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Net Unrealized Appreciation and Your Retirement Account

October is here, time is passing by and the deadline for opening a SIMPLE IRA for your company for this year has passed. Do not despair! Other retirement plans for your company and yourself are still available!This topic is not for everyone. You need to be in a certain situation and an age to make this a viable option. This contains general tax information and is not intended to be relied on as tax advice by any individual. See your own tax advisor for determining how these rules apply to you.Now that the disclaimers and disclosures are out of the way, let us get into the topic. I did see this option used during the heady days of the technology market by people who were in a high tax bracket. Do they still work in today’s market?What is Net Unrealized Appreciation?If you’re about to change jobs or retire, you could receive a substantial lump-sum distribution from your employer’s retirement plan. There are two common options for the distribution of assets from qualified plans. The first is to withdraw the funds and pay substantial ordinary income taxes. The second is to roll over the assets and defer the taxes.There is a third option. It is Net Unrealized Appreciation (NUA) and it may only be applied to employer securities distributed from a qualified plan. Employer’s securities would be individual stock that has been purchased for your account but it does not include a company stock fund. The net appreciation of the security remains unrealized until you sell it.When Does the NUA Option Apply?NUA applies only when the employer security is received as part of a lump-sum distribution. This refers to the distribution of the entire balance, within one tax year, of all similarly qualified plans – such as 401(k) plans, profit-sharing plans or stock bonus plans.It also must occur because of one of four reasons: death, disability, separation of service, or attainment of age 59 and a half. Check with your plan administrator to determine whether your distribution qualifies as “lump sum.”How are Taxes Calculated?The employer securities were credited to your qualified plan at various prices throughout your working career. Hopefully, the value of this asset increased over the years.In order to determine the portion of the employer security that is taxable, you must calculate the cost basis of the asset, i.e., the sum of the original purchase price of each individual share. The cost basis, not the current value, becomes the basis for paying income tax. To find the cost basis, look at box six of the IRS Form 1099-R. Your plan administrator includes the original value of employer securities on this form.When you sell or exchange any portion of this stock, the gain (or difference between the purchase price and the selling price) is taxed at capital gains tax rates. This is generally more favorable than the normal tax rates. For instance, if you hold the asset for more than one year, the maximum capital gains tax rate is 15 percent. Compare that to your normal income tax rate, and you could see the advantage. Also, the tax does not apply until you actually sell or exchange the asset. If you decide to keep the asset and pass it on to your heirs, you do not have to pay those extra taxes.What Happens When Your Beneficiary Receives This Asset?To figure your capital gains on most investments, you take the sale price of an investment and subtract your cost basis. The cost basis is simply the price you paid for an investment, such as stock. Although it’s sometimes a good idea to gift assets away during your lifetime to reduce your taxable estate, your cost basis will carry-over when your beneficiary goes to sell the asset. This means your beneficiaries will incur a capital gains tax upon the sale of the asset.On the other hand, if you leave assets to your beneficiaries at your death, they usually receive a new or “stepped-up” basis that is equal to the fair value of the asset at the time of your death. Although the assets were valued in your gross-estate, the stepped-up basis could mean lower capital gains taxes when the beneficiaries sell the asset.However, the “stepped-up” basis rule is very different as applied to employer stock. When employer stock is passed at death to beneficiaries, the beneficiaries will not receive a stepped-up basis for the unrealized appreciation that occurred between the time the stock was purchased by a decedent’s qualified plan and the time the stock was distributed to the decedent. On the other hand, any appreciation occurring after the date the plan distributed the stock to decedent will receive a stepped-up basis.Assuming there is appreciation after the distribution date, the beneficiaries essentially receive a partial stepped-up basis equal to the post-distribution appreciation.As a practical matter, it is very important for your beneficiary to know the status of the asset, including the original cost basis and distribution amount. Please seek the advice of a professional tax advisor regarding this complex tax matter.Will Using the NUA Option Help You?The value of using NUA option depends on a number of factors, including cash flow and whether you have a sufficiently diversified investment portfolio. If company stock is your biggest asset, you may find yourself heavily weighted in just one security. It is generally advisable to carry a blend of investments to help weather the volatility of the financial market.Donnell Services, LLC719-886-3377Registered RepresentativeSecurities America, Inc.Member NASD, SIPCwww.alexdonnell1.sarep.comDonnell Services, LLC, Securities America, Inc. are independent companies.

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