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Is My Net Unrealized Appreciation Option Lost Forever?

Friday, April 29, 2016

By Sarah Brenner and Beverly DeVeny

This edition of The Slott Report Mailbag looks at minimizing the upfront tax impact of a Roth IRA conversion, highlights the 401(k) and SEP IRA contribution limits and answers a question on the BIGGEST break in the tax code - net unrealized appreciation. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure.


1.


Hi, I am contributing to 401(k) and SEP IRA. What is the maximum contribution amount?

Answer: For 2016, if you are under age 50, and if the plans are with unrelated or not affiliated employers, you may receive up to $53,000 in contributions to the 401(k) and also receive up to $53,000 in contributions to the SEP IRA for a total $106,000. If the plans are with related or affiliated employers, total contributions to both plans for you cannot exceed $53,000. In either case, if you are age 50 or over in 2016, you may contribute an additional $6,000 as a catch-up contribution to the 401(k). This would increase the contribution amount allowed for that plan to $59,000. There are no catch-up contributions allowed to a SEP IRA. The rules for determining if employers are related or affiliated are complicated. If you have more questions regarding your situation your best resource is a knowledgeable financial advisor.


2.

I am 54 years old, and have $180,000 in a traditional IRA. I want to do a Roth conversion, but want to know if there is anything I can do to decrease my tax rate. My only source of income is capital gains and dividends. I do my own investing which would allow me to have only long, or short term gains in a year. Also, I could work part time during the year if needed for the reason of lowering the taxes on a conversion. Will any of these affect the taxes on the converted money?

Answer: Converting a traditional IRA to a Roth IRA is a great strategy for many taxpayers. However, there is a trade-off. You are paying taxes now in exchange for enjoying tax-free earnings down the road. There is no way to completely avoid the taxman when converting. Working part-time in the year of the conversion probably is not the answer. Your Roth IRA conversion income will increase your ordinary income for the year of the conversion – potentially causing the loss of valuable exemptions, credits, tax deductions – but, here is the good news, this only happens for the year of the conversion. Also, there are ways to minimize the tax bite. You may consider a strategy of partial conversions to a Roth IRA. You can do many small Roth conversions year after year to keep your income in a low tax bracket. You should consult with a tax advisor to determine your best strategy for reducing the tax generated in the year of a Roth conversion.


3.

Help, help, help! I have a company 401(k) with significant (to me) appreciation in company stock. I am 72 years old and have been taking distributions since I retired. To my knowledge, I was never advised by Fidelity or by my company with the NUA (net unrealized appreciation) option before I started taking distributions. In a recent conversation with my financial planner, it was determined that the approximate cost to me for the difference between the ordinary income rate versus the long-term capital gains rate was over $120,000! Needless to say, I am not anxious to give up on the NUA option even though all the information I have seen thus far indicates that once I took my first distribution I was no longer eligible for the NUA option. Please tell me that you know a way to save me the $120,000. Your assistance would be greatly appreciated.

Answer: You are right to leave no stone unturned! The rules for net unrealized appreciation (NUA) can be tricky. To take advantage of NUA, there must be a lump sum distribution after a triggering event such as retirement. This means that the entire plan balance must be withdrawn in one tax year after a triggering event. Unfortunately, it does not sound like that was the case in your situation because you have been taking distributions from the plan since retiring.

In your case, the only way the NUA break could be salvaged would be if there were another triggering event. For example, if you leave the funds in the plan, the NUA tax break would be available to your plan beneficiaries after the triggering event of your death. If you roll the plan funds to an IRA, the NUA opportunity is lost forever.