Net Unrealized Appreciation (NUA) is a tax strategy that lets retirees with appreciated employer stock inside their 401(k) take that stock as an in-kind distribution to a taxable account, paying ordinary income tax only on the original cost basis (not the appreciation). The appreciation is then taxed at long-term capital gains rates when sold, often 15-20% federal vs 22-37% ordinary income, a substantial savings.
NUA is a legitimate but underused tax strategy specifically designed for employees who hold their employer's stock inside their 401(k) plan. It works only with employer stock acquired through the 401(k), not with mutual funds, target date funds, or stock acquired outside the plan. For Northern Suburbs employees at AbbVie, Abbott, Baxter, Walgreens, or other public companies who have accumulated significant company stock through their 401(k), NUA can save tens or hundreds of thousands of dollars in lifetime taxes.
The mechanics: at retirement (or other qualifying triggering event), the employee takes the company stock as an in-kind distribution to a taxable brokerage account. The remaining 401(k) balance (mutual funds, etc.) typically rolls to an IRA. Ordinary income tax is paid in the distribution year on the cost basis of the stock, not the current value. The appreciation (NUA) is preserved as long-term capital gain treatment when the stock is later sold, regardless of how long it was held in the 401(k).
Example: an employee retires with $1M in company stock in their 401(k), $200K cost basis, $800K appreciation. With NUA, they pay ordinary income tax on $200K in the distribution year (at marginal rate, maybe $50K-$70K of tax). The $800K of NUA is taxed at long-term capital gains rates when sold (15-20% federal + 4.95% Illinois). Total tax over time: roughly $250K-$300K. Without NUA (rolling everything to IRA and taking distributions as ordinary income), total tax could be $370K-$450K, a savings of $100K+ via NUA.
NUA isn't always the right answer. It requires upfront cash to pay the tax on cost basis (the distribution year creates a one-time spike in income). The appreciated stock is now in a taxable account, exposed to single-stock concentration risk. If the company stock represents a small percentage of the 401(k), the strategy may not be worth the complexity. And NUA must be done as part of a 'lump sum distribution', meaning the entire 401(k) must be distributed in the same calendar year, with the non-stock portion typically rolled to an IRA simultaneously.
Key facts
- NUA: appreciation on employer stock in 401(k) taxed at long-term capital gains rates instead of ordinary income
- Cost basis: taxed as ordinary income in distribution year
- NUA preserves long-term capital gains treatment regardless of holding period in the 401(k)
- Requires lump-sum distribution: entire 401(k) balance must be distributed in same calendar year
- Triggering events: separation from service, death, disability, age 59½ (with restrictions)
- Subsequent appreciation after distribution: taxed at standard short-term or long-term rates based on post-distribution holding period
Who should consider an NUA strategy?
NUA is typically attractive when: (1) you have at least $250K of appreciated employer stock in your 401(k); (2) the appreciation (NUA) is at least 50% of current market value (low cost basis); (3) you're separating from service or retiring; (4) you have cash outside the 401(k) to pay the ordinary income tax on cost basis; (5) your marginal tax rate is high (22%+) so the spread between ordinary rates and capital gains rates is meaningful. Below these thresholds, the complexity often outweighs the tax savings, and a clean rollover to an IRA may be simpler.
Can I do NUA on partial company stock or do I have to take all of it?
You can choose to apply NUA to all or a portion of the company stock. Common variations: (1) NUA on all company stock; (2) NUA on lowest-basis lots only (where appreciation is highest); (3) NUA on highest-basis lots only (lower upfront tax cost, less benefit). The election is per-share, not per-account, so analysis can identify which specific lots produce the best tax outcome. The non-NUA portion of the 401(k) can be rolled to an IRA tax-deferred. The election is made at the time of distribution and is irrevocable.
