Employer Stock Distributions
How to Handle Net Unrealized Appreciation (NUA) On Employer Stock

Today, many qualified retirement plans contain employer stock. While this may have advantages for employees, it may also complicate decisions when the time comes to receive a distribution. For instance, taking an in-kind distribution of employer stock instead of rolling it over into an IRA may qualify you for special tax treatment on the stock's net unrealized appreciation (NUA).

The decision you make with respect to your distribution of employer stock can have an impact on your retirement nest egg. Therefore, you should become familiar with the special tax treatment available to distributions of employer stock.

Net Unrealized Appreciation Defined
Each share of employer stock you receive is comprised of cost and appreciation. For example, say you bought a share of stock for $10 through your employer's retirement plan. If the share is now worth $25, the appreciation is $15 per share ($25 value minus $10 cost). Since you have not yet sold the share, however, the appreciation has not yet been realized—thus, the term "net unrealized appreciation" (NUA).

If the share is distributed to you in-kind from your employer's retirement plan, you will be subject to current income taxes on the cost ($10 per share). You will not, however, be subject to taxation on the NUA until you sell the share. At that time, you will be subject to taxation on the amount the share appreciated while the stock was in the plan.

The taxation will be at long-term capital gains rates. Any additional amount the stock appreciates after distribution will be taxed at either long or short-term capital gains rates, depending on how long it was held after distribution from the plan.

If, on the other hand, you had elected to roll your employer stock into an IRA, you would avoid current taxation. In this case, however, the entire amount would ultimately be taxed as ordinary income upon distribution from the IRA.

Reasons to Consider Special Tax Treatment
Perhaps the most compelling reason to consider the NUA option is the potential tax savings attributable to federal long-term capital gains rates. The long-term capital gains tax rate generally is 15%, compared to a marginal ordinary income tax rate that can be as high as 35%.

Any gain that occurred while the stock was invested in an employer's retirement plan will benefit from the long-term capital gains rate. If you plan to hold on to your employer stock for at least 12 months after distribution, this option could also mean tax savings for you on any additional appreciation. Be aware that state income taxes also generally apply to such distributions.

If you decide to receive your distribution of employer stock outside of an IRA, you will not be subject to the required minimum distribution rules that apply to IRAs (i.e., you must begin making certain distributions from your IRA by no later than April 1 of the year following the year you turn age 70 1/2).

Who Should Consider the NUA Strategy?
If you take a taxable distribution before age 59 1/2, you may be subject to a 10% early distribution penalty tax in addition to ordinary income taxes. If you separate from service during the year you become age 55 or later, however, and then receive distribution from your former employer's retirement plan, the 10% penalty tax will not apply.

If you will not be subject to the 10% penalty, the NUA strategy may be beneficial. Otherwise, current taxation may diminish the possible benefits of using the NUA strategy, in which case a Rollover IRA may be the better choice.

Whether you will benefit from the NUA strategy depends on a variety of factors, including your age, tax bracket, how much your employer stock has appreciated, how long you plan to hold the stock and the composition of the rest of your portfolio. So it is important, as with all financial decisions, to assess your entire situation before using the NUA strategy. Due to the highly complex nature of retirement plan distributions, you should also consult with your personal tax advisor before making any final decisions.

James B. Marcus is a Financial Advisor with the Baum Consulting Group of UBS Financial Services, Inc. To find out more about your distribution options, contact the Baum Consulting Group at 412-288-4800 and ask for our Retirement Plan Distributions brochure.