If you've spent years buying your employer's stock inside your 401(k), you may be sitting on one of the more valuable and least understood breaks in the tax code. It's called net unrealized appreciation, NUA for short, and it can turn most of that stock's growth from ordinary income into long-term capital gain.
It only works if you use it at the right moment, and the most common way to lose it is the most routine thing people do when they leave a job: roll the whole 401(k) into an IRA. Once the shares are in an IRA, the NUA option is gone for good.
How it works
Normally, every dollar that comes out of a 401(k) is taxed as ordinary income, no matter what it was invested in. NUA is an exception for shares of your employer's stock.
When you take those shares out of the plan as actual shares, rather than selling them first, and move them to a regular taxable brokerage account, the tax splits in two:
The cost basis, meaning what the plan originally paid for the shares, is taxed as ordinary income in the year you take them out.
The growth inside the plan, the net unrealized appreciation, isn't taxed until you sell. When you do, it's taxed as long-term capital gain, even if you sell the next day.
Any growth after the shares leave the plan is taxed like any other investment: long-term if you hold more than a year from the distribution, short-term if you don't.
Everything else in the 401(k), the index funds, the bond fund, the target-date fund, can still be rolled into an IRA as usual. You're only pulling out the company stock, and it has to leave the plan as shares. If the plan sells them and sends you cash, it's an ordinary distribution and the NUA treatment is lost.
What it's worth, in dollars
Take someone retiring at 58 with a $900,000 401(k). $400,000 of it is employer stock that the plan bought over the years for a total of $60,000. Assume they're in the 24% bracket now and expect to be in the same bracket later, and that long-term gains are taxed at 15%.
Roll everything into an IRA. No tax today. But whenever that $400,000 comes out, it's ordinary income. At 24%, that's $96,000 of tax.
Use NUA for the company stock. They pay ordinary income tax on the $60,000 basis this year, which is $14,400 at 24%. The $340,000 of NUA is taxed at 15% when they sell, another $51,000. Total: $65,400.
That's about $30,600 less on the same shares. Under IRS regulations, the NUA portion is also kept out of the 3.8% net investment income tax, which matters for higher earners. Growth after the distribution isn't protected that way. NUA wins here because the future tax rate stays high. The third bar shows what happens when it doesn't.
When it doesn't win
The third bar is the important one. If this person expected to retire on a modest income and pull the money out of an IRA slowly at 12%, the rollover costs $48,000 in tax, less than the NUA route. NUA always means paying some ordinary income tax now, on the basis, in exchange for a lower rate later on the growth. That trade only pays off if the rate you're avoiding is meaningfully higher than the capital gains rate.
A few other things push the answer toward a plain rollover:
A high cost basis. If the plan bought the shares recently, or they haven't grown much, most of the value is basis, which is taxed as ordinary income now. NUA works best when the basis is a small fraction of the value. There's no magic cutoff, so run the numbers both ways.
A long time horizon. Tax paid on the basis today is money that would otherwise have kept growing tax-deferred in the IRA for years. For a 50-year-old with decades ahead, that lost growth can eat into the advantage.
Heirs. NUA doesn't get a step-up in basis at death. If you hold the shares until you die, your heirs still owe capital gains tax on the NUA when they sell, although growth after the distribution does get the step-up. If you were planning to leave the shares to your children, the comparison changes.
Early retirees. If you're under 59½, the 10% early-withdrawal penalty can apply to the taxable basis portion, though not to the NUA itself. Leaving your job in or after the year you turn 55 avoids that penalty for distributions from that employer's plan.
The rules you have to get right
NUA has strict conditions, and missing any of them turns the whole thing into an ordinary distribution.
A triggering event. The distribution has to follow one of these: leaving your job, reaching age 59½, or death. For self-employed people, disability also counts, and leaving a job doesn't.
A lump-sum distribution. You have to empty your entire balance from the employer's plan, and from any other plans of the same type with that employer, within a single calendar year. You don't have to take everything as cash. The company stock goes to a brokerage account and the rest can be rolled to an IRA, as long as it all leaves the plan in the same year.
Shares, not cash. The employer stock has to come out "in kind," as shares. If the plan sells it and sends you the proceeds, the NUA is gone.
Watch earlier withdrawals. If you took money out of the plan after a triggering event in an earlier year without emptying it, you've generally used up that event, and you'll need a new one before NUA is available again. This catches people who started taking withdrawals after leaving a job and only heard about NUA later.
You don't have to put all the company stock through NUA, either. If the plan tracks individual purchase lots, you can often choose to take out the low-basis shares under NUA and roll the high-basis shares into the IRA with everything else. Ask the plan administrator what they can do before you request the distribution.
You don't have to keep the stock
People sometimes assume NUA means holding on to the company stock for years. It doesn't. The NUA is long-term capital gain the moment the shares leave the plan, so you can sell them the same week and still get the lower rate. That makes NUA a good way to reduce a concentrated position, not just a way to keep one.
And reducing it is often the right call. Someone with a large slug of employer stock in their 401(k) has frequently spent a career with their salary, bonus and retirement savings all tied to one company. Our article on reducing a concentrated stock position covers the other ways to bring it down.
What to actually do
Before you roll over a 401(k) that holds your employer's stock, get the plan's cost basis for those shares. It's on your statements or available from the administrator. Compare the value with the basis, think about the tax rate you're likely to pay on IRA withdrawals later, and run both routes.
If NUA looks worthwhile, plan the whole lump-sum distribution for one calendar year, ask the plan to send the company stock in kind to a taxable brokerage account, and roll the rest to an IRA. Expect a Form 1099-R showing the NUA amount, and set aside cash for the tax on the basis, since the plan may withhold little or nothing on the shares themselves.
And don't roll everything over first and look into it later. That one's irreversible.