If your 401(k) includes stock in the company you work for, you may have an important decision to make when you retire or leave your job.
Many employees in this situation roll their entire retirement plan into an IRA. While that may make sense depending on their circumstances, doing so could eliminate a tax strategy known as net unrealized appreciation, or NUA.
If certain requirements are met, NUA may allow some of the stock's growth to be taxed at long-term capital gains rates instead of ordinary income tax rates. However, once employer stock is rolled into an IRA, NUA treatment is generally no longer available for those shares. Because the rules are specific, it is important to evaluate NUA before selling company stock, taking money from your plan, or rolling your 401(k) into an IRA.
📌 Learn more about Retirement Planning
What Is Net Unrealized Appreciation?
Net unrealized appreciation is the increase in value of employer stock held within a qualified workplace retirement plan, such as a 401(k), profit-sharing plan, or employee stock ownership plan (ESOP).
For example, suppose the shares are now worth $100,000, and the plan's cost basis is $20,000. Because the cost basis generally represents what the retirement plan paid for the stock, the remaining $80,000 of value is considered net unrealized appreciation (NUA).
If the shares qualify for NUA treatment and are transferred directly to a taxable brokerage account:
- The $20,000 cost basis is generally taxed as ordinary income in the year of distribution.
- The $80,000 of NUA is generally taxed at long-term capital gains rates when the shares are sold.
- Any growth after the distribution is taxed under the usual capital gains holding-period rules.
The potential benefit is that long-term capital gains tax rates are often lower than ordinary income tax rates. Depending on the investor’s tax rates and circumstances, this difference in tax treatment could result in a lower overall tax cost. NUA may be more appealing when the stock has substantial appreciation relative to its cost basis.
By comparison, if the stock is rolled into a Traditional IRA, future withdrawals are generally taxed entirely as ordinary income. That difference in tax treatment is what makes NUA worth evaluating for investors with highly appreciated employer stock.
📌 Learn more about Investment Tax Planning
What Are the Requirements for NUA Treatment?
NUA treatment generally depends on three main requirements.
A Qualifying Event Must Occur
The distribution generally must occur after one of these events:
- Reaching age 59½
- Separation from service
- Total and permanent disability, in the case of a self-employed participant
- Death of the plan participant
For many employees, retirement or another separation from service is the event that creates an opportunity to consider NUA.
The Company Stock Must Be Distributed in Kind
The company stock generally must be transferred as actual shares from the retirement plan into a taxable brokerage account.
If the shares are sold inside the plan and the money is rolled into an IRA, the NUA opportunity is generally lost. Once employer stock is rolled into an IRA, the special NUA tax treatment is generally no longer available for those shares. An IRA does not preserve the special tax treatment.
The Lump-Sum Distribution Rules Must Be Met
You generally must distribute the entire balance from all of the employer's qualified plans of the same type within a single calendar year.
This does not mean all assets must go into the same account. Employer stock may be transferred to a taxable brokerage account to preserve potential NUA treatment, while other eligible investments may be rolled into an IRA.
The important part is identifying which employer plans are included and ensuring the required distributions are completed within the required calendar year.
Because the rules can be complex, it may be helpful to coordinate with your plan administrator, financial advisor, and tax professional before beginning the transaction.
Can You Lose the Ability to Use NUA?
Yes. The timing rules around NUA are strict. A distribution taken after a qualifying event, but before completing the required lump-sum distribution, may cause you to lose the ability to use that event for NUA treatment.
For example, suppose you retire or otherwise separate from service. If you then take a withdrawal from the plan without completing the required lump-sum distribution within the same calendar year, you may lose the ability to use that separation-from-service event as the basis for an NUA transaction later.
Similarly, selling company stock inside the retirement plan or rolling the shares into an IRA will generally eliminate the opportunity to apply NUA treatment to those shares.
Before taking distributions, selling company stock, or rolling assets out of a workplace retirement plan, it may be worth evaluating whether NUA applies to your situation.
What Are the Pros and Cons of Using NUA?
Before choosing NUA, it is important to compare the potential tax benefits with the immediate costs, IRA rollover options, and investment considerations.
Potential advantages of NUA:
- The stock's appreciation may qualify for long-term capital gains treatment, which is often taxed at lower rates than ordinary income.
- You can decide when to sell the shares and recognize the gain.
- Stock transferred to a taxable brokerage account is generally no longer included in future required minimum distribution calculations.
Potential disadvantages of NUA:
- Ordinary income tax is generally due on the stock's cost basis in the year of distribution.
- The distribution could increase your taxable income and affect other parts of your financial plan.
- Continuing to hold employer stock may leave too much of your portfolio invested in one company.
- An IRA may offer continued tax deferral, additional investment choices, and easier account consolidation.
- The distribution rules are strict, and mistakes can affect your ability to use NUA treatment.
Whether NUA or an IRA rollover makes more sense depends on the stock's cost basis and appreciation, your tax rates, when you expect to sell, and how the decision fits into your broader retirement plan.
Should You Use NUA for Company Stock in Your 401(k)?
NUA can provide different tax treatment for appreciated employer stock, but it is not the right choice for everyone.
Before rolling over your 401(k), selling employer stock, or taking a withdrawal, consider asking your plan administrator for the stock’s cost basis, current market value, and available distribution options. A financial advisor and tax professional can then help you compare NUA with an IRA rollover and review how each choice may affect your broader retirement plan.
If you would like to discuss your 401(k), employer stock, or retirement income strategy, we’re here to help. You can schedule a complimentary introductory meeting with our team in Glastonbury or Wilton, Connecticut.
Have a quick question instead? Send us a note.
| Schedule a Complimentary Introductory Meeting |
Jordan Hickey is a CERTIFIED FINANCIAL PLANNER® professional who helps clients create personalized financial plans. Based in Glastonbury and Wilton, CT, Jordan offers guidance on retirement, insurance, investments, and overall wealth management. Schedule a complimentary introductory meeting with Jordan.
This information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete, it is not a statement of all available data necessary for making an investment decision and it does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Be sure to contact a qualified professional regarding your particular situation before making any investment or withdrawal decision. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional. Any opinions are those of the author, and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice.