mind, but the financial decisions are overwhelming.

    Lynn has been with her company for thirty years- an anomaly for this day and age. At age 23, she started purchasing company stock in her 401k.

    Lynn’s Situation

    + Retires at age 52

    + 37% tax bracket

    + 401(k) holds $400,000 worth of company stock with a cost basis of $100,000

    + She needs access to the funds immediately

    Scenario Utilizing NUA

    + Total Taxes and Penalties = $107,000

    + Remaining Cash Balance = $293,000

    Rollover & Withdrawal Scenario

    + Total Taxes and Penalties = $188,000

    + Remaining Cash Balance = $212,000

    Lynn has a savings of $81,000 by utilizing the NUA strategy

Case Study No. 2 ⭢

  • George is a 58-year-old supervisor and retiring.

    George serves as Supervisor of Facilities for a large distribution company. His career has been professionally rewarding and intellectually stimulating- but it’s time to call it quits. Retirement would allow him to spend more time with his family and pursue several investment projects he is passionate about. He has been with his current company for 17 years. When he was 41 years old, his employer started making contributions to an ESOP as a part of his benefits package for retirement.

    George plans to have supplemental income from his investment projects and his wife plans to work for another five years, so he doesn’t need to have immediate access to his funds. He has a general understanding of rollover strategies, mostly from conversations with friends in finance but knows he needs professional help to ensure he doesn’t waste hard earned assets on tax penalties.

    George’s Situation

    + Retires at age 58

    + 25% tax bracket

    + ESOP holds $400,000 of company stock with a cost basis of $300,000

    + Access to funds not needed immediately

    +Expected tax bracket during retirement: 18%

    Scenario Utilizing NUA

    + Total Taxes and Penalties = $125,000

    + Remaining Cash Balance = $275,000

    Rollover & Withdrawal Scenario

    + Total Taxes and Penalties = $72,000

    + Remaining Cash Balance = $328,000

    Lynn has a savings of $81,000 by utilizing the NUA strategy

Steps to a Successful Implementation of NUA

Start early – the process takes time.

Allow ample time to gather the right documents. You must obtain written documentation from your employer indicating your cost basis. You also need to notify your employer if you plan to utilize the NUA strategy (for tax reporting purposes).

Determine your gain.

As a general rule, you will only want to use the NUA strategy on shares that have a low-cost basis and have significantly appreciated in value. You can choose which shares you want to designate for NUA tax treatment.

Have a strategy for your concentrated stock position.

Consider the stock’s future potential rise (or fall) in value, your overall asset allocation, and the risk of continuing to hold a concentrated position. The concenquences of not having an accessible after-tax bucket may outweigh the benefits of maintaining a concentrated position.

Know your tax liabilities.

Make a plan to meet your tax obligations by April 15th of the year following your taxable withdrawal.

Do I Qualify for NUA Treatment?

The Conditions that Must Be Met

  • When utilizing the NUA strategy, your clients must take a lump-sum distribution of all the assets in their employer-sponsored retirement plan account. The employer stock is distributed in kind and is usually moved to a brokerage account. The rest of the assets may be rolled over.

  • The process of executing the strategy takes time; therefore, it is not suggested you wait until the end of the year.

  • The employer stock is distributed in kind and may not be converted to cash prior to the distribution.

    • Separated from service

    • Reached age 59 1⁄2

    • Total Disability

    • Death

Secure futures are built on a series of intentional decisions.

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Disclaimer.

The decision to utilize NUA can be complicated and you should consider not only taxes but also your overall financial condition. The information contained in this presentation is designed to give a general overview of the NUA rules and is not an endorsement or recommendation to utilize NUA.