$400,000 in Employer Stock Inside Your 401(k)? This Tax Rule Could Save You $65,000 Before You Retire

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The Net Unrealized Appreciation (NUA) rule allows employer stock appreciation in a 401(k) to be taxed at long-term capital gains rates instead of ordinary income rates, potentially saving retirees significant tax dollars compared to a standard IRA rollover.

How the NUA Election Works

Four conditions must be met for NUA treatment:

• A triggering event: separation from service, reaching age 59½, disability, or death.
• A lump-sum distribution of the entire 401(k) balance in a single tax year.
• Employer shares must move in-kind to a taxable brokerage account (not an IRA).
• Cash and non-employer-stock assets can roll to an IRA in the same year.

Upon distribution, only the cost basis of the employer stock is taxed as ordinary income. The appreciation (NUA) is taxed at long-term capital gains rates when sold, regardless of holding period outside the plan.

Running the Math on Company Stock

For example, a retiree with $400,000 of employer stock (basis: $60,000) in the 24% tax bracket would owe:

• Ordinary income tax on the $60,000 basis (~$14,400).
• 15% long-term capital gains tax on the $340,000 NUA (~$51,000).

Total federal tax under NUA: ~$65,400. Rolling the same shares into an IRA would tax the full $400,000 as ordinary income, costing substantially more over time, especially when factoring in RMDs, Social Security taxation, and Medicare IRMAA surcharges.

The Cascade Most Retirees Miss

IRA withdrawals increase taxable income, which can:

• Make up to 85% of Social Security benefits taxable.
• Trigger Medicare IRMAA surcharges (based on a two-year lookback).

NUA distributions avoid this cascade by taxing appreciation at lower capital gains rates. Strategic sequencing (e.g., selling shares in low-income years) can further minimize taxes.

Note: While NUA reduces tax liability, holding a concentrated position in employer stock carries investment risk. Diversification should be addressed separately.

Three Actions Before You Sign the Rollover Paperwork

• Pull your cost basis statement: Confirm the average cost basis of employer shares (lot-level basis if available). NUA is most advantageous when appreciation is large relative to basis (e.g., basis <30% of market value).
• Model both paths: Compare NUA vs. IRA rollover over a 10-year horizon, including RMDs (starting at age 75), Social Security taxation, and IRMAA brackets. The break-even often favors NUA once IRMAA is included.
• Confirm lump-sum eligibility: Partial distributions or missing the single-tax-year requirement disqualify NUA treatment. Consult a fee-only CPA or CFP experienced with NUA transactions.

NUA is a one-time, irreversible election. It’s particularly valuable for retirees with seven-figure 401(k)s and long tenures at a single public employer.