The obscure acronym NUA, which stands for “Net Unrealized Appreciation”, is one that Lockheed Martin employees holding shares of company stock in their 401k plans might have heard. The Lockheed plan allows for the company’s stock to be an investment option in the plan, along with other more diversified selections such as mutual funds. This is a great way to allow employees to incrementally purchase shares to have a stake in the company, an incentive for them to perform well so in turn the company does as well.
NUA Rules
It is critical for Lockheed retirees to know about three important rules that must be met, to have the option of distributing the appreciated Lockheed shares and receiving more favorable tax treatment when those shares are ultimately sold. When considering whether this strategy makes sense, a multitude of factors including the income tax bracket, appreciation in the stock, expenses, and income must be considered to see if this is an attractive option to pursue.
As mentioned above, there are three important rules that must be met in order to qualify for this favorable tax treatment.
- The assets in your Lockheed 401k must be completely withdrawn within a single calendar year. You cannot make a partial withdrawal or rollover. 100% of the 401k must be distributed.
- The appreciated company stock that you wish to utilize the favorable NUA treatment on must be moved to a taxable account. You do not have to move 100% of the company stock to a taxable account, only the amount that would be most beneficial for your specific scenario.
- This distribution strategy can only take place after any of these triggering events:
- Reaching 59 1/2
- Separation of service (i.e. retirement, job change, etc.)
- Death or total disability of the employee
You will pay normal income tax on only a specific portion of the LMT stock, allowing you to keep the majority of the stock and hold it until you are ready to sell. At that time, you will pay tax at much more favorable capital gains rates, so long as the stock is held outside the 401k for at least one year.
One important side point about holding company stock in your 401k: it is good practice to review the investment lineup in your 401k annually to make sure that one position is not creating a concentrated or overweight position in the account. If there is one position that is creating a larger weighting, it would be prudent to review this with your financial advisor before making any changes.
Through the creation of a financial plan and working to determine the timing of various income sources or expenses, an advisor can assist in structuring a potentially more tax efficient plan. A common application of this strategy is to distribute a portion of the appreciated company stock to meet shorter-term expense goals, instead of taking a distribution from a qualified account.
NUA Example
Jim, age 62, has worked for Lockheed for most of his career and is contemplating retirement next year. He has purchased company stock in his 401(k) throughout his tenure there. The cumulative cost basis in the Lockheed stock is $200,000, but because the company has performed well the overall position is worth $400,000 resulting in $200,000 of growth.
Jim estimates his living expenses are approximately $100,000 per year. After an in-depth analysis it is determined that the optimal scenario is for Jim to take distributions from his retirement savings for 2 years, then begin his pension at age 65, and defer taking Social Security until age 70.
If Jim draws his living expenses from his 401k (or rolls the 401k into an IRA and draws from there), 100% of his withdrawals are taxed at Jim’s ordinary income tax rate.
Alternatively, if Jim utilizes the NUA option and then makes his withdrawals using just Lockheed Martin stock, his monthly distributions would be taxed at more favorable rates.
The example above provides a relatively simplistic scenario but does paint a picture of some of the different variables that must be accounted for. There may also be scenarios where a smaller amount is needed for an upcoming expense or goal and some, but not all, of the appreciated stock could be utilized for this purpose. This is not a strategy where it is either “all or none”, but one that requires a reviewing of the different options through a comprehensive financial plan.
Here at BentOak Capital we take a holistic approach to planning and factor in numerous scenarios to create an efficient plan to help meet your needs and goals. If you are interested in having a more in-depth conversation on this topic, please contact us at 817-550-6750 to coordinate a call or meeting with one of our advisors.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
