Key Takeaways
You’ve worked hard to accumulate substantial company stock over your career. Make sure your ducks are in a row as you near retirement.
NUA rules allow you to transfer your company stock out of a retirement plan and into an after-tax brokerage account for substantial tax savings.
Don’t try an NUA transfer without consulting with your CPA and financial advisor; incorrect implementation could be costly.
"How should I handle my company stock?”
This is one of the most frequent questions we receive from clients and those considering our services. Many of our clients are senior corporate executives who receive a significant portion of their compensation in the form of company stock (options, restricted stock, RSU, etc.). Most do not have a clear understanding of how their equity compensation works and which strategies would work best for them. There are many different types of equity compensation that companies can offer valued employees as an incentive to stay. Restricted stock units (RSUs) are one of the most common we see being offered by pharmaceutical and other mature companies. While RSUs are potentially very valuable, many employees are unsure about how to handle them, especially as they approach retirement. This lack of knowledge could cause them to forego substantial tax savings.
Company stockholders know they need to be better diversified and not have so much of their wealth tied up in a single asset, but they’re unsure how to proceed. It’s natural to feel emotionally attached to company stock if you’ve been with your employer for years. Longtime executives often have company stock within their 401(k) as well as outside of their 401(k). When company stock represents an outsized portion of your overall wealth, it can leave you vulnerable if the company’s stock price goes down sharply shortly before (or early in) retirement.
In response, some executives will simply sell some of the company stock they’ve long held in their 401(k) and not realize there’s a better tax planning opportunity. Many publicly traded companies (and some private companies) allow for a technique called a Net Unrealized Appreciation transfer. NUA allows you to transfer your company stock out of a retirement plan and into an after-tax brokerage account. Any remaining balance can be rolled over into a pre-tax account (rollover IRA). You pay income tax on the amount that you paid for the company stock when you bought it. After the NUA transfer, the gain on the stock is taxed at the long-term capital gain rate, rather than at the higher ordinary income rate.
So, if you’ve been amassing company stock for a long time and there has been substantial appreciation in those shares, an NUA transfer could provide massive tax savings.
This is where integrating your investment planning, retirement planning, and tax planning with a qualified advisor can be immensely valuable. We often help our executive clients determine how much company stock to hold, how much to sell within their retirement plan, and how much to transfer via NUA. We determine how cash needs will be funded early in retirement and figure out the best way to replace your paycheck when you are no longer working.
NUA Transfer Example Let’s say you purchased $100,000 worth of company stock over the course of your career and put it in your 401(k). Assume the company has done well throughout most of your career and your company stock is now worth over $1 million. Let’s assume you have an additional $2 million in mutual funds within your 401(k), which brings your total to $3 million.
When you retire (assuming you are older than age 59-1/2), you can roll over the $2 million of mutual funds into a traditional IRA – tax-free. Meanwhile, you can move your $1 million worth of company stock into a brokerage account in your name. Now the $900,000 worth of growth in your account is taxed as a long-term capital gain, rather than an ordinary income rate, which is what would have happened if transferred everything into your traditional IRA. The immediate cost of the strategy is that you must pay income tax on the original $100,000 that you used over the years to buy company stock.
If you can change the tax characteristics of $900,000 in your retirement account from ordinary income into long-term capital gain income, that’s a massive tax savings. Assuming you’re in the highest tax bracket, you’ve just lowered your rate to 15% ($214,200) from 37.0% ($333,00) which is a savings of $118,800.
Compare this NUA strategy to what most people would do: roll over their entire $3 million nest egg into a traditional IRA and invest the money.
Just make sure you keep your CPA informed about your rollover plans or the transaction won’t be reported correctly on your tax return. There are specific rules to follow and if you don’t do the transaction (and filing) correctly you will likely miss out on significant tax savings.
Also, a quick estate planning note, NUA stock doesn’t get a step up in cost basis if you die and the stock is included in your estate. As a result, it should be part of your tax plan for raising cash for living expenses in retirement while allowing other holdings to receive the step-up in cost basis.
The NUA strategy works best for executives who’ve been at their company for a long time, who bought company shares early in their careers that have appreciated dramatically. But if you make trades mid-career or late career, you could jeopardize the benefit. For instance, if you sold shares later in your career and then bought the stock again a month later (after the 30-day wash sale rule expires), you have substantially increased your basis in that stock. That makes it much harder to take advantage of NUA.
The decision to sell company stock is specific to your financial circumstances and in some cases, it is the best course of action. However, understanding all of your choices (including this NUA strategy) is important so you can make an informed decision. We make sure our clients are not tempted to sell company stock later in their careers due to jitters about the market or the need for extra cash. Also, you don’t have to wait until retirement is upon you to start the planning process for your hard-earned company stock.
Conclusion
If you or someone close to you has questions about how to handle your company stock, please don’t hesitate to reach out. We are happy to help.
RYAN M. VOGEL, CFP® is the CHIEF PLANNING OFFICER, PARTNER at Novi Wealth