What’s NUA? Does it apply to me and when does it make sense?

We often hear about tax strategies to reduce our tax burden. For individuals who own company stock in their employer sponsored retirement plan (i.e., 401(k)), Net Unrealized Appreciation (“NUA”) is a unique strategy to consider and you should keep reading. If you don’t own company stock in your company retirement plan, then the below may be of interest to know, but it won’t apply to you.

The purpose of choosing to elect NUA is to take advantage of the difference in tax rates between ordinary income and long-term capital gains and to be apply the lower long-term capital gains rate to the appreciated value of the company shares in your 401(k).

Federal Income and Long-Term Capital Gains tax rates for 2025

While individuals are working, they often take advantage of making pre-tax contributions to their company sponsored retirement plan (401(k)) in order to save for retirement and reduce their taxable income in that given year. Yet, few think about the tax burden on the back end after they decide to retire and start taking distributions. Normally, any funds distributed from an employer sponsored plan that represent pre-tax contributions and/or earnings/gains are taxed as ordinary income.

Before electing the NUA strategy, you need to know that the cost basis of any shares you own in your 401(k) will be taxed as ordinary income in the year that the stock is distributed “in-kind”. The term “in-kind” is critical because each lot of shares of company stock that you purchased over time in your employer sponsored plan needs to be transferred out of your 401(k) with its respective cost basis.

If you sell the company stock in your 401(k) before making an in-kind distribution of shares instead and instead you transfer the cash proceeds to a taxable account, then this will be treated as a normal retirement account distribution, which will be taxed as ordinary income and then you’ve missed the opportunity to elect NUA treatment.

Let’s say your 401(k) is worth $750,000, of which $450,000 represents company stock and your cost basis on the shares of the company stock is $90,000. The gain on your company stock is $360,000. If you were to elect NUA when you decide to retire, then you would need to transfer the shares of company stock, in-kind, into after-tax brokerage account and you would rollover the remaining $300,000 ($750,000 – $450,000) into an IRA. In addition to any other income you may have earned, there will be an additional $90,000 of ordinary income (the value of your cost basis) that would be taxed that year. This may be a tough pill to swallow because you need to plan to have cash available to pay the tax bill on this additional ordinary income.

How much will your tax bill be? That is completely dependent on your marginal tax rate. For example, let’s says you are married and file jointly in 2025 and you decide to retire. Your household adjusted gross income is $110,000 and your marginal tax bracket is 22%. The additional $90,000 of ordinary income would be taxed at 22% (you can see that income from $96,951 – $206,700 is taxable at 22% in the above chart), which results in additional $19,800 of federal income. And there’s state income tax to consider as well.

At this point you may be scratching your head thinking, “I thought this was about reducing taxes, and this idea is just making me pay taxes sooner. I thought the whole idea of putting money in 401K plan is to defer taxes as long as possible”.

Deferring taxes doesn’t mean not paying taxes – it means paying them later. And the truth is that the IRS will make sure either you or your beneficiaries will ultimately pay taxes on any pre-tax retirement plan contributions and any growth in your retirement accounts (except for Roth IRAs). The only question is when those taxes will be paid and by whom and at what tax rate.

For individuals nearing or now at retirement, the amount of time for deferring taxes may be relatively short because the funds inside a tax deferred account (401K, IRA, etc.) will eventually be subject to required minimum distributions (RMDs). RMDs essentially force money out of retirement accounts each year, which creates taxable income, and retirees who no longer have a salary will often use these retirement account distributions to help cover their living expenses.

So, how could electing NUA lower my tax bill and save me money? Let’s go back to the example and play out two scenarios:

Scenario 1: You treat the company stock in your 401(k) like any other investment and, when you retire, you roll the entire $750,000 into a Rollover IRA. Good news – no taxes are owed at the time of that rollover. Bad news – any money out of the Rollover IRA is taxed as ordinary income. Let’s say you take out money each year for living expenses and you are still in the marginal 22% bracket every year, so that the cumulative amount of federal income tax on $750,000 of IRA distributions would be $165,000.

Scenario 2: You elect NUA for the $450,000 worth shares of company stock in your 401(k) and are able to apply the 15% long-term capital gains rate to the appreciation (market value – cost basis) of these shares.

The federal income taxes that apply are as follows:
– $19,800 – Ordinary income taxes on cost basis of company stock ($90,000 x 22% tax rate);
– $54,000 – Capital Gains taxes on growth of stock ($360,000 x 15% tax rate);
– $66,000 – Ordinary income taxes on the remaining/cumulative taxable IRA distributions ($300,000 x 22% tax rate).
$139,800 – Total Taxes

Electing NUA lowers the effective tax rate from 22% to 18.64% and creates a federal income tax savings of $25,200 ($165,000 – $139,800).

This tax savings is the value of electing NUA and the value for you will depend on the size of the unrealized gain on your company stock relative to your cost basis, the absolute dollar amount of the shares you own, and whether or not you have a short-term need to generate the cash that comes from selling your shares.

If, for example, your cost basis is very low and the gain is large, then the NUA strategy is more attractive. If the cost basis is high relative to the current value of your shares, however, then electing NUA strategy is less attractive. If the company stock worth $450,000 in our example had a cost basis of $425,000 (with only a $25K gain) instead of $90,000, then the $425,000 would be taxed as ordinary income with part being tax at higher, 24% and 32% tax rates, which is a lot less attractive and will reduce the amount of your tax savings.

At this point, you may be wondering about how any subsequent growth on the shares you transferred to your taxable brokerage account is taxed if you decide continue to hold the shares and not sell them right away. Any subsequent growth in the value of the shares the company stock you transferred in-kind to the taxable account will be taxed at capital gains rates, making the NUA strategy potentially suitable if you hold the stock and the value of your shares appreciates even more over time.

Finally, employing the NUA strategy may seem simple in concept, but it can be complex in practice as you can see and there some very specific rules that must be followed. Here are three key requirements:

The employer retirement plan must make a “lump-sum distribution”. The entire vested balance of the 401(k) plan must be distributed in a single tax year, but it’s up to you to determine where the dollars end up. Any amount of company shares can be transferred to a taxable brokerage account and any amount to the shares or other investments can be rolled over to and IRA, but none of the money can stay in the 401(k) plan past the end of that year.

The lump-sum distribution must be made after a “triggering event”. The triggering events are death, disability, separation from service or reaching age 59 ½ years old. It’s any on of these events, not all. For example, you can retire at 55 and keep your 401(k) in place and then elect NUA later after you’ve reached 59 ½ years old and perhaps are in a lower tax bracket

The employer stock must be distributed “in-kind”. As mentioned above, and in order to complete the in-kind distribution, the employer stock should be transferred directly to a taxable investment (i.e., brokerage account in your name). It does not have to be all the shares you own. You can transfer the low-cost basis shares to a taxable account and elect NUA on them, while rolling over high-cost basis shares to an IRA where you do not elect NUA.

In summary, the NUA strategy may:
• help to reduce taxes on the income from the sale of employer stock.
• help to reduce income taxes by reducing future IRA RMDs, since the value of the company stock is being removed from your retirement account.
• offer the possibility of stepped-up basis treatment on the full value of the shares for estate planning purposes.

In the appropriate circumstances, electing NUA can be extremely valuable for individuals who own company stock in their company-sponsored retirement plans, but the value will be more or less depending on particular circumstances. As a result, it’s critical to work with your wealth advisor and tax advisor in order to evaluate the benefit of electing NUA, or not. As always, if you have any questions or would like to discuss, please reach out to your ACM Wealth Advisor.

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