Typically, funds in your 401k from salary deferrals and company match are contributed on a pre-tax basis, grow tax-deferred, and are taxed at ordinary income tax rates when you eventually withdrawal the funds in retirement. It is possible however, to pay tax at the lower capital gains rate on employer stock in your 401(k) with a rule known as Net Unrealized Appreciation (NUA).
The option to pay capital gains tax rates on employer stock was almost always a surprise when I would explain it to a retiring client. Taking advantage of NUA can save you thousands of dollars in taxes (or more) due to the difference between ordinary income and capital gains tax rates.
Ordinary Income Tax Brackets (2025)
Long Term Capital Gains Tax Brackets (2025)
What is Net Unrealized Appreciation (NUA)?
Net Unrealized Appreciation (NUA) refers to the gain in the employer stock in your 401(k) while it is in the plan. It is possible to pay capital gains tax rates on the NUA of your employer stock during certain trigger points. The rest of the (pre-tax) assets in your 401(k) will be subject to ordinary income tax when distributed.
What are the rules of NUA tax treatment?
1. Triggers. There are certain triggers that qualify your employer stock for NUA treatment. If you miss a trigger event there’s no going back. However, if you miss a trigger and another event happens you will have another opportunity. The triggering events are:
- Separation from service with your employer (any age)
- Reaching age 59 ½
- Disability
- Death (Your beneficiaries can get NUA treatment)
2. Transfer rules. Employer stock must be transferred in-kind to a taxable brokerage accounts. You cannot sell the stock in the plan and transfer cash. Also, the employer stock cannot be transferred to an IRA without losing NUA treatment.
3. Entire Balance. The entire balance of your 401k plan must be distributed in the same year you transfer the employer stock. This can be a rollover to an IRA.
What is the tax treatment of NUA?
When you transfer your employer stock to a brokerage account you will owe ordinary income tax on the cost basis of the shares. This should be a big factor in determining if the NUA route makes sense for you vs. rolling over your employer stock to an IRA or leaving it in your plan.
The growth (NUA) is not taxed when you distribute the stock to your brokerage account. If/when you sell shares this growth (NUA ) will be taxed at the more favorable capital gains tax rate. This is the purpose of employing the strategy so you will want to make sure these tax savings are sufficient to outweigh any negatives.
If you continue to hold the stock and it appreciates you will also pay capital gains tax rates on that growth when you sell. If you hold for less than a year you would pay the short-term capital gains rate (which is the same as the ordinary income tax rate).
Factors to consider before taking advantage of NUA
Cost basis of employer stock. This is a key consideration and a lower basis makes taking advantage of NUA much more beneficial. An ideal situation would be employer stock that has appreciated significantly with a low basis. A higher basis could mean a large tax bill this year and you may be better off rolling into an IRA to defer the tax.
Goals with the funds. If you are planning to diversify the stock you might be better off either doing that inside your 401k or rolling over the employer stock to an IRA. Although if your basis is really low this may still be a consideration. Good tax planning is key.
If your cost basis is low and you plan to hold the employer stock long term this would be an argument in favor of NUA vs. rolling to an IRA.
Tax bracket now and expected in retirement. Let’s say you were laid off early in the year and thus your tax bracket will be much lower this year than you expect it to be in future years (assuming you don’t get another job right away!). You could take advantage of the lower bracket to pay tax on your basis, and the NUA rate might be lower (or even 0% for a small amount of stock!) than it would be during a higher income year.
Don’t forget about Roth conversions. If you are in a temporarily lower income bracket make sure to contrast the NUA strategy vs. a Roth conversion of some or all of the funds.
Estate planning. The NUA will receive step-up in basis for your heirs thus eliminating the NUA tax for them. Traditional IRA funds will eventually be fully taxable for your heirs.
Your age. Early withdrawal penalties still apply (59 1/2 or 55 if separating from service).
The Net Unrealized Appreciation rules are a little known and somewhat complex strategy that can save you significantly on taxes if employed in the right situation. Make sure to do your research and consider all of the factors before using this strategy. This is a good reason to consult with a financial planner and tax advisor prior to rolling over your 401k if you have employer stock in the plan.
If you have any questions on the content in this post feel free to Contact me. I try to answer all reader emails.
