Should You Use Net Unrealized Appreciation (NUA) in Your 401(k)? Key Considerations for Company Stock Owners

 

Should I use net unrealized appreciation for my 401k company stock?

If you hold company stock within your 401(k) and that stock has significantly appreciated, you may benefit from a tax strategy known as Net Unrealized Appreciation (NUA). NUA can potentially reduce your long-term tax liability, but it’s not right for everyone.

When you leave your employer, or after you turn 55, it’s essential to evaluate whether using the NUA rules aligns with your overall retirement income strategy. Here are five key takeaways to help you decide.

 

1. NUA May Let You Pay Less in Taxes Over Time

The primary benefit of Net Unrealized Appreciation is the potential for lower taxes on the growth of your employer stock. Rather than paying ordinary income tax on the entire value of the stock (as you would in a traditional 401(k) distribution), you pay ordinary income tax only on the original cost basis—the amount you paid for the stock.

The appreciation, or gain, is taxed later at more favorable long-term capital gains rates when you sell the stock. This can be a major advantage in retirement tax planning.

NUA Only Applies if:

• You own your employer’s stock inside your 401(k) or other qualified retirement plan, such as through an Employee Stock Ownership Plan (ESOP) or Stock Purchase Plan.
• The stock has significantly increased in value since it was acquired.
• A triggering event has occurred such as separation from service, reaching age 55 (or 50 for public safety employees), disability, or death.

 

2. NUA Works Best with Highly Appreciated Employer Stock

If your company stock has appreciated significantly (say by 500% or more) NUA could be a powerful tool. A general rule of thumb: if your cost basis is 20% or less of the current stock value, it may be worth exploring.

However, if your company stock hasn’t appreciated much or has declined, this strategy may not provide meaningful tax savings and could increase your risk or tax liability.

 

3. NUA Is Entirely Optional and Flexible

NUA is not required. You’re not obligated to use this strategy when you retire or leave your employer. In fact, most people roll over their 401(k) into an IRA and never use NUA. That’s okay.

You also don’t need to apply NUA to all of your company stock. You can selectively choose how many shares to apply it to, offering flexibility based on your financial goals and tax situation.

 

4. NUA Increases Your Tax Burden in the Year of Distribution

Choosing NUA means pulling your company stock out of your 401(k) and paying ordinary income tax on the cost basis in the year of the distribution.

If your cost basis is low, the tax hit may be minimal. But even a small NUA transaction increases your taxable income in the year it’s executed. Make sure you plan for this with your financial advisor or tax professional, particularly if you’re near a tax bracket threshold or have other large income events that year.

 

5. It’s Often Best to Sell the Stock Immediately After Using NUA

Once you’ve executed a NUA strategy, it’s generally advisable to sell the employer stock shortly thereafter. Here’s why:

• If you expect the stock to rise further, it would have been more tax-efficient to leave it in your 401(k) or IRA and defer taxes.
• Holding too much of one company’s stock increases investment risk. Diversification improves your portfolio’s risk-adjusted return.
• Using NUA creates two types of capital gains: short-term and long-term. This adds complexity and may lead to higher tax liability if the stock is sold within a year.

Selling right away reduces risk and simplifies your tax situation.

 

In Summary: Is NUA Right for You?

When it comes to managing company stock in your 401(k), the NUA strategy may allow you to:

• Reduce long-term tax liability
• Take advantage of capital gains tax rates
• Customize how and when you pay taxes on your retirement assets

However, this strategy only makes sense in specific situations. It is most beneficial when your company stock has significantly appreciated and your cost basis is low. It also adds complexity and increases your tax burden in the year you use it, so it’s important to evaluate carefully before moving forward.

If you’re considering whether to use NUA when rolling over a 401(k) or preparing for retirement, consult with a fiduciary financial advisor or tax expert. They can evaluate your specific situation and help determine the best approach to maximize after-tax retirement income.

Need More Guidance?

Download our free white paper:
To NUA or Not: What to Do If You Own Company Stock in Your 401(k) 

 

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People Also Ask:

1. How do I know if NUA is worth it for me?

Start by checking your cost basis versus current value. If your cost basis is less than 20% of your employer stock’s market value, NUA might be worth considering. A financial advisor can help model the tax impact based on your full financial picture.

2. Does NUA make sense for every type of company stock?

Not necessarily. NUA works best with volatile or high-growth stock. If your company stock is slow-growing or highly uncertain, the tax benefits may not justify the risk.

3. What are common mistakes people make with NUA?

Waiting too long to act after leaving an employer, not tracking cost basis properly, and misunderstanding the tax timeline are common errors. Timing and documentation are critical.

4. Can I combine NUA with a 401(k) rollover?

Yes. You can apply NUA to part of your employer stock and roll over the rest of your 401(k) to an IRA. This allows for a blended strategy that fits both tax and investment goals.

5. Is it ever smart to hold the stock after using NUA?

In rare cases, yes—such as when you’re confident in the company’s short-term outlook and have minimal exposure elsewhere. But in general, diversification is safer and more tax-efficient.

 

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Disclaimer: The information provided in this blog post is for general informational purposes only and should not be construed as financial or legal advice. Please consult with a qualified professional for advice regarding your specific situation.

DISCLOSURE: Client stories included in this blog reflect hypothetical client situations that represent those commonly encountered by AIWM representatives.