Net Unrealized Appreciation (NUA): The Tax Move for Company Stock in a 401(k)
CORE INSIGHTS
- Tax Arbitrage: NUA allows the huge growth (appreciation) of company stock to be taxed at low long-term capital gains rates instead of high ordinary income rates.
- Lump-Sum Required: The strategy only works if you take a lump-sum distribution of your entire 401(k) balance in one tax year.
- The Basis is Key: The stock’s original cost basis is taxed immediately as ordinary income, while the massive gain (NUA) is deferred until the stock is sold later.
If you hold highly appreciated company stock within your 401(k) plan, standard retirement planning often dictates rolling it into an IRA. However, this common move forfeits one of the most powerful tax optimization strategies available to long-term employees: Net Unrealized Appreciation (NUA). Understanding NUA is crucial for minimizing taxes on your company stock windfall.
The Tax Cost of Missing NUA (Scenario):
Imagine you have $100,000 in company stock ($20,000 cost basis) in your 401(k).
• Standard Rollover: You pay 30% ordinary income tax on the full $100,000 when you withdraw it in retirement.
• Using NUA: You pay 30% tax on the $20,000 cost basis now. The $80,000 gain is taxed at only 15% later when you sell the stock.
Result: This arbitrage saves tens of thousands in taxes, dramatically increasing your net retirement wealth.
Imagine you have $100,000 in company stock ($20,000 cost basis) in your 401(k).
• Standard Rollover: You pay 30% ordinary income tax on the full $100,000 when you withdraw it in retirement.
• Using NUA: You pay 30% tax on the $20,000 cost basis now. The $80,000 gain is taxed at only 15% later when you sell the stock.
Result: This arbitrage saves tens of thousands in taxes, dramatically increasing your net retirement wealth.
Visualizing the Tax Savings Potential
The chart below illustrates the shift in tax burden when using the NUA strategy. While you pay a small amount of ordinary tax upfront, the bulk of the profit moves into the favorable long-term capital gains category.
*Scenario assumes a 30% ordinary income tax rate and 15% long-term capital gains rate. NUA provides significant tax deferral.*
“The NUA strategy is a ‘use it or lose it’ deal. Once you roll that company stock into an IRA, the special tax treatment is gone forever.”
NUA Eligibility and Rules
| Rule/Requirement | Standard Rollover | NUA Strategy |
|---|---|---|
| Tax Rate on Gain | Ordinary Income (High Rate) | Long-Term Capital Gains (Low Rate) |
| Lump-Sum Distribution | Not Required | Required (Entire balance in 1 year) |
| Timing | Can be done anytime | Must be after a “qualifying event” |
| Tax Due at Distribution | None (Deferred) | Tax is due on the cost basis immediately. |
Strategic Action Steps
1
Verify Plan Eligibility
Confirm your 401(k) plan holds the company stock and that you are eligible for a lump-sum distribution following a separation from service.
Confirm your 401(k) plan holds the company stock and that you are eligible for a lump-sum distribution following a separation from service.
2
Analyze Cost Basis vs. Value
The larger the difference between the stock’s original cost and its current value, the more valuable the NUA strategy becomes.
The larger the difference between the stock’s original cost and its current value, the more valuable the NUA strategy becomes.
3
Execute Immediately Upon Leaving
If chosen, the entire lump-sum distribution must be initiated within one tax year. Failure to do so disqualifies the NUA treatment.
If chosen, the entire lump-sum distribution must be initiated within one tax year. Failure to do so disqualifies the NUA treatment.
The Bottom Line: Who Should Use NUA?
- Yes, if: You hold highly appreciated company stock and expect to be in a high tax bracket.
- No, if: Your company stock has not appreciated much, or you need to roll over to a new plan.
Frequently Asked Questions
Q. What is Net Unrealized Appreciation (NUA)?
NUA is the difference between the cost basis (original purchase price) of company stock held in a 401(k) and its current market value. The NUA strategy allows this appreciation to be taxed at lower long-term capital gains rates.
Q. Who is eligible to use the NUA strategy?
The investor must be taking a ‘lump-sum distribution’ of their entire 401(k) balance within one tax year, typically triggered by separating from service, reaching age 59½, or becoming disabled.
Q. How is the NUA taxed?
The cost basis of the stock is taxed immediately as ordinary income. The net unrealized appreciation (the massive gain) is taxed only when the stock is sold later at the lower capital gains rate.
Disclaimer: This article is for educational purposes only. NUA rules are highly complex and irreversible. Consultation with a qualified tax professional is essential before executing this strategy.