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Test Your Knowledge of the Net Unrealized Appreciation Strategy
(Updated: 10/08/2018)

If you invest in your employer's stock through a 401(k), an employee stock ownership plan, or another qualified retirement plan, you may be eligible to take advantage of a tax deferral strategy called net unrealized appreciation (NUA).

Normally, any distribution from a qualified plan is taxed at ordinary income tax rates. With an NUA strategy, however, you may distribute your employer's stock to a taxable account and pay ordinary income tax on your cost basis only. The NUA portion of the distribution (i.e., the difference between the fair market value of the stock at the time of distribution and the cost basis) is tax deferred until the shares are sold. Once you sell the shares, the NUA portion will be taxed at long-term capital gains rates, which are typically much lower than ordinary income tax rates.

Which of the following must occur in order to successfully execute an NUA strategy?

  1. You must wait for specific "triggering events" to occur, which include turning age 59½, separation from service (if you're an employee), disability (if you're self-employed), or death.
  2. You must take a lump-sum distribution of your entire plan balance (including the non-employer stock portion) within the tax year in which you elect NUA treatment.
  3. You must elect NUA treatment on all employer stock.

Answer: A and B

To successfully execute an NUA strategy, you must take a lump-sum distribution after a triggering event has occurred. You are not required to elect NUA treatment on all employer stock. Instead, you can elect NUA treatment on individual share lot(s), as long as there are records to identify those share lots. One common strategy is to pick the lowest-basis lot(s) to minimize the ordinary income tax owed on the initial NUA distribution. Any lot(s) that you elect not to take NUA treatment on can be rolled into an IRA to allow them to continue to appreciate tax deferred.

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