Net Unrealized Appreciation and Qualified Retirement Plan Distributions

Often, individuals employed by large corporations have the option to invest some of their qualified retirement plan contributions (e.g., 401(k) contributions), as well as employer contributions, into their employer’s stock. If you believe in the long term prospects of the company, that may make sense as part of your asset allocation strategy.

But what happens to that stock when you retire or leave the company? What happens if you still believe in the future prospects of the company and still considers the company stock a sound investment? You probably already know that distributions from a qualified plan can be somewhat complicated and have income tax consequences. But, is there a distribution strategy that may be effective to help you maintain the stock and minimize income taxes when you leave the company?

A Possible Solution: Net Unrealized Appreciation (“NUA”)

NUA is a tax strategy that allows you the opportunity to convert taxable ordinary income into long-term capital gain. Ordinarily, if you took a lump sum distribution of the assets in the plan, you would pay ordinary income taxes. However, when company securities are part of the distribution from the plan, using the NUA strategy, you can pay ordinary income taxes on just the cost basis of the shares, but defer and convert to capital gain the tax on the difference between the fair market value of the shares and the average cost basis of those shares. The difference is the net unrealized appreciation. When the shares are actually sold, the NUA will be taxed at long term capital gains rates regardless of how long the plan held the shares. If there is additional appreciation of the shares after the shares are distributed from the plan, that growth is taxed as long or short-term capital gains, depending on whether the ultimate sale is more or less than one year after the distribution.

Note: you can elect to pay the taxes upon distribution instead of waiting until the shares are sold. In some situations, depending upon cash flow concerns and anticipated future tax rates, payment of the taxes at distribution may make sense. In addition, in order to qualify as a lump sum distribution, the distribution must be on account of death, separation from service or the attainment of age 59 ½ years. (The definition is slightly different for self-employed persons: “separation from service” does not qualify; disability does.)

Example:

Jim, age 60, is ready to retire and has a balance in his employer’s retirement plan of $300,000, including company stock with an average cost basis of $30,000, and a fair market value of $130,000 (the NUA is thus $100,000). Jim’s account is a result of the many years of pre-tax contributions and employer matches to the account. If Jim takes a lump sum distribution from the plan, normally, he would pay ordinary income tax on the full $300,000 in the year of distribution. Under the NUA strategy however, Jim deposits the company stock into a brokerage account but does not sell it. As a result, only the $30,000 average cost basis of the company stock, and the $170,000 value of the other assets in his account (for example, mutual funds), would be taxed at ordinary income rates. The NUA would not be taxed. Sometime later, Jim sells the company stock. At that time, the NUA will be taxed at long term capital gains rates when the employer securities are sold, regardless of the holding period. However, any additional appreciation of the securities after distribution from the plan is taxed as either a short or long term capital gain depending on Jim’s holding period after distribution.

Now, suppose that instead of taking a lump sum distribution, Jim wants to roll over his entire qualified plan account into an IRA. This may be the appropriate strategy depending upon Jim’s situation. However, by rolling over the company stock into the IRA, the NUA tax treatment would be lost. Jim should take the company stock, place it into a regular brokerage account and roll over the remaining balance to an IRA. Jim would roll over the $170,000 of his account balance (i.e., everything other than the company stock) to an IRA. He would take a direct lump sum distribution of the $130,000 in company stock and place it in a securities brokerage account. $30,000 would be ordinary income, and the $100,000 of NUA would qualify for the special tax treatment.

If Jim was under age 55 at distribution, (or even if he were under 59 ½ and not leaving the company, he would not be able to take a lump sum distribution from the plan without a 10% premature distribution penalty on the taxable portion, i.e. the $30,000 average cost basis component of the stock distribution. In that case, Jim may wish to roll the entire account into an IRA.

So far, we’ve talked about the NUA strategy using your pre-tax employee contributions and the company match, if any. Some plans also allow employees to make after-tax contributions to the plan. Suppose you also made after-tax contributions and used that money to purchase company stock?

You can roll the entire account into an IRA, but the appreciation of these shares of company stock, purchased with after-tax contributions, will be subject to ordinary income taxes when you take distributions from the IRA. Similar to the situation mentioned above, where company stock is purchased with pre-tax contributions, shares purchased with after-tax contributions should be distributed to utilize the NUA strategy. The difference is that the average cost basis is not taxed when the contributions are made with after-tax dollars. The reason: these shares were purchased with after-tax dollars so it was already taxed. The NUA and additional appreciation will be subject to capital gains tax as explained before.

Could you do a direct Roth IRA conversion of the entire plan balance and still maintain the favorable NUA tax treatment? This area is unclear, but probably not. The lack of clarity is a result of inconsistent language between certain provisions in the Internal Revenue Code, legislative history and the interpretation of these provisions by the IRS.

Conclusion

If you invested in your company’s stock in your employer sponsored qualified retirement plan, before you decide upon a lump sum distribution from the plan, or a rollover of the account balance, including the company stock, into an IRA, consider whether you may be entitled to use the NUA tax strategy to reduce your income tax liability.

The foregoing information regarding estate, charitable, retirement and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only.  You should consult with your tax and legal advisor regarding your individual situation.

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Free 30min phone chat with a sr financial advisor at Harding Financial to help you reduce income taxes using a business structure and financial strategies, connie.dellobuono@hardingfinancial.com or conniedbuono@gmail.com 408-854-1883

Make 2014 and 2015 be the year to protect your wealth and secure your retirement.

 Connie Dello Buono
Jr Financial Advisor
hardingfinancial.com

Retirement woes and stock market loses of 45-65 yrs olds

 

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  • At 45 yrs of age, you want to save in the next 25 yrs and ensure your lifetime retirement income to support the lifestyle that you want.
  • At 50 yes of age, you want a safe place to grow your savings or investments with no market loses like the stocks and you want to recoup what you have lost in the market to retire early.
  • At 60 yrs of age, you want to use some of your savings tax free without paying penalties and taxes which would amount close to 40-50% of your savings.
  • At 65 yrs of age, you know that you might need long term care and you have no long term care insurance and might not be insurable any longer.
  • At 70 yrs of age, you are required to withdraw your savings and incur a huge tax as a result.

Now, you do not have to have these pains of the future if you know there is an Index Universal Life policy with additional living benefits such as terminal and chronic illness riders and lifetime retirement income riders.

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After saving away in the next 20 yrs, around 10% of your net income you are scheduled to receive a lifetime retirement income until you are 120 yrs old. For sure, you will not outlive your money.

Using an index strategy, in an IUL policy your savings do not participate when the market is in downside potential but keeps your principal and gains intact. You can create an estate of $500k to $2M at a stroke of a pen with a policy that is not term (renting) or whole life insurance (1-3% with return) but an IUL for tax free cash accumulation between 8-13% return.

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Mon-Friday: San Jose 8pm
Also available online and via skype

More than 10 reasons why we need life insurance

Your greatest asset to protect is your life. As a mother and a life insurance agent, I want to show you why we need life insurance, not just for creating an immediate estate to my children in the absence of an inheritance as I am not rich at the moment. Connie Dello Buono CA Life Lic 0G60621 motherhealth@gmail.com 408-8541883 (in 50 US states) Here are the top reasons why we all need a life insurance:

1. create an asset or estate, up to $2M

2. allow my family to grieve peacefully, without worries and can remember me during the time that the life insurance proceeds can help them with college, buying a house or sending their children to college

3. allow my family to find money should I need a similar to long term care needs after a stroke, disability or an early/last stage terminal illness

4. provide for a lifetime retirement income for me as I do not have other retirement plans in place

5. More than ten reasons for business owners, like a buy and sell agreement would allow the other partner not to deal with the spouse should the business partner dies, and here are  the other reasons:

mortgage protection how much disability income do I need index strategy and rates indexing strategy dividends return of premium IRS rules and modified endowment contracts riders LSW 1035 exchange p2 1035 exchange p1 survivorship no probate estate created mortgage protection money purchase key person executive bonus final expenses life insurance with added LTC similar to long term care policy buy sell agreement life insurance you do not have to die to use

 

Note: Chronic illness rider is currently being reevaluated in California. Some IUL caps or returns up to 10%,12%,13%,15% or more with guarantees of 2%,2.5%,3%
Your referral to anyone who needs a retirement review, estate plan review, life insurance review, college plan review and life review is much appreciated.

Connie Dello Buono , CA Life Lic 0G60621
motherhealth@gmail.com

From spender at 20 yrs old to senior citizen at 66 yrs old

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motherhealth@gmail.com

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1708 Hallmark Lane San Jose CA 95124

 

 

 

 

 

 

 

Roth IRA and Index Universal Life Policy, both tax free retirement plans

Roth IRA, municipal bonds and Index Universal Life Policies (IUL) are all tax free retirement plans. I choose  Index Universal Life Policy with living benefits because of the many limitations of Roth IRA. With my age and income fluctuations, I can save more in sickness or health, create a bigger estate when I die and not have many limitations. The only one limitation of an IUL is that you must be healthy or have a manageable health condition.

But it is good to diversify.

Here are the most common and sometimes costly mistakes you must avoid with your Roth IRA:

1) Not Being Eligible. You or your spouse must have earned income to contribute to a Roth IRA, but not everyone qualifies, specifically if you’re a higher income earner. The IRS adjusts income thresholds every year to determine if you qualify for a Roth contribution. It’s important to note that you file Married Filing Separate you generally lose the ability to contribute to a Roth IRA.

2) DIY Roth Conversion. While it’s technically possible to draw out your IRA funds (take possession) and then transfer to a Roth IRA it’s not worth the risk of missing the 60-day deadline which could cause you big taxes and the loss of the Roth. It’s easier and more preferred to convert an IRA/401(k) to a Roth via a custodian to custodian transfer.

3) Excess Contributions. It’s no secret that just contributing the max to your Roth won’t provide you enough money throughout your retirement, but be mindful of the annual contribution limits of $5,500 (ages under 50) and $6,500 (ages 50 & over). If you over contribute you may be assessed an IRS excise penalty.

4) Missing Out. One of the biggest mistakes is not having a Roth at all! Even if you contribute to your company 401(k) you still may qualify to contribute to your Roth IRA. Even if your spouse isn’t working you may be able to contribute to his/her Roth as well, in addition to yours, what’s called a “Spousal Roth IRA Contribution.”

5) Not Maximizing Your Tax Bracket. Are you in a low tax bracket? If so, have you maximized your bracket? Say you make $50,000…you’re in the 15% bracket, meaning that you make less than $73,000, why not convert $23,000 of your IRA/401(k) to a tax-free Roth…all at a 15% tax rate? The same logic may hold true for the 25% bracket, those making less than $148,000, married filing joint.

6) Beneficiary Boo Boo. One of the benefits of a Roth is that you are not required to take a yearly RMTD (Required Minimum Taxable Distribution) at age 70 1/2 and older. This is welcome news for Roth IRA owners and their spouses, but when the Roth is passed to non-spouse beneficiaries they are required to take yearly RMDs (of course tax-free), which is often missed and penalties ensue. I suppose this requirement is to limit the amount of wealth that can be passed for generations, but the Roth is still a good deal because, if structured and invested properly, it may pass through 3 generations…all tax-free!

7) Missed RMD Before Conversion. If you’re 70 1/2 or older and subject to the dreaded required taxable distribution from your Traditional IRA be careful when converting to a Roth IRA. Contrary to common sense, before a Roth conversion takes place you must first satisfy your yearly IRA required distribution, then you may convert the remaining balance in your IRA to Roth.

8) Missing Beneficiaries. I know it sounds elementary, but I estimate about 2 out of every 3 prospective clients I meet with have incomplete beneficiary designations. It’s typically due to one of two mistakes. First, there are no beneficiaries listed beyond the primary beneficiary…with everything in life you must have a contingency plan, so make certain you have a contingent beneficiary listed on your Roth. Second, if there are beneficiaries listed they are vague…there’s a big difference between “named beneficiaries” and “designated beneficiaries”, be specific. List their name, DOB, social security number, and address to avoid confusion and problems upon inheriting the Roth.

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