Your 401(k) Has Employer Stock? Make Sure You Know About This Tax Rule Before You Retire

The post Your 401(k) Has Employer Stock? Make Sure You Know About This Tax Rule Before You Retire appeared first on 24/7 Wall St..

A 61-year-old technology vice president retiring this summer has roughly $1.4 million in her 401(k). About $500,000 of that balance sits in employer stock she accumulated through years of stock purchase contributions and the company match. The default move, rolling everything into an IRA, would cost her tens of thousands she does not have to pay.

The mechanic that changes the math is Net Unrealized Appreciation, a provision tucked inside IRC Section 402(e)(4). Plan sponsors rarely highlight it because the rules are narrow and the paperwork moves outside the recordkeeper’s system.

How the NUA election actually works

In a qualifying lump-sum distribution, employer stock leaves the 401(k) and lands directly in a regular taxable brokerage account. The cost basis, meaning what the plan paid for those shares, is taxed as ordinary income in the year of distribution. The appreciation above that basis, the “NUA,” is taxed at long-term capital gains rates when the shares are sold, regardless of how long they sit in the taxable account after the rollover.

The contrast with a standard IRA rollover is what makes the strategy valuable. Inside an IRA, every dollar of the eventual withdrawal is ordinary income. Under NUA, only the basis carries that ordinary-income label.

The $68,000 difference on $500,000

Assume the executive’s $500,000 position has a $100,000 cost basis and $400,000 of appreciation. Her final W-2 puts her in the 24% federal bracket, which covers married joint income above $211,400 in 2026.

Rollover path: the full $500,000 moves into an IRA. When eventually withdrawn, or forced out by RMDs, every dollar is ordinary income. At 24%, federal tax on the full position runs $120,000. At the 32% bracket that kicks in above $403,550 for joint filers, the bill grows to $160,000.

NUA path:

• $100,000 cost basis added to current-year ordinary income at 24%: $24,000.
• $400,000 of NUA taxed at the 15% long-term capital gains rate when shares are sold: $60,000.
• Combined federal tax: $84,000, a $36,000 saving against the lower-bracket rollover comparison.

The gap widens at the top. The 2026 top marginal rate of 37% applies above $640,600 for singles and $768,700 for married joint filers. At that level, the spread between ordinary income and the 20% long-term capital gains rate runs 17 points on $400,000, or roughly $68,000 of avoidable federal tax on a single position.

The four rules that disqualify most people

1. Triggering event. A separation from service, reaching age 59½, total disability, or death must have occurred. No event, no NUA.
2. True lump sum. The entire 401(k) balance must be distributed within one tax year. A single in-service withdrawal in December forfeits NUA on everything until the next qualifying event.
3. In-kind transfer. The employer shares move directly to a taxable brokerage account, not to an IRA. Cash or other assets in the plan can still roll to an IRA in the same lump-sum transaction.
4. Original employer shares. Stock must have been contributed by the employer or purchased inside the plan, not acquired through a post-rollover trade.

Where the strategy quietly breaks

The cost basis lands on the current year’s tax return all at once. For an executive still drawing $400,000 in salary, stacking another $100,000 of ordinary income can push the household into the 32% or 35% bracket and pull other investment income into the 3.8% net investment income tax. Most advisors run the lump-sum year after wages drop to zero, frequently the first full year of retirement.

Concentration risk also lingers. If the $500,000 represents a meaningful slice of total net worth, the NUA tax win can be erased by a 30% drop in a single name. Selling shares the day after distribution locks in the capital gains discount and resets diversification, at the cost of triggering the tax bill in year one rather than spreading it across retirement.

Three steps before calling the plan administrator

1. Request the per-share cost basis report from the 401(k) recordkeeper. Savings scale with the ratio of appreciation to basis. A 5-to-1 ratio is the rough breakeven against a straight rollover, and 10-to-1 is a clear win.
2. Model the distribution year against the rollover year in a tax projection that includes IRMAA. The basis bump becomes modified adjusted gross income and can lift Medicare Part B and Part D premiums two years later.
3. Confirm the plan document permits in-kind distribution of employer shares. Some plans force liquidation at separation, which destroys the NUA election before the paperwork is filed.

The post Your 401(k) Has Employer Stock? Make Sure You Know About This Tax Rule Before You Retire appeared first on 24/7 Wall St..