Net Unrealized Appreciation (NUA): Tax-Free Growth on Concentrated Stock Positions

Net Unrealized Appreciation (NUA) is a hidden gem in the tax code that allows employees to extract highly appreciated employer stock from their 401(k) with only ordinary income tax on the cost basis—while the appreciation is taxed later at preferential long-term capital gains rates. For an employee with $2M in employer stock (cost basis $300K, appreciated $1.7M) in their 401(k), using the NUA election can save $200-400K in taxes compared to standard 401(k) rollover treatment. Yet fewer than 5% of eligible employees use this strategy, leaving massive tax benefits unrealized. This comprehensive guide explores NUA mechanics and optimization strategies.

The NUA Advantage: Tax Treatment Comparison

Standard 401(k) Rollover vs. NUA Election

Scenario: $2M Employer Stock in 401(k)	Cost Basis	Unrealized Appreciation (NUA)	Total Value
Standard Rollover (to Traditional IRA)
Tax at distribution (37% bracket)	$300K × 37% = $111K tax	Deferred in IRA (taxed later at 37%)	Net: $1.889M ($111K less)
Future tax on full amount (withdraw at retirement)	All $2M taxed at ordinary rates (37%)	All $1.7M appreciation taxed at 37%	$2M × 37% = $740K total lifetime tax
NUA Election (Lump-Sum Distribution)
Immediate tax on cost basis (37% bracket)	$300K × 37% = $111K tax	$0 tax (deferred until sale)	Hold $2M stock in brokerage
Future tax on appreciation (hold 1+ year, then sell)	Already taxed at $111K	$1.7M × 20% long-term gains tax = $340K	Total lifetime tax: $451K
TAX SAVINGS with NUA	$740K - $451K = $289K (39% savings)

NUA Eligibility and Requirements

Who Is Eligible?

• Triggering Event: Must receive "qualifying lump-sum distribution" (entire plan balance distributed within one calendar year due to: separation from service, age 59.5, disability, death, or plan termination)
• Stock Requirement: 401(k) must contain employer company stock (NUA only applies to employer stock, not mutual funds or other investments within plan)
• Timing: Election made at distribution; cannot retroactively elect NUA on prior rollovers

Key Disqualifications (Cannot Use NUA)

• Rolling over employer stock to traditional IRA (once in IRA, NUA election lost forever; treated as ordinary IRA distribution)
• Partial distributions (NUA typically requires full 401(k) account liquidation; partial distributions may not qualify)
• Non-qualifying separation (terminating employment but staying on as contractor; not treated as separation from service)
• Stock in subsidiary company (NUA only works for parent company stock)

NUA Strategy Mechanics

Step-by-Step Execution

Step	Action	Tax Impact
1	Separate from service (retirement, job change, etc.)	Triggers lump-sum distribution eligibility
2	Contact 401(k) plan administrator; request FULL account distribution (all investments including employer stock)	Plan administrator issues check or direct transfer; documents NUA election opportunity
3	CRITICAL: DO NOT roll employer stock into IRA; take distribution directly to brokerage account	If rolled to IRA, NUA election is lost permanently + stock taxed at ordinary rates
4	Elect NUA treatment on Form 5498 or plan statement (file with tax return year of distribution)	Cost basis taxed in year of distribution at ordinary rates (37% max); appreciation deferred
5	Hold employer stock in taxable brokerage 1+ year (for long-term capital gains treatment)	Appreciation receives long-term capital gains rate (20% max); no additional tax accrual
6	Sell stock or hold indefinitely (hold at death for step-up in basis benefit)	If held until death, appreciation never taxed (receives step-up to then-current value)

Critical Pitfall: The IRA Rollover Trap

AVOID THIS MISTAKE: Upon receiving lump-sum distribution, rolling employer stock into traditional IRA "for simplicity." This permanently disqualifies NUA treatment; stock becomes subject to ordinary income taxation (37% max) instead of preferential capital gains rates (20% max), costing $100-300K+ in lifetime taxes on concentrated positions.

Handling Non-Employer Stock within 401(k)

Strategy for Mixed Accounts

If 401(k) contains both employer stock AND mutual funds/diversified investments:

Distribution Method	Employer Stock Treatment	Other Investments	Net Result
Receive employer stock + non-stock to brokerage	NUA treatment possible (if elected)	Ordinary income tax on full amount	Optimal (captures NUA benefit on concentrated position)
Roll non-stock to IRA; take stock to brokerage	NUA treatment possible	Traditional IRA (tax-deferred)	Efficient (IRA protects most diversified assets; only taxable stock is concentrated position)
Roll everything to IRA (common mistake)	NUA election lost permanently	Tax-deferred in IRA	Suboptimal (loses $100-300K+ in tax savings)

Concentration Risk Management Post-NUA

The Diversification Dilemma

After NUA election, holding 50-100% portfolio in single employer stock creates concentration risk (Enron, Bear Stearns, GM bankruptcies destroyed employee wealth). Yet selling creates capital gains tax (20% on unrealized appreciation).

• Risk Tolerance Approach: Sell 10-30% of position annually to reduce concentration while spreading tax over multiple years
• Hedging Strategy: Buy protective puts or short calls on concentrated position (costs 1-3% annually but caps downside)
• Charitable Strategy: Donate concentrated stock to charity/donor-advised fund (avoid capital gains entirely + receive deduction; simultaneously reduce concentration)
• Hold Until Death: If financially secure, hold until death; step-up in basis eliminates all appreciation taxes; heirs receive fully diversified inherited assets at market value

NUA with Employer Stock Appreciation Scenarios

Timing Benefits (Hold Until Death Strategy)

Scenario	Distribution (Age)	Stock Growth	At Death (10-20 years later)	Heirs' Tax
Retire at 65	$2M stock; $300K basis cost; $111K tax paid	$2M → $5M (compound growth 5% annually over 15 years)	Step-up to $5M basis; $0 capital gains tax	Heirs inherit $5M stock completely tax-free ($595K in avoided taxes)
Alternative (standard rollover)	$2M to IRA; $740K lifetime tax	IRA compounds tax-deferred to $5M	Heirs inherit IRA; taxes paid on full $5M over life expectancy	Heirs pay ~$1.85M in income taxes on IRA withdrawals
NUA Benefit (hold until death)	$1.85M - $0 = $1.85M additional wealth preserved for heirs

Conclusion: Strategic NUA Planning

NUA is one of the most underutilized tax benefits for high-net-worth employees with concentrated employer stock positions. The optimal strategy: (1) file for full lump-sum distribution upon separation from service, (2) elect NUA treatment (not IRA rollover), (3) take employer stock to taxable brokerage account, (4) balance concentration risk through gradual diversification while harvesting long-term capital gains treatment, and (5) consider holding into estate for step-up in basis. For concentrated stock holders, this difference between NUA and standard rollover can be $300K-1M+ over a lifetime.

Frequently Asked Questions