Net Unrealized Appreciation (NUA): The Secret 401(k) Exit Strategy for Company Stock
Net Unrealized Appreciation (NUA): The Secret 401(k) Exit Strategy for Company Stock
COACHING POINTS
- The Opportunity: If you hold highly appreciated company stock (e.g., Apple, Microsoft, Exxon) inside your 401(k), the standard “Rollover to IRA” advice is a mistake. It converts capital assets into ordinary income assets.
- The Strategy: Use the NUA Election. Move the company stock to a Taxable Brokerage account (not an IRA). You pay tax now on the original cost basis, but the massive growth is taxed later at the preferential Long-Term Capital Gains rate.
- The Spread: For high earners, the difference between Ordinary Income Tax (37% + NIIT) and Capital Gains Tax (20%) is huge. NUA captures this spread, saving tens of thousands in taxes on large positions.
Normally, the IRS is rigid: “Money coming out of a pre-tax 401(k) is Ordinary Income.”
But there is one major exception buried in the tax code: Net Unrealized Appreciation (NUA).
If you worked for a successful company for 20 years and accumulated stock, this rule lets you treat your 401(k) gains like a founder’s stock, not a paycheck.
Source: IRC Section 402(e)(4)
Calculating the savings on $1 Million of Company Stock.
- Total Value: $1,000,000.
- Cost Basis (What you paid): $200,000.
- NUA (The Growth): $800,000.
- Scenario A (IRA Rollover): Withdraw $1M later. Taxed at 37%. Total Tax = $370,000.
- Scenario B (NUA Election): Pay 37% on Basis ($74k) + 20% on Growth ($160k). Total Tax = $234,000.
- The Alpha: You save $136,000 instantly by choosing the right box on the distribution form.
What-If Scenario: Long-Term Tech Employee (Age 60)
Portfolio: $500k Diversified Funds + $500k Company Stock (Low Basis).
| Action | Diversified Funds | Company Stock ($500k) | Est. Total Tax Liability |
|---|---|---|---|
| Standard Rollover | Roll to IRA | Roll to IRA (Taxed as Ord. Income) | ~$185,000 (on stock portion) |
| NUA Strategy | Roll to IRA | Distribute In-Kind (Taxed as Cap Gains) | ~$110,000 (Basis + Cap Gains) |
Result: The NUA strategy reduces the tax drag on the stock portion by ~40%, preserving more wealth for retirement or heirs.
Visualizing the Tax Savings
| Strategy | Total Tax Liability ($) |
|---|---|
| Standard IRA Rollover | 370000 |
| NUA Strategy | 234000 |
*By paying the lower Capital Gains rate on the growth, the NUA strategy keeps over $130,000 more in your pocket.
Execution Protocol
You cannot just do this anytime. You must have a “Triggering Event”: Separation from service (quitting/retiring), reaching age 59½, total disability, or death.
You must distribute the ENTIRE balance of the 401(k) plan within ONE calendar year. You cannot leave $1 behind.
Logistics: Roll the non-stock funds to an IRA, and move the company stock shares to a Taxable Brokerage account.
Be prepared. In the year of distribution, you will owe ordinary income tax on the Cost Basis of the stock (the $200k in the example). Have cash outside the 401(k) ready to pay this bill.
COACHING DIRECTIVE
- Do This: If your Cost Basis is low (less than 30% of market value). The lower the basis, the bigger the NUA benefit.
- Avoid This: If your Basis is high (stock hasn’t grown much). Paying tax now on a high basis defeats the purpose. Just roll it to an IRA.
Frequently Asked Questions
What is Net Unrealized Appreciation (NUA)?
NUA is the difference between the original cost basis of the employer stock in your 401(k) and its current market value. The IRS allows you to pay ordinary income tax only on the cost basis, while the NUA (growth) is taxed at the lower long-term capital gains rate.
Why shouldn’t I just roll it into an IRA?
If you roll company stock into an IRA, it converts to cash/funds inside the IRA. When you eventually withdraw it, EVERY dollar is taxed as Ordinary Income (up to 37%). By using NUA, you lock in the 20% Capital Gains rate on the growth portion.
What is the catch?
You must take a ‘Lump Sum Distribution’ of the entire 401(k) balance within one tax year. The cost basis of the stock is taxable immediately in the year of distribution. You need cash on hand to pay this tax bill.