Power Up Wealth podcast – Company Stock Down Big? – Episode 22 transcript:
Sharla Jessop 0:00
Holding company stock in your 401k may create some advantages, especially if your company stock is down. I’m Sharla Jessop, and today my friend and colleague Mikal Aune will share a little-known strategy with some big advantages.
Welcome to the SFS Power Up Wealth podcast, where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics, preparing you to make smarter decisions with your money.
Mikal, thank you for joining me today.
Mikal Aune 0:48
Glad to be here Sharla.
Sharla Jessop 0:50
Mikal is Vice President of Wealth Management at Smedley Financial Services. He’s a Certified Financial Planner and holds an MBA. Mikal, many 401k investors, hold company stock in their 401k and will pay ordinary income tax on the value of that when they sell it. But there are ways to reduce that tax burden with some advanced planning.
Mikal Aune 1:10
Yes, one strategy that some people will probably have heard of, is called net unrealized appreciation, or NUA, if you look it up. And it’s just a way to reduce your taxes in the future, right, and to try to get long-term capital gains rates, instead of ordinary income tax rates. You’re just looking at ways to reduce your income. One thing that people have not heard of is net unrealized depreciation. And that may be a phrase that’s coined, you know, recently, because stocks are down. But net unrealized depreciation is a way to set you up so that you can do net unrealized appreciation in the future. And the point of all that is to lower your cost basis now. And it works just at this point in time because stocks are down across the board. There are a few companies that are still up, we especially look at our Silicon Slopes companies, and most of those are down right now. Some are still up. It gives us a great opportunity to do some tax planning now that could set you up for good opportunity in the future.
Sharla Jessop 2:13
A lower tax basis seems backwards. Don’t you want a higher basis, typically?
Mikal Aune 2:19
Outside of a 401k? Yes, exactly. Because basis just means what did you pay for it? And how much have you already paid tax on? So, for example, if I have already purchased a stock, and I’ve already paid tax on it, I don’t wanna have to pay tax on that again, I only want to pay tax on the growth. And that’s what you do outside of a 401k. But inside of a 401k most high earners are putting in their money pre-tax. And if you’re putting it in their pre-tax, when you will retire, what you pull out is all going to be taxed at that point in time. And it’s taxed at ordinary income tax rates. And that can be as high as 37% for federal and in Utah is 5% for state that hurts when you have to pay that much in taxes.
Sharla Jessop 3:02
How does NUD protect you from taxes.
Mikal Aune 3:05
The point of it is setting you up for NUA in the future. So let’s understand and unpack NUA a little bit. And this is a little complex. But it can really benefit you if you have the your own company stock instead of your 401k. And it has to be your own company. It can’t be like, hey, I work at Smedley Financial and I’m buying Coca-Cola. Right? It has to be your own company stock. Usually when you turn age 59 and a half or retire, you can pull out your own company stock into a brokerage account. And you have to do this transaction in kind. It comes out in two pieces. There’s basis and there’s growth and we talked a little bit about basis. That’s going to be taxed immediately. And that is taxed at your ordinary income tax rate could be as high as 37%. But the growth could be taxed at a long-term capital gains rate, which is only 20%. An example of what that would look like is that if you inside of the 401k, purchase 10,000 shares at $1 each. So you spent $10,000 of your hard-earned money. But your company has done really good and the stock has taken off, it’s now worth $100 a share, which is not out of the realm of possibility. I’ve seen stocks that are appreciated a lot more than that. But your $10,000 you put in is now worth a million dollars. If you cashed out that full million dollars and paid 37% in federal tax, that’s 370. You’re only left with $630,000. If you want to do NUA after a trigger event, you can transfer company stock into a brokerage account. Now let’s say if you did that your basis is $10,000. So you’d be taxed on that immediately, which would be 37% or $3,700. But you turn around and the growth of $990,000 is taxed at only 20%. That’s only $198,000. So if you put those two together, you’re still left with $798,000. That sounds a heck of a lot better than getting 630,000.
Sharla Jessop 5:00
What do you mean by trigger event?
Mikal Aune 5:01
Trigger event. There’s four different things that could be. So a trigger event is either separation of service, or you turn age 59 and a half, or disability or death. Now, death is only your family would care about doing NUA if you have death as a trigger event, right, but a separation of service, there’s a lot of people that, you know, they’re over 59 and a half, and they leave the company because they decide that they’re going to retire. And they can pull their money out and do an NUA transaction and save themselves a lot of taxes. A lot of times under 59 and a half, you don’t do it, because you have to pay a 10% penalty on the basis. It can still make sense though, like if your basis is really low, even if you pay a 10% penalty, it might be worth it now to pull it out. You let the company stock grow back, and all the growth is taxed at long-term gains rates. So there is a case to say, hey, you could do it now even if you’re under 59 and a half. But most of the time you do it you know age 59 and a half or older. One thing to keep in mind it has to be age 59 and a half or the years that you turn 59 and a half. And if you miss that, it’s not like you can just do it any year after that you have to wait until separation of service or another trigger event like that.
Sharla Jessop 6:14
That’s NUA, net unrealized appreciation. How does this apply to net unrealized depreciation?
Mikal Aune 6:21
Well, NUA only really works. If your stock is highly appreciated. That’s the only time that it makes sense. If, if your stock is worth less than what you paid for it, I’m not going to pull it out and pay tax on the higher amount, I’m going to just pay tax on the lower amount of what it is right at that point. So the point of net unrealized depreciation, and how it can save you a lot right now is, if your company stock is down, you can reset the basis. You can lower that basis to what it is currently. So what that looks like is, let’s say you did the inverse, or the opposite of what we just talked about, as an example. And you forked out a million dollars to buy 10,000 shares at 100 bucks apiece, and your company stock has really tanked and it’s now worth a buck. That would really hurt because you’re like, oh, that’s only worth $10,000. Now, you know, in my retirement seems like it’s a ways off, it’s not going to happen, like I thought it was going to happen. But if you still have time on your hand, you can reset the basis. You can sell that company stock. You can turn around and buy it back and depending on your 401k company, you might be able to buy it back the next day. And that’s not a wash sale, and then you can let that money grow for the future. And then you can do NUA. So the point of NUD is being able to set you up for NUA in the future or net unrealized depreciation now, resetting the basis gives you the ability to do NUA in the future. So that includes a wash sale rule outside of the 401k if you sell a stock at a loss, you have to wait for at least 30 days to buy back the same stock. That rule does not apply inside of a 401k, which is nice.
It seems like you’d want the company that you’re working for and stock you’re talking about to be pretty consistent, something you think is going to have growth in the future.
Yes. So one, you have to trust the company, you have to have real belief that they’re going to grow for the long run, which there are a lot of companies that will do good even if their stock is down right now. There are some that won’t, and some companies will disappear. And you know, trying to do something like this may not benefit you. And so it really behooves you to find a good financial adviser and a CPA that know about NUA and NUD and can really help you set yourself up for the future.
Sharla Jessop 8:34
Sounds like there could be some potential pitfalls. Tell us about that.
Mikal Aune 8:38
There are a lot of potential pitfalls. It’s complex financial instrument. Some of the things you have to pay attention to are like the company plan and what they allow, because some company plans won’t allow you to buy the stock back the next day anyway, you have to wait 15 days. Some company payment plans may not allow you to buy or sell the whole amount that you want to sell. So you’d have to check with your plan provider to make sure that it’s possible to do what you want to do. Some other caveats you have to pay attention to is that when you take the money out, the distribution has to be in kind, you can’t sell it first and then take the cash out in then buy the stock back outside. Doesn’t work that way it has to go in kind. Also, you have to take a lump sum distribution of the full account in that year. So if you take out, you know, say a million dollars, that’s your company stock and you have another million dollars invested in other assets that has to be gone or out of that plan by the end of that year. Now, typically, people will take that money and they’ll put it over and roll it over into an IRA. And then they don’t pay tax on the other portion and you only pay tax on the basis of the stock that you did the NUA transaction on. So it is very complex. There are lots of pitfalls and unless you do a lot of research on it, it’s best that you consult with some qualified professionals.
Sharla Jessop 9:54
It does sound complex, but Mikal I think that experience tells us that some of the best ideas are the little known ideas and the ones that are a little more complex because they give you the larger advantages.
Mikal Aune 10:05
Yes. And I agree. And that’s why we wanted to bring this up now is now’s a good time to take advantage of this. Don’t wait until your company stock has come back because then it doesn’t help you at all. So if your company stock is down, and you want to save yourself potentially a boatload of taxes in the future, now is a great time to take advantage of NUD.
Sharla Jessop 10:23
And that’s if you hit those triggers.
Mikal Aune 10:25
Yes.
Sharla Jessop 10:25
Not available to everybody you have to hit the trigger.
Mikal Aune 10:27
So you can sell the stock now, but in order to do NUA in the future, you have to hit those triggers before you’re able to pull the money out of the plan to take or do in NUA transaction.
Sharla Jessop 10:38
Mikal, thanks for sharing this advanced concept with us.
Mikal Aune 10:41
Happy to do so.
Shane Thomas 10:47
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn.
The views expressed are Smedley Financials and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Securities America. Inc., Member FlNRA/SIPC. Roger M. Smedley, Sharla J. Jessop, James R. Derrick, Shane P. Thomas, Mikal B. Aune, Jordan R. Hadfield, Lorayne B. Taylor, Registered Representatives. Investment Advisor Representatives of Smedley Financial Services, Inc.®. Advisory services offered through Smedley Financial Services, Inc.® Smedley Financial Services, Inc.®, and Securities America, Inc. are separate entities.
