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ConocoPhillips 401K is ripe with opportunity and just one piece of an excellent benefits plan. But with these benefits come critical tax decisions. NUA is certainly one of them.
By utilizing NUA, you are setting your assets up for a potentially lower tax bill.
The ConocoPhillips NUA opportunity is unique. This post will talk through how to analyze your NUA opportunity at retirement, including which steps you should take before deciding whether or not you want to pursue this strategy.
Net unrealized appreciation is the opportunity to move stock shares in your 401k plan to a nonretirement brokerage account. By removing the stock from the retirement plan, you avoid income taxes and instead face capital gains. In many cases, capital gains tax rates are substantially less than income tax. So, making the right decisions around NUA can be a terrific way to lower your future taxes.
As a word of caution, NUA has very delicate rules from the IRS. In order to execute net unrealized appreciation, you cannot have prior distributions from the account. When you do your NUA distribution, you are required to either take NUA or rollover 100% of the account. In other words, you cannot elect NUA on 10% of your 401k and keep the remaining 90% in the account. In this example, the 90% portion must be rolled to an IRA and the 10% stock shares must be sent to a brokerage account.
NUA, similar to Roth conversions, does sign you up for an immediate tax bill. So why would you voluntarily offer to pay more taxes now? Because it can lower your taxes later.
Understanding this allows you to analyze your specific opportunity properly. As a general rule, you want to elect NUA on the stock shares that have huge appreciation. Any shares that have little appreciation can be ignored.
For example, if you have a $5,000 basis in a leveraged stock fund with a $50,000 market value, that’s an excellent opportunity. On the other hand, if your regular stock fund has a $90,000 basis with a $100,000 market value, that’s not compelling and should likely be rolled over with the rest of your 401k.
One of the lesser-known aspects of financial planning is that every single 401k is different. The HR department of each company has a tremendous amount of leeway to write their own bylaws and rules. That’s why some 401k plans offer Roth and after-tax contributions and others don’t. NUA structure also varies greatly between plans.
The ConocoPhillips 401K NUA structure has four main components depending on how long you’ve been at the company. Most of our clients have spent decades there and have exposure to both COP and Phillips66 (PSX) stock.
In addition to COP or PSX, the plan offers leveraged shares as well as standard shares. Leverage is an amplifier. If you add debt or leverage to a bad investment, it gets very bad. But adding leverage to a good investment obviously makes it very good.
As we wrote in the section prior, the first thing you’re looking for with NUA is BIG appreciation in your stock shares. Because of this, the leveraged stock funds (for both COP and PSX) are likely your best NUA opportunities.
In our firm, we use a service team to execute most of our paperwork, transfers, and rollovers. But with an NUA rollover, Jared or I always lead the process. NUA is a complicated part of our tax code that most people haven’t studied. Additionally, it can be difficult to determine if this applies to your plan as it’s seldom mentioned in the ConocoPhillips 401k plan document.
We have several examples of NUA rollover calls where the customer service representative gave bad information that was not correct. We’re talking about representatives that work for this specific 401k plan provider! In the last month, we helped one of our clients with their ConocoPhillips 401K to execute their NUA rollover, and the first customer service rep told us that we had to elect NUA on all four COP/PSX positions.
This is not correct. Had we taken this person at their word (given that this is their job–most people do), our client would have had to realize over $90,000 in additional income tax this year. That would have been a disaster!
The point being, you either need to know the NUA rules extremely well or work with a professional who does. Do not take your 401k plan’s employees at their word.
Once you have elected your NUA/rollover, the process takes a few weeks and involves Computershare. Your NUA shares will go to a Computershare brokerage account. The shares you do not elect NUA on will go to a Computershare IRA. The remaining portion of your 401k will go to the IRA of your choice (our clients can either have an IRA at Fidelity or TD Ameritrade, soon to be Schwab).
Once the COP/PSX shares arrive at Computershare, you can transfer them to the same custodian as your IRA (in our case, TD Ameritrade/Schwab or Fidelity).
NUA is such a great opportunity because of the future tax benefits of owning shares in a brokerage account instead of an IRA. Two opportunities stick out:
Let’s pretend that you elect NUA on leveraged COP, leveraged PSX, and regular COP. For this example, your cost basis in all three is $30,000. The market value is $160,000.
Electing NUA would create a taxable income of $30,000 in the rollover year (you could use after-tax funds to lower this amount). But you’ve now released $160,000 from your retirement account. You could enjoy qualified dividends from these shares in future years.
But you could also sell the shares in future years and live off the proceeds completely tax-free!
If your income and capital gains fall below $80,000 in the calendar year, you can enjoy a 0% capital gains tax bracket (married filing joint). So, you could theoretically enjoy two years of income with no tax consequence at all.
Due to the benefits at ConocoPhillips, it’s common for retirees to have substantial pretax assets. The marginal rate you’ll pay on a substantial IRA is likely 22-32%. Realizing a 0% capital gains tax rate is a huge win.
There is one other option for NUA shares: charitable giving.
If you are giving to your church or a charity at all, stop giving cash. Always give appreciated stock.
Another idea: Bunch or combine multiple years of giving into one year using a donor-advised fund. As we’ve written about, most Americans do not receive a tax deduction for their charitable giving. By strategically planning multiple years of giving, you can maximize your deduction and still enjoy the substantial standard deduction in other years!
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