As discussed in a previous post, it’s usually a good idea to roll over your 401k when you leave a job. However, there are exceptions.
One good reason to pause before you roll over your 401k is to check if you might benefit from a little known tax break that goes by the rather cryptic term “NUA”. NUA stands for Net Unrealized Appreciation, which probably doesn’t help clarify things much either.
Essentially, NUA is a strategy by which people who hold company stock in their 401k plans can end up paying less income tax when making a withdrawal from the plan. Just as its name is a bit of a challenge to decipher, so is the rule itself. I won’t reinvent that wheel, since there is an excellent discussion of it in this Wall Street Journal article.
Suffice it to say that not everyone benefits, and there are downsides (such as having to pay the tax sooner than you otherwise might), but for those in certain situations, the tax savings can be worth it. Which situations are most favorable for NUA?
- You’re in a high tax bracket
- The stock is highly appreciated
- You own quite a bit of it
- You’re old enough to no longer be subject to a 10% penalty on withdrawals
- You need the money now (e.g. got laid off) and have to take at least some anyway
If you seem like a good candidate, be sure to check into it before you roll over your 401k. And DON’T sell the stock! Once it’s sold or the account is rolled over into an IRA, you’re out of luck when it comes to NUA.
There are a few other gotchas that can invalidate the whole effort, so be extra careful, read the fine print (yes, I mean the IRS documents), do the math, and seriously consider working with a tax specialist or financial planner, if you decide to go this route. In the end, if it doesn’t make sense for you, you can always just roll over…