When changing jobs or retiring, many people roll their 401(k) plans into an IRA. While this can usually be a smart move, there’s an exception if you have a lot of highly appreciated company stock in your retirement account. In this case, you might want to consider using a little-known tax break called Net Unrealized Appreciation (NUA).

What is NUA?

NUA is the increase in value of company stock in your retirement plan from the time it was bought to the time you take it out. This tax break lets you pay less tax on this growth when you sell the stock.

How NUA Works

When you roll over a 401(k) into a traditional IRA, your assets keep growing without being taxed. But when you eventually take out money, you have to pay taxes on everything at regular income tax rates.

With NUA, if you transfer your appreciated company stock to a taxable account instead of an IRA, you’ll only pay tax on what the company stock originally cost, not its current value. You’ll owe this tax when you transfer the stock, but it’s still taxed at regular income tax rates. The rest of the stock’s growth will be taxed at a lower capital gains rate when you sell it, instead of the higher income tax rate.

For example, let’s say your company stock in your 401(k) was worth $100,000 when you got it, but it’s now worth $1 million. If you use NUA, you’ll pay tax immediately on the $100,000 (the original price), but not on the $900,000 in gains. When you sell the stock later, you’ll only pay the lower capital gains tax on the $900,000.

Key Points to Know

1. NUA only works for stock from the company where you worked, not other stocks in your retirement plan.
2. You’ll need to get the original cost of the stock from your employer.
3. If you take out the stock before age 55 (and left the company before then), you might have to pay a 10% penalty.

Selling the Stock

Once you transfer the stock to a taxable account, you can sell it right away or hold it for years. No matter when you sell, you’ll pay capital gains tax on the NUA. The amount of tax on any further growth depends on how long you’ve held the stock after transferring it.

Is NUA Right for You?

NUA is not for everyone. It works best if you have a lot of company stock that has gone up significantly in value. If the stock’s current value is close to what you originally paid, NUA might not be worth it since you’ll be paying tax sooner.

Also, if company stock makes up a large part of your retirement plan, it’s a good idea to diversify—spread out your investments so you’re not relying too much on one stock. If you roll the stock into an IRA, you can sell it and diversify without paying tax until you take money out.

When NUA Makes Sense

NUA can be useful in certain situations:

• If you need the money right away (like starting a business), you can sell the stock and pay the lower capital gains tax instead of regular income tax.
• If you have capital loss carry-forwards (past stock market losses you can use to offset gains), you might sell the stock and not owe any tax.
• If you’re older (70 or more) and qualify for some older tax rules, NUA might save you even more.

Downsides of NUA

One downside of NUA is that you won’t get a step-up in cost basis for your heirs if they inherit the stock. This means when they sell it, they’ll owe tax on the NUA, just like you would. However, they may get a tax break on any gains that happened after the stock was transferred.

NUA: Yes or No?

Deciding whether to use NUA is tricky. You’ll need to run the numbers to see if it works for your situation, especially if you’re in a high tax bracket, own a lot of company stock, and have other investments. You’ll also need enough money to pay the taxes due when you transfer the stock to a taxable account. Make sure to talk to a tax professional to help make the best decision.