The Ultimate Guide To Net Unrealized Appreciation (NUA) - Microsoft 401 (k) Rollover Example

Net Unrealized Appreciation or NUA is one of the most powerful tax advantages in our tax code. NUA allows you to transfer company stock out of your retirement account (401k) and pay taxes on the stock's cost basis (the original purchase price) at the time of distribution, while deferring taxes on the appreciation (the increase in value) until the stock is sold. When the stock is eventually sold, the appreciation is taxed at the more favorable long-term capital gains rate, rather than ordinary income tax rates associated with a 401k or IRA withdrawal.

This strategy can result in significant tax savings, especially if the stock has appreciated substantially over time.

This strategy involves a lot of different variables to be aware of, and I’d highly recommend working with a CFP who was accomplished one of these transfers in the past, as one mistake could become incredibly expensive by making the entire transfer taxable at your income tax rate and even a possible early withdrawal 10% penalty.

In this blog, we’ll explain how the NUA strategy works and illustrate its potential tax savings with an example below.

Good NUA Candidates

1.      You own company stock within your 401 (k)

2.      The stock you own has appreciated by over 500% since you purchased it. So if you purchased the shares for $10/ea, they are now worth at least $50/ea.

• This doesn't work if you've sold and re-purchased your company stock. If you sold it and re-purchased at a higher price, then you will need to use the higher price as your cost basis.

• Some companies will allow you only to transfer out specific tax lots that are the most advantageous, and others, like Microsoft, require you to use the cost basis average for all of your shares.

  
  

3.      Not required, but it is beneficial if you were let go after age 55 or 59.5 would be even better.

4.      You reached a triggering event.

• The triggering events are (a) Death, (b) Disability, (c) Separation from Service, or (d) reaching age 59 ½. Notably, this means that an in-service distribution generally does not qualify for NUA treatment, unless it is a distribution that also happens to occur after a triggering event (e.g., upon reaching age 59 ½).

Reducing future RMDs (Required Minimum Distributions)

The NUA strategy can also reduce your future RMDs. Keep in mind that if you have a $1.5 million 401 (k) and $500k is in an attractive NUA position, then removing that $500k from your $1.5 million 401 (k) can drastically reduce future RMDs.

How is your company stock taxed?

Once you transfer your company shares out of the 401 (k) and into an individual account, then you will pay income tax on the cost basis of those shares at year's end. The gain you had in them before the transfer will be considered long-term capital gains and won’t be taxed until sold. This means that you could spread the sale out over future years when your income may be low enough to qualify for the 0% capital gains rate. All gains received after the NUA transfer will be taxed at short-term capital gains rates until 12 months have passed since your last transfer. Please see the chart below for clarification.

Example: Jim (60), a Microsoft Employee

Background:

• Age: 60 (eligible for penalty-free withdrawals from his 401(k)). If Jim were under 59.5 years old, then he may be subject to a 10% early withdrawal penalty unless he qualified for the rule of 55, as seen below.

• Employment Status: Laid off from Microsoft in June 2025.

• 401(k) Value: $1.5 million, including $500,000 in Microsoft stock.

• Cost Basis of Stock: $50,000 (purchased over the past 15 years).

• Other Assets in 401(k): $1 million in various low-cost ETFs

  
  

Steps Jim Would Take:

Confirm Eligibility for NUA:

1. Jim qualifies for NUA treatment because he experienced a triggering event (separation from service) and plans to take a lump-sum distribution of his entire 401(k) in 2025. It is very important that his entire account is worth $0 as of year-end; otherwise, you may make the whole transfer taxable as income.

2. Request a Lump-Sum Distribution:

   1. Jim transfers the Microsoft stock ($500,000) to a taxable brokerage account.

   2. He rolls over the remaining $1 million in non-stock assets to an IRA to avoid immediate taxation on those assets.

   3. Jim is also sure to check on his 401k to verify it’s worth $0 two and four months after the rollover.

3. Pay Taxes on the Cost Basis:

   1. The $50,000 cost basis of the Microsoft stock is taxed as ordinary income in 2025. Assuming Jim is in the 24% tax bracket, he would owe $12,000 in taxes on the cost basis.

4. Defer Taxes on the NUA:

   1. The $450,000 NUA (the appreciation in the stock’s value) is not taxed until Jim sells the stock. When sold, the NUA will be taxed at the long-term capital gains rate, which is 15% for most taxpayers in Jim’s income range. But could be 0% if he sold these in the year after he lost his job, assuming his income was $0 in that year. 

   2. If he wanted to pay $0 in taxes on the $450,000 gain, then he could realize up to $124,050/yr in 0% long-term capital gains, assuming he was married filing jointly and that was his only income for the year. If his goal was to pay $0 in taxes, then he could stretch this sale out over 4 years to live off the tax-free gains in his portfolio. Of course, this comes with the risk of the stock's value decreasing.

5. Sell the Stock When Needed:

   1. If Jim sells the stock while his income is in the 24% tax bracket, he will owe 15% capital gains tax on the $450,000 NUA, which amounts to $67,500. He could alternatively spread out the sale, donate the stock, or wait until he has a low-income year to qualify for the 0% capital gains tax.

      
      

Tax Comparison: NUA Strategy vs. Standard 401(k) Distribution

NUA Strategy:

• Ordinary Income Tax on Cost Basis: $50,000 × 24% = $12,000.

• Capital Gains Tax on NUA: $450,000 × 15% = $67,500.

• Total Taxes: $12,000 + $67,500 = $79,500.

• These gains are sold over time to keep Jim in the 15% capital gains tax bracket.

  
  

Standard 401(k) Distribution:

• If Jim takes a standard distribution of the $500,000 in Microsoft stock, the entire amount would be taxed as ordinary income at 24%.

• Taxes: $500,000 × 24% = $120,000.

• Of course, this assumes he withdraws the funds over time and stays in the 24% tax bracket. If he sold it and withdrew it in one year, then the taxes would be in the 32% or higher tax brackets.

  
  

Tax Savings with NUA:

• By using the NUA strategy, Jim saves $120,000 - $79,500 = $40,500 in taxes.

  
  

Nuances

• Cost basis selection

  • Some 401 (k) providers will allow you to select the most beneficial cost basis to transfer in your NUA selection. But others, such as MSFT, require an average cost basis reporting at tax time.

• $0 Balance by year-end

  • If the 401 (k) isn’t entirely removed into your individual account and Roth/Traditional IRA by year's end, then the NUA transfer is null and void.

• Timeline

  • This strategy typically takes 3-4 weeks and must be completed within one tax year. That being said, I wouldn’t pursue this strategy if it were Nov. or Dec. just to be safe. But Jan - October, I would feel comfortable pursuing this and ensuring the account had a $0 balance by 12/31.

• Employer stock must be distributed in-kind.

  • You can’t sell the stock and then transfer the cash. The shares need to stay in their current format and transfer in-kind to the individual account.

• Taking advantage of a loss carryforward

  • If you have a tax loss carryforward from a large loss in your past, surrounding a business, real estate, or stock, then you could take advantage of this and sell a large amount of stock at one time. For instance, if you had a $400k loss carryforward, then you could realize up to $400k in capital gains, which is then offset by the loss carryforward for a $0 tax bill.

• Taking advantage of 0% capital gains tax rates

  • Individuals who file married filing separately can realize up to $124,050 in capital gains per year at a 0% tax rate if that’s their only income. This number is less if you are single.

• Multiple Plans (Aggregation Rules)

  • If your company has more than one plan that you participate in, you will want to be careful. When looking at the lump sum distribution rule mentioned above, the IRS requires you to aggregate all “like” plans. That means both plan accounts need to be distributed for NUA treatment to apply. These rules are complicated, but a good rule of thumb is that if one of the plans is a 401(k) plan that you contribute to, and another is a defined benefit plan which pays an annuity, they are not aggregated. (excerpt taken from Ed Slott)

• Loss of step-up in basis at death

  • If you die with NUA stock, then the amount of gain you rolled over will not receive a step-up in basis along with your other assets. However, any gain that occurs after the NUA rollover will receive a step-up in basis.

• Rule of 55

  • The Rule of 55 under U.S. tax law allows individuals who are 55 years old or older to withdraw funds from their 401(k) plan without incurring the 10% early withdrawal penalty, provided they have separated from their employer during or after the year they turn 55. This exception applies only to qualified plans like 401(k), 403(b), and certain other employer-sponsored plans, but not to IRAs.

• What does one tax year mean?

  • This means that once the first distribution is taken from the 401 (k), the entire 401 (k) needs to be distributed into your IRA/individual account in one tax year. You are not limited to taking advantage of NUA in the year you hit a triggering event or the year after. It can be any number of years after assuming you haven’t made any withdrawals from the 401 (k).

• Can you donate NUA stock?

  • Yes, you can donate NUA stock to charity, which is beneficial to avoiding long-term capital gains taxes and giving you a tax deduction depending on your gift amount and other itemized deductions.

  • This must be done after the stock has left the 401k and landed in your individual account.

  • Limitations on Deductions - AGI Limitations: The deduction for appreciated stock is generally limited to 30% of the donor's adjusted gross income (AGI) when donating to public charities. Any excess can be carried forward for up to five years

• Allowable distributions that occur after the lump-sum distribution.

  • Some remaining plan distributions occurring in a year AFTER the lump-sum distribution will NOT disqualify the lump-sum distribution requirement. Examples: Additional contributions and dividends. An additional contribution attributable to the last year of service will not disqualify the lump-sum distribution. Dividends deposited after the year-end will not disqualify the lump-sum distribution. From Prop. Regulations Section 1.402(e)-2(d)(1)(ii)(B): “… if a distribution or payment constitutes the balance to the credit of the employee, such distribution or payment shall not be treated as other than a lump sum distribution merely because an additional amount, attributable to the last or a subsequent year of service, is credited to the account of the employee and distributed.”

• An in-plan Roth conversion after the triggering event disqualification

  • If you complete an in-plan Roth conversion after the triggering event and before the lump sum distribution year, you will be disqualified from the NUA opportunity.

• NUA stock gains do not pay 3.8% net investment income tax

  • The 3.8% Tax on Net Investment Income Does Not Apply to NUA The Final Regulations for the net investment income tax (the 3.8% tax) under Section 1411 of the Internal Revenue Code, released by IRS on November 26, 2013 state that a sale of NUA stock is EXEMPT from the additional 3.8% tax, but any future appreciation (not NUA) after the stock is distributed from the plan will be subject to the 3.8% tax.