You have worked at a great company for 20 years. Your 401(k) has grown nicely, and a big chunk of it is invested in your Company's Stock.
Now you are retiring or changing jobs. Your financial advisor says:
"Let's roll everything over to an IRA to defer taxes."
Wait.
If you follow that advice, you might be making a huge mistake.
By moving company stock to an IRA, you are voluntarily turning low-tax Capital Gains into high-tax Ordinary Income.
You need to know about the Net Unrealized Appreciation (NUA) rule.
Disclaimer: NUA rules are complex and irreversible. Consult a qualified CPA or tax attorney before requesting a distribution.
How the 'NUA' Rule Saves You Millions in Tax
1. The Tax Trap: IRA vs. NUA
Usually, when you withdraw money from a Traditional IRA, it is taxed as Ordinary Income (currently up to 37% federal + state tax). It doesn't matter if the growth came from stocks; the IRS treats it like a regular paycheck.
The NUA Exception:
If you distribute the company stock in-kind (as actual shares) to a taxable brokerage account instead of an IRA, you strictly limit the damage:
- Immediate Tax: You only pay ordinary income tax on the Cost Basis (the original price you paid).
- Future Tax: The growth (Appreciation) is taxed at the much lower Long-Term Capital Gains rate (0%, 15%, or 20%) whenever you eventually sell the shares.
2. Let's Look at the Numbers (Example)
Imagine you have $1 Million in Company Stock in your 401(k).
- Cost Basis: $100,000 (average price you paid)
- Growth (NUA): $900,000
| Scenario | Tax Rate Applied | Estimated Tax Bill |
|---|---|---|
| Option A: Roll to IRA | Ordinary Income (e.g., 37%) on full $1M | $370,000 |
| Option B: Use NUA | Income Tax on $100k + 20% Cap Gains (plus 3.8% NIIT) on $900k | $37k + $214k = $251,000 |
Result: Even with the 3.8% NIIT surtax included, NUA saves you roughly $119,000 in this example.
3. The 3 Strict Rules (How to Qualify)
You cannot use NUA whenever you want. You must trigger a "Qualifying Lump-Sum Distribution." This requires three things:
- The "One Year" Rule: You must empty the ENTIRE 401(k) account within one single tax year. (e.g., You cannot take a partial withdrawal in December and the rest in January. That voids NUA).
- Triggering Event: It must happen after one of these:
- Separation from service (leaving the job).
- Reaching age 59½.
- Death.
- In-Kind Transfer: You must receive the actual shares into a brokerage account. Do not sell the stock inside the 401(k) first!
4. When Is NUA a Bad Idea?
NUA isn't for everyone. Skip it if:
- High Cost Basis: If the stock price hasn't grown significantly (e.g., basis is 80% of value), the immediate tax bill isn't worth the small capital gains savings.
- Diversification Risk: Holding 100% of your wealth in one single company is dangerous (remember Enron?).
5. The "Immediate Tax" Warning
Crucial Warning: When you execute the NUA transfer, you owe income tax on the Cost Basis immediately in that tax year.
Also, if you are under age 59½ (and do not qualify for the "Rule of 55"), the Cost Basis portion may be subject to a **10% Early Withdrawal Penalty.** (The NUA appreciation itself is exempt from the 10% penalty, but the basis is not).
Don't Auto-Pilot Your Rollover
Rolling over a 401(k) is standard advice, but "standard" doesn't work for high-net-worth employees with appreciated stock.
Check your 401(k) statement today. If you see a significant balance in "Company Stock," pause immediately.
Action Plan:
- Check your 401(k) statement for "Cost Basis" vs. "Market Value" of company stock.
- Calculate the potential tax spread (Ordinary Rate vs. Capital Gains Rate).
- Instruct your plan administrator: "I want to do a Lump Sum Distribution with NUA treatment."
Helpful Resources:
Fidelity: Net Unrealized Appreciation Strategies
IRS Topic No. 412: Lump-Sum Distributions
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