Net Unrealized Appreciation (NUA) is a specific IRS tax concept that applies to employer stock held within a qualified retirement plan, such as a 401(k). It represents the difference between the cost basis—the price paid for the stock when contributed to the plan—and its fair market value at the moment the stock is distributed from the plan. Understanding NUA can unlock significant tax benefits when you retire or leave your job.
Why NUA Matters
Without using the NUA strategy, when you take a distribution of your employer stock from a retirement plan, the entire value of the distribution is typically taxed as ordinary income, which can mean paying relatively high taxes, especially if you’re in a higher tax bracket. However, under IRS rules introduced in 1984, the appreciation portion—the NUA—is taxed later at the capital gains tax rate, which is usually lower than the ordinary income tax rate.
How NUA Works
When you take a lump-sum distribution of employer stock, you owe ordinary income tax only on the cost basis amount included in your plan. The gain or NUA is held until you sell the stock, at which point it is taxed as a long-term capital gain regardless of how long the stock is held after distribution. For example:
- You purchased employer shares within your 401(k) for $15,000 (cost basis).
- The shares are worth $60,000 at distribution.
- You pay ordinary income tax on the $15,000 cost basis when you take the stock out.
- The $45,000 NUA is taxed later as capital gains when you sell the stock.
Because capital gains tax rates max out lower than ordinary income tax rates, this can result in substantial tax savings.
Eligibility and Distribution Requirements
To qualify for NUA treatment, the distribution must be a lump-sum distribution—meaning the entire balance of your qualified plan must be distributed within one tax year due to retirement, separation from service after age 55, disability, or death. Partial distributions or rollovers of employer stock into IRAs disqualify you from NUA treatment.
Moreover, only employer stock held within the plan qualifies, not other assets like mutual funds or bonds.
Strategic Considerations
If you have a large amount of employer stock in your retirement plan, consider taking a direct in-kind distribution of the shares rather than rolling them into an IRA. This allows you to:
- Pay ordinary income tax only on the cost basis initially.
- Take advantage of lower long-term capital gains rates on the NUA when you sell.
- Manage capital gains timing by controlling when to sell after distribution.
It’s important not to sell the shares immediately after distribution to ensure the appreciation qualifies for long-term capital gains treatment. Holding the stock for more than one year after distribution usually qualifies you for long-term capital gains rates on the gain portion.
Risks and Common Pitfalls
- Rolling employer stock into an IRA voids NUA treatment, making all withdrawals taxable at ordinary income rates.
- Taking partial distributions won’t qualify for NUA and could trigger higher taxes.
- Selling the stock immediately after distribution means gains will be short-term and taxed at higher rates.
- Failing to confirm or document your cost basis can lead to tax reporting errors.
Real-Life Example
Consider Jane, who owns employer stock with a cost basis of $100,000, currently worth $400,000. By taking a lump-sum distribution of her shares directly from her 401(k), she pays ordinary income tax on $100,000 now, while the $300,000 NUA is deferred until she sells the stock and then taxed at favorable capital gains rates, potentially saving tens of thousands in taxes compared to rolling over the stock to an IRA.
Additional Tax Implications
If you’re under 59½, the 10% early withdrawal penalty applies only to the cost basis portion of the distribution. The NUA portion is not subject to this penalty. NUA does not directly affect Social Security or Medicare benefits, but increasing your taxable income through distributions can influence taxation on these programs.
Related Topics
For more on retirement accounts and distributions, see Lump-Sum Distribution, and learn about Traditional IRA rollovers and their tax implications.
Sources and References
- IRS: Net Unrealized Appreciation (NUA) (2025)
- Investopedia: Net Unrealized Appreciation – NUA
- NerdWallet: What Is Net Unrealized Appreciation (NUA)?
Understanding NUA can offer you an important tax planning tool for handling employer stock in your retirement plan. Consult a tax professional to assess your situation and ensure you optimize your retirement income and tax savings.