Net Unrealized Appreciation Strategy for Company Stock in a 401(k) (a Walkthrough from Scotia Wealth Management)

Vernon's company shares are worth almost seven times what he paid

Vernon, 59, is chief operating officer at a public industrial manufacturer and plans to retire in two years, at 61 (hypothetical, round numbers). Of his $2.8 million in low-basis company shares, $800,000 sits in the 401(k) company stock fund with a $120,000 basis. He also has $1.1 million in deferred compensation, and his wife Judy, 57, is a retired pharmacist. Their advisor of 15 years had penciled in a direct rollover of the whole 401(k) into an IRA, and they assumed that was simply what retirees do.

The NUA rule says something different. Company shares taken out in kind as part of a lump-sum distribution are taxed two ways: ordinary income on the $120,000 basis now, and long-term capital gains rates on the $680,000 of appreciation whenever the shares are sold. Before Scotia Wealth Management suggests changing a rollover, it pulls the plan's cost-basis report for the company stock fund; everything else in the existing roadmap stays as it is unless the numbers say otherwise. Applying the shortcut here, $120,000 divided by $800,000 is 15 percent. That is well under a quarter, so the NUA route earns a full calculation.

When does the NUA window open, and when does it close?

The NUA window opens when a triggering event lets the whole 401(k) leave the plan, and it closes on December 31 of the year the lump sum is taken, because the IRS requires every balance in same-type plans at that employer to be distributed within one tax year.

Vernon and Judy assumed the calendar was flexible. At 59 Vernon has already passed 59½, which is itself a triggering event, so any in-service withdrawal or partial rollover taken before his planned lump sum can spend that trigger. His rule for the next two years: take nothing out of the 401(k) until he retires. Separation from service at 61 is a fresh trigger. Because he leaves no earlier than the calendar year of his 55th birthday, the 10 percent additional tax would not touch the basis anyway.

Timing inside the lump-sum year matters more than most people expect. Vernon can wait until the January after he retires, so the $120,000 of basis income lands in a year with no salary. Later markers come in order. Income in the year he turns 63 sets his Medicare Part B premium at 65 through IRMAA, and required minimum distributions start at 75 for both Vernon and Judy, since they were born in 1960 or later.

What happens if the shares go into an IRA with everything else?

A full rollover defers all tax today, but every dollar of the $800,000, basis and appreciation alike, becomes ordinary income when withdrawn. Vernon's $680,000 of appreciation would lose its claim to long-term capital gains rates, and an IRA gives heirs no discount on it either. Their advisor had priced none of this. We compare three options on four criteria: tax now, tax later, what Judy or an heir receives, and flexibility.

Cash flow decides how the options feel once salary stops. Assume, for illustration, that the $1.1 million of deferred compensation pays in five annual installments of $220,000. Those installments cover spending first, because the payout election is fixed. Sales of NUA shares fill gaps after the installments end, at capital-gains rates, and the IRA waits for RMDs.

The basis is ordinary income and adds to MAGI in the distribution year. In a year with an installment, that is $220,000 plus $120,000, or $340,000, well under the $768,700 where the 37 percent rate starts for married couples filing jointly (2026 figure). NUA gains count in MAGI when the shares are sold, so selling at 63 or later can raise IRMAA. The appreciation itself is not net investment income for the 3.8 percent tax, but growth after the distribution can be. Markets go down as well as up, and the shares can lose value before they are sold.

Which facts should push Vernon and Judy toward NUA, and which toward a rollover? The table answers that.

• Full rollover (A): nothing is taxed now, every dollar is ordinary income when withdrawn, and RMDs start at 75.
• NUA on all 401(k) shares (B): $120,000 is ordinary income now and $680,000 is taxed at long-term rates when sold, with no step-up on the NUA.
• NUA on part of the shares (C): the lowest-basis lots come out and the rest roll over, but only if the plan tracks basis lot by lot, so ask the recordkeeper.

The net unrealized appreciation strategy, priced for Judy as well as Vernon

Vernon held $800,000 of company stock in the 401(k) and assumed the tax comparison was his alone. Taking the shares out in kind at 61, he reports the $120,000 basis as ordinary income: at an assumed 30 percent, that is $36,000. The $680,000 of NUA is taxed when sold, and at an assumed 15 percent that is $102,000. The NUA route totals $36,000 plus $102,000, or $138,000. Rolled into an IRA instead, all $800,000 is ordinary income on withdrawal.

Judy is two years younger and may well outlive him. As a widow she would file single, so assume a 35 percent rate on IRA withdrawals, for illustration. That makes the IRA route $800,000 times 35 percent, or $280,000, against $138,000 for NUA, a difference of $142,000. As a spouse she can roll an inherited IRA into her own, but that does not change the ordinary-income treatment. The NUA portion gets no step-up at death, so unsold shares still carry tax on the $680,000; growth after the distribution date does get a step-up.

Heirs see it differently. Most non-spouse heirs of an IRA must empty it within ten years at their own ordinary rates, so a child in a high-earning decade could pay more than Judy would.

Take now a contrast household that should choose the other way (hypothetical). A plant controller at the same company, 62, has $300,000 of company stock with a $210,000 basis. NUA would put $210,000 of ordinary income on one return, an assumed $63,000 tax now, to move only $90,000 to capital-gains rates. At 30 percent versus 15 percent on that $90,000, the saving is about $13,500 over a lifetime. Rolling everything to an IRA keeps the $63,000 working, so the rollover wins for him.

One limit applies to both men. NUA changes how the shares are taxed, not how concentrated Vernon is; he still holds $2.8 million in one company, and the selling pace belongs to his broader concentrated stock planning.

If the plan's distribution form goes in before the brokerage account exists

Vernon assumed the form was a formality his recordkeeper would handle. Sending in the 401(k) distribution form before a taxable brokerage account is open in the participant's name lets the plan default the company shares into the IRA rollover. Once the shares are in the IRA, NUA treatment on them is lost permanently, which on Vernon's numbers could raise Judy's eventual tax by about $142,000. There is no undo after processing; the only fix is to catch it before the recordkeeper acts.

Gather these before anyone signs:

The fix itself is short. Open a taxable brokerage account titled in Vernon's name, with Judy as transfer-on-death beneficiary, and write that account number in the in-kind section. Ask the recordkeeper to confirm the share count in writing before processing. Check that no small balance in another same-type plan is left behind, because a leftover balance can break the lump sum.

• The cost-basis report for the company stock fund, from the recordkeeper's website or by request.
• The latest 401(k) statement with the share count.
• The distribution packet showing the in-kind option, from the recordkeeper.
• A list of every qualified plan of the same type at the employer, including any old profit-sharing balance, from HR benefits.
• The deferred compensation payout schedule and election form, from the plan portal.
• Last year's Form 1040.

When Judy asks what happens to her

In reviews, the spouse who will one day handle the accounts usually raises this first, and here that is Judy, asking what she would owe on the shares. We sit down with both of them and one sheet. It shows the $120,000 basis tax paid now and the $102,000 she would owe whenever the shares are sold. It also shows the $280,000 the IRA route could cost her as a single filer and which brokerage account she would log into.

The question for Scotia Wealth Management if your 401(k) holds company stock

Bring your plan's cost-basis report and ask Scotia Wealth Management two things. First, what does NUA save your spouse compared with the rollover your current roadmap assumes? Second, in which tax year should the basis be taxed, given your deferred compensation installment schedule?