NUA: The 401(k) Company Stock Tax Strategy Most Savers Miss

You’ve given your blood, sweat, and tears for decades to your company. You experienced all the ups and downs, celebrating the exhilarating highs and sticking out the inevitable lows. Now the moment has arrived for you to finally walk away, whether to a new role or to the next chapter in retirement.

Along the way, you regularly siphoned off a portion of your paycheck into that 401(k). It compounded and grew over the years, amassing a significant nest egg. You were told early on that it would do well if you stick with it. But maybe you didn’t even expect this to be such a good decision.

You’ve also heard that when people leave the company, they often roll over their 401(k) accounts, and you decide that’s your next step as well. The HR Department shares with you the steps of what you need to do, you’ve taken your time and checked off all the correct boxes, and your funds are now being sent directly to a Traditional IRA, maintaining the tax deferral. You sit back and relax on a proactive job well done. However, if you happened to be one of the millions of 401(k) savers who own company stock within your workplace 401(k), and that stock happened to have already appreciated significantly, completing that rollover could become a six figure tax mistake you never even knew you made.

There is a powerful IRS rule called Net Unrealized Appreciation, or NUA, where you can potentially swap ordinary income tax rates (up to 37%) for long-term capital gains tax rates (up to 20%). This little known strategy has very rigid rules and is easily overlooked, even within the financial and tax industries. Here is a guide explaining NUA, so you’ll know exactly what to look for when evaluating your own situation.

What is NUA?

NUA is only applied to the company stock holdings of a qualified employer-sponsored retirement plan, most commonly a 401(k) or ESOP. When looking at the total value of the company stock, it is broken down into two components: the price paid for it, and the growth it accumulated. The price paid is what is known as the Cost Basis. The accumulated growth, the difference between what was paid and what it’s now valued at, that is what is known as Net Unrealized Appreciation, or NUA.

Option A) What a standard IRA Rollover looks like

If you choose a standard rollover, your company stock inside the 401(k) is liquidated into cash and then moved to a Traditional IRA. Growth continues tax deferred. However, every single dollar you withdraw in retirement will be taxed as ordinary income (up to 37%).

Option B) The NUA Strategy

With the NUA strategy, you do not liquidate the stock. Instead, you transfer the actual shares in-kind out of the 401(k) and into a taxable brokerage account. Any remaining non-stock assets in the 401(k) can still be rolled over into an IRA as normal.

• You pay ordinary income tax only on the cost basis in the year of the transfer.
• The entire accumulated growth (the NUA) is now eligible for more advantageous long-term capital gains rates (up to 20%).
• Tax on that accumulated growth is deferred until you choose to sell the shares.

The added advantage of executing the NUA strategy is that the entire company stock value is now completely separated from the IRA, where at a certain age Required Minimum Distribution calculations take place. No RMDs are required once the company stock is sitting in a non retirement brokerage account. What makes the NUA strategy even more beneficial is that when IRAs get passed onto non-spousal beneficiaries, these inherited IRAs have to be liquidated over a 10 year time frame. This can potentially be extremely punitive to a beneficiary's tax bracket, and it's completely out of their control. However, pulling out company stock using the NUA strategy at least prevents that portion of stock values from future RMD liquidations at ordinary income tax rates.

How To Qualify for NUA

Anyone who has company stock in their qualified retirement plan such as a 401(k) or ESOP has access to NUA. You do not have to be in the highest tax brackets for this strategy to be worthwhile, since long-term capital gains (LTCG) tax rates are virtually lower at every income tier.  your distribution must adhere to a strict, mechanical sequence. Failing a single step permanently destroys the tax break.

• Triggering Event: You must have a qualifying event. This includes separation from service (retirement/quitting), reaching age 59½, total disability, or death.
• Lump Sum Distribution: You must empty the entire account balance across all qualified plans with that specific employer within a single calendar year. This can be done by rolling over all non-stock assets to an IRA to maintain tax deferral. Your balance must hit zero by December 31st.
• In-Kind Transfer: The company stock must move in-kind directly into a taxable brokerage account as shares. The cost basis of that stock will result in ordinary income taxes due in the year of distribution. If the stock inside the 401(k) is sold during the rollover process, it can never be reversed and the opportunity to take advantage of NUA is permanently over. 

Due to these highly rigid steps, executing an NUA strategy requires careful coordination. We highly recommend reaching out and having an introductory review before making any distribution decisions.

NUA Benefits with Real World Numbers

To see how this works, let's use hypothetical figures based on a real world scenario we analyzed for a family while discussing their comprehensive financial plan. One of our topics dealt with the husband's two different 401(k) accounts from previous employers, one of which held company stock. This specific 401(k) was valued at $700,000, of which $180,000 was in company stock. He had never heard of the NUA rule. After review, we were able to determine that the cost basis was $20,000. That meant the stock had $160,000 in accumulated growth that was eligible for potentially more beneficial tax treatment. To proceed, he would have to zero out the 401(k) with the company stock in it by December 31st. The $520,000 portion with mutual funds gets rolled into an IRA, and his stock shares are transferred in-kind into a brokerage account. He will then have to pay ordinary income taxes, but only on the $20,000 cost basis. Since his other 401(k) account belonged to a different past employer, he could execute the NUA strategy independently of that account.

By extracting the $180,000 in company stock out of the 401(k) into a brokerage account, he now has access to several financial planning advantages:

1. Tax Bracket Optimization: The tax on $160,000 in growth transitions from ordinary income tax rates to long-term capital gains (LTCG) rates whenever he chooses to sell any shares. All NUA shares instantly qualify for LTCG rates no matter how recently the shares were bought.
2. Continued Tax Deferral: The shares do not have to be sold and the growth can continue to be deferred for as long as he doesn’t sell them, and there are no RMDs required on this $180,000.
3. RMD Reduction: No RMDs required on the $180,000 now in a taxable brokerage account. This also reduces the IRA balance that will require RMDs when he reaches age 73 (for others, it may be age 75), meaning less in mandatory withdrawals.
4. Advanced Estate Planning Benefits: If he never sells the shares and passes away, any gains on top of the NUA gains will be stepped up when passed to his beneficiaries. NUA gains cannot be stepped up. So for example, if the stock value is worth $300,000 at the time of passing, the additional $120,000 in gains achieved after the execution of the NUA strategy can now be stepped up on top of the $20,000 cost basis for his beneficiaries, resulting in a new total cost basis for his beneficiaries of $140,000. His beneficiaries will still owe LTCG tax on the $160,000 accumulated NUA growth when the stock is eventually sold.

When is NUA right for you?

To determine if NUA makes sense, consider what an ideal NUA candidate might look like:

• Someone who has a very low cost basis and a very high market value (such as a $20,000 basis on $180,000 of stock)
• Someone with enough liquid cash outside of retirement accounts to pay the upfront ordinary income tax on the cost basis.
• Someone who may want to lower the amount of their future RMDs
• Someone who is comfortable and has the risk tolerance to hold a potentially overweight position in an individual stock position.
• Someone who may consider holding the stock long enough to take advantage of future step ups

When might NUA not be ideal?

• If the cost basis on your company stock shares is too high relative to the amount of gains
• If paying the immediate ordinary income tax is so substantial that it may immediately push you into a much more prohibitive tax bracket
• If there is not enough liquid cash to cover for the the tax payment of the stock’s cost basis
• If you are uncomfortable with the concentration risk of holding one stock, potentially for years
• If the company stock you’re holding ends up underperforming, and the tax savings ends up being offset by the potential loss in market value
• If you may want to consider selling out of all or a substantial portion of the stock relatively quickly. While the LTCG tax treatment is beneficial on the gains, you are also realizing all of the tax relatively up front, and you may end up coming out ahead by simply deferring the tax in a standard rollover into an IRA
• If you live in a state that does not fully recognize federal NUA tax treatment, potentially taxing the distribution less favorably at the state level
• If you are under age 59 1/2 and cannot utilize the Rule of 55 for your 401(k), the cost basis may be exposed to an additional 10% early withdrawal penalty

There are other scenarios that come into play and must be carefully evaluated before pulling the trigger. An NUA distribution will cause a temporary spike in Modified Adjusted Gross Income (MAGI), which can potentially affect the taxation of your Social Security benefits or an increase in Medicare premiums. It’s important to coordinate with a financial or tax professional regarding your specific situation before any decisions are made.

What if you have both High Cost Basis and Low Cost Basis Shares in the 401(k)?

The great thing is you do not have to treat all company stock shares the same way. If you've decided executing the NUA strategy makes sense, you can absolutely cherry pick how you want to handle it. The low cost basis shares are the ideal shares for NUA, and you can select those specific lots as the shares moving to the taxable brokerage account. As for the high cost basis shares, it might not make sense to pay ordinary income tax up front just to protect a relatively smaller amount of appreciation. You can roll over those lots into the IRA holding the other non-stock assets.

Why Most Financial and Tax Professionals Miss the NUA Opportunity

The NUA strategy is a niche opportunity that just happens to fall into a blind spot between separate financial disciplines. To execute it, you may need a professional who is aware and knowledgeable of this rule, understands your specific retirement timeline, and reviews the holdings in your 401(k). While an advisor may manage your main portfolio, only 37% of investors say their advisors proactively discuss tax planning strategies. The majority of wealth managers lack the specialized training or professional tax credentials necessary to analyze tax code. Due to these licensing constraints, advisors will typically defer all tax questions to a client's accountant. However, a forward looking strategy can be created by coordinating directly with your accountant and, in specialized cases, involving additional advanced tax planning resources such as with LPL Financial's Tax Planning Team. Due to the significant amount of coordination and analysis that may be required, it often gets bypassed. 

From my personal experience, high level specialized training can be difficult to find in standard corporate environments. I was incredibly fortunate because my firm prior to me joining the bank provided regular extensive training. Most crucially, I had the opportunity to work under a seasoned mentor which allowed me to experience much more complex planning strategies early in my career.

If NUA is a tax strategy, why didn't your accountant bring this up? Probably because most accountants aren’t financial advisors. They’re not typically reviewing your 401(k) statements and looking for company stock inside your holdings. They’re typically meeting you once a year during a high stress window called tax season, where their primary goal is to get everyone's data from the previous year correctly entered. If you complete a 401(k) rollover, a 1099-R is sent to you, and then you hand that document over to your accountant to prepare your taxes, and that’s it. By the time you handed over the 1099-R, the rollover was already completed, the stock was already liquidated, and the NUA opportunity was already gone. There was never a chance to even have the conversation. This is why having a forward looking tax planning strategy can be very important, as opposed to only having your tax discussion once a year during tax time.

And the 401(k) customer service specialist, why didn't they mention it? That's because their job is to help you with administrative tasks, like...selling the stock inside of your 401(k), or executing the rollover process. They legally cannot offer tax or financial planning advice.

You must either know the exact technical questions to ask, or partner with a professional who can help you spot the potentially hidden opportunities before your retirement assets get moved.