Withdrawing company stock from a
401(k) to take advantage of a tax break called net
unrealized appreciation (NUA) sounds like a
no-lose proposition, and most advisers tell their
eligible clients to go for it. But there’s just
one big problem: When you run the numbers, this
maneuver often doesn’t pay off.
employees accumulate substantial company stock in
their 401(k), especially if they have worked for
the company many years and the stock has done
well. (And the individual may be overconcentrated
When the employee retires, leaves
the company or otherwise qualifies for a lump-sum
distribution, he or she may remove the stock from
the plan and put it in a taxable account but still
get favorable tax treatment. Only the cost basis
of the stock counts as ordinary taxable income.
When the stock is sold, the additional
“unrealized” appreciation that occurred within the
401(k) is taxed at long-term capital gains rates.
So if the stock’s basis is $20,000 and it’s now
worth $100,000, the transfer and an immediate sale
will produce $20,000 in ordinary income and
$80,000 of long-term capital gain. Most people who
take advantage of NUA sell the stock immediately,
but this isn’t required. Any sale after
the transfer out of the 401(k) will produce a
separate long- or short-term gain or loss.
However, be aware that a 10% withdrawal penalty
for early distribution could apply if the employee
is under age 59½, unless he or she is at least 55
and there is a complete separation from service.
To determine full eligibility and make sure other
requirements are met, see IRS Publication 575.
In contrast, if the stock is rolled over
into a traditional IRA, the entire amount will be
counted as ordinary income as it’s withdrawn
during retirement. Potentially, the tax savings
under the NUA approach can be substantial. So
what’s not to love? Plenty.
advising your client to take the NUA option, run
the numbers. On a spreadsheet, simulate the
distribution, sale and federal and state tax
returns, including the resulting additional
capital gains and ordinary income. Now, assume a
realistic after-tax rate of return over time on
the remaining asset.
Next, compare that
scenario with rolling over the stock into an IRA,
selling it tax-free inside the IRA, assuming a
suitably higher pre-tax rate of return, and paying
taxes on the mandatory distributions starting at
You’ll probably discover that the
NUA approach works best only when the cost basis
is very low or the investment horizon is
relatively short. Otherwise, as shown in the chart
below, the client will have more money in the long
term by transferring the stock to an IRA. With
NUA, the funds grow at after-tax investment rates.
In contrast, keeping the money in the IRA lets the
entire amount grow until distributions start. And,
while those distributions are fully taxable, the
interim tax-deferred buildup—at higher, pre-tax,
investment rates—can be substantial.
Of course, there are
situations in which the NUA option may be more
profitable. If the client needs the money in the
short term, taking advantage of NUA can make
perfect sense. For many people, though, net
unrealized appreciation is a net loser
By Robert J. DiQuollo,
CPA/PFS, CFP, a senior financial adviser with
Brinton Eaton Wealth Advisors, in Morristown,
N.J. He can be reached at