There is a provision in the tax code that allows certain 401(k) participants to convert what would be ordinary income — taxed at rates up to 37 percent — into long-term capital gains, taxed at 0, 15, or 20 percent for most retirees. The provision applies specifically to employer stock held inside a 401(k). It is called Net Unrealized Appreciation, or NUA. Most 401(k) participants who would benefit from it have never heard of it. And once they roll their account to an IRA — the reflexive default at retirement — the opportunity is gone permanently.
When a worker holds employer stock inside a 401(k), two components exist within that holding: the cost basis and the appreciation. The cost basis is the price at which the shares were originally purchased or contributed — essentially the amount that went into the account to acquire them. The net unrealized appreciation, or NUA, is the gain on top of that — the difference between what the stock is worth today and what it originally cost. Under a standard 401(k) rollover to an IRA, every dollar eventually withdrawn — including both the original cost basis and all the appreciation — is taxed as ordinary income. If the retirement tax bracket is 24 percent and the account contains $1,000,000 in appreciated stock, the eventual tax bill on that stock, when withdrawn, is $240,000 or more. Under the NUA strategy, the company stock is distributed in-kind from the 401(k) directly to a taxable brokerage account — not rolled to an IRA. The participant pays ordinary income tax immediately, but only on the cost basis of the stock. The accumulated appreciation — the NUA — is taxed at long-term capital gains rates when the stock is eventually sold. For most retirees in the 22 percent federal bracket, that means the appreciation is taxed at 15 percent rather than 22 or 24 percent. Tax Treatment IRA Rollover NUA Strategy What is taxed at 100% of all withdrawals, Cost basis only — paid ordinary income including all growth at time of distribution rates What is taxed at Nothing — all taxed as The NUA (all appreciation capital gains rates ordinary income above cost basis) When tax is paid At each future withdrawal Partially now (cost basis); rest at stock sale Tax rate on Up to 37% ordinary income 0%, 15%, or 20% long-term appreciation rate capital gains rate Access to funds Through IRA, subject to In taxable account — no RMD rules RMD requirements
Tony has a $2,000,000 401(k). Half of it — $1,000,000 — is in heavily appreciated employer company stock with a cost basis of $50,000. His retirement tax bracket is 24 percent. Under an IRA rollover: Tony pays no tax today. When he withdraws the stock's value in retirement, every dollar is ordinary income. On the $950,000 of appreciation alone, he will eventually pay approximately $228,000 in federal income tax. Under the NUA strategy: Tony takes the company stock as a lump-sum distribution to a taxable brokerage account. He pays 24 percent tax on the $50,000 cost basis immediately — a tax bill of $12,000. The $950,000 of appreciation is now subject to long-term capital gains rates when he sells. At 15 percent, the tax on the appreciation is $142,500. Total tax under the NUA strategy: approximately $154,500 — saving Tony more than $73,000 compared to the IRA rollover. THE ALL-OR-NOTHING RULE The NUA strategy is not optional for just the company stock portion. The IRS requires a lump-sum distribution of the entire account balance from all plans of the same employer within a single calendar year. This means Tony cannot pick out the company stock, use the NUA strategy on it, and roll the rest to an IRA in two separate transactions over two years. He must distribute the entire 401(k) — all of it — in one calendar year. The non-stock assets can be rolled to an IRA in the same transaction; only the company stock goes to the taxable account. If the company stock is rolled to the IRA instead of distributed in-kind, the NUA treatment is permanently lost. There is no correcting this after the fact. Source: IRS Publication 575 (Pension and Annuity Income); IRS Notice 98-24
The NUA strategy only applies after a qualifying triggering event, as defined by the IRS. The four events are: separation from service (leaving the employer), reaching age 59½, death of the participant, or disability. Any of these events can initiate the NUA-eligible lump-sum distribution. For most retirees, separation from service — retirement — is the triggering event. But age 59½ is also a trigger that can be used while still employed, which creates a planning window for workers with heavily appreciated company stock who want to act before leaving the company.
Once the company stock is in the taxable brokerage account, any additional growth from that point forward does not qualify for the immediate long-term capital gains treatment — that treatment was locked in at the time of the distribution for the NUA that existed then. Post-distribution growth is short-term capital gain if sold within a year, long-term if held more than a year. Net Investment Income Tax (NIIT) — a 3.8 percent surtax on investment income for higher earners — also applies to the sale proceeds once the stock is in the taxable account. For single filers with modified adjusted gross income above $200,000 and married filers above $250,000, the effective capital gains rate on NUA stock is 18.8 percent rather than 15 percent. This does not eliminate the advantage over ordinary income rates but narrows it. The cost basis tax is also due immediately, in the year of distribution. A retiree who needs to fund that tax bill must have available cash outside the 401(k) — typically from savings or proceeds from other assets. If the immediate tax cost creates a cash flow problem, the strategy may not be executable regardless of its theoretical tax efficiency. WHAT TO DO NEXT NUA eligibility requires a qualifying trigger event and must be acted on before funds are rolled to an IRA. **→ Review IRS Publication 575 (Pension and Annuity Income) for the full NUA rules and distribution requirements** **→ Obtain the cost basis of your employer stock from your plan administrator before making any distribution decision** **→ Compare the projected tax outcomes of the NUA strategy vs. full IRA rollover using both figures** **→ Do not roll company stock to an IRA until this analysis is complete — the NUA option cannot be recovered after the fact** EDITORIAL NOTES *mission_test_pass: TRUE — NUA is explicitly flagged in the KW research as having 'near-zero competition' and 'high CPA referral conversion.' The strategy is standard knowledge among tax professionals and is missed by the majority of retiring employees who hold appreciated company stock — precisely because the default IRA rollover path happens automatically.* *compliance_reviewed: PENDING — IRS Publication 575 and IRS Notice 98-24 are accurate citations for the NUA rules. The $73,000 savings figure in Tony's example is derived arithmetically from the stated assumptions ($950,000 NUA, 24% ordinary rate vs. 15% capita
IRS Publication 575 (Pension and Annuity Income); IRS Notice