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We recently discussed Net Unrealized Appreciation (NUA) and how it works. For those unfamiliar, it may be good to start with that piece before digging into some of the details here.
But this benefit, if utilized properly, can offer a great tax planning strategy for pre-retirees and retirees, especially ones who only have pre-tax retirement assets.
What I thought would be helpful today was to give the facts and breakdown of two recent cases, and the thinking behind how each retiree decided to proceed.
Case #1: Small, But Impactful NUA
Our first example centers around a soon-to-be-retiree, Sally Saver, who has spent over 30 years at a larger, well-known company. She has been an excellent saver and is planning to retire at the age of 60.
Her entire retirement account balance is within her 401(k) at her current employer, and she also has a company pension and a health insurance continuation plan that will cover her until she is Medicare-eligible. A great plan for a great saver.
If there’s any weakness within the plan, it’s that all of the assets are held within a pre-tax account, meaning any distributions she plans to take from her accounts are taxable as ordinary income. This in and of itself is by no means a reason she cannot retire, but it may hinder flexible withdrawals in retirement. Adding tax diversification is a move she would like to make.
The Facts of the Case
Sally:
- Is married
- Just turned 60 in late 2025
- Is still employed, but planning to retire in mid-2026
- Has a 401(k) of $1.2M, with a company stock position of $25,000 current value and an $800 cost basis
- Has no Roth savings or taxable investment accounts
Sally is planning to roll over her 401(k) into an IRA upon separation of service and utilize that for income. So let’s make sure she’s eligible for NUA and that this move will make sense for her.
Sally:
- Has turned 59½ in 2025, and has not taken any type of distribution nor partial rollover from her existing 401(k)
- Is planning to separate from service in mid-2026
- Has not yet opened a taxable investment account or IRA
- Is set to be squarely in the 22% bracket this year with her husband
The Strategy
This is a textbook case for using NUA. She and her husband will have to pay ordinary income tax on the $800 cost basis. Since she is over 59½, she will NOT be subject to a 10% penalty when she completes the distribution. The company stock will be transferred into a taxable brokerage account, where it will receive capital gains treatment moving forward.
Here’s the math:
- Cost basis taxed as ordinary income now: $800 (22% bracket = $176 tax)
- NUA amount eligible for capital gains treatment: $24,200
- Future appreciation: Also taxed as capital gains when sold
When Sally eventually sells the stock, that $24,200 of appreciation will be taxed at long-term capital gains rates (likely 15%), not ordinary income rates (22% in her bracket). That’s a permanent tax savings of 7 percentage points on $24,200, or about $1,694.
It’s fair to say she still has a good bit of pre-tax assets relative to Roth or taxable accounts, but this is a fast and simple way to start accumulating assets that will receive preferential tax treatment.
She is eligible now to complete the NUA (she’s hit the age 59½ trigger) and will also be eligible upon her separation of service. However, we want to make sure she fully liquidates her 401(k) (and any other retirement accounts through the company) to make sure the NUA distribution is valid.
Case #2: A Grey Area
Amy Accumulator worked for a sizable company years ago but left the company when she had children. She more or less forgot about her 401(k), but as she’s approaching retirement, it’s back on the front burner.
Amy is facing an issue of the stock ballooning in value (which is a good thing, objectively), but with competing interests.
The Facts
Amy:
- Is married
- Just turned 56
- Is no longer employed by the company that had the company stock in the 401(k)
- Left the company 15 years ago but never touched or transacted in her 401(k)
- Does not have an IRA or taxable investment account
Amy is in a different position compared to Sally for several reasons, but one is also due to her NUA opportunity. Amy’s cost basis is $61,000 and the value of her company stock is $325,000.
There are a couple of factors that complicate this strategy.
For starters, she and her husband are both working, and her husband is targeting retirement in 2-4 years (he’s currently 63). They are both currently in the 22% tax bracket.
Similar to Sally, they only have pre-tax assets—no Roth or taxable accounts in their names. They have a combined $1.4M in assets. Therefore, the company stock represents almost 25% of their investable net worth. This is alarming to both us and the pre-retiree, despite the fact the stock has done well and is a stable company.
The Competing Interests
- She’s not yet 59½, so she’d have to pay a 10% penalty on the $61,000 cost basis portion if she executes NUA now
- The $61,000 basis would be taxable as ordinary income (22% bracket = $13,420 in taxes)
- The 10% penalty on that $61,000 would add another $6,100
- Combined tax hit: $19,520 just to execute the NUA strategy
- We have to deplete the entire 401(k), so we can’t do a partial amount and spread out that $61,000 of basis
- The stock, while it has done well, makes up a significant amount of net worth, which creates too much concentration risk
The Solution
To manage these risks, we wanted an eye on the present and the future, trying to preserve the NUA opportunity while also addressing the concentration risk of one stock position.
The takeaway is as follows: rebalance out of the existing stock within the 401(k) to a position where it makes up approximately 10% of their net worth. With $325,000 as the existing value, we reposition it to $140,000 and the proceeds are rebalanced within her 401(k).
This move also lowers cost basis accordingly, as the custodian uses an average cost basis method. With this in mind, the basis would lower to about $26,000 (proportional reduction from $61,000).
This move now puts us in position to consider a future NUA distribution when she turns 59½ (to avoid the 10% penalty), or to reevaluate if the value of the stock fluctuates significantly.
Why This Works
By selling company stock within the 401(k) and rebalancing to other investments:
- We reduce concentration risk from 25% to about 10% of net worth
- We preserve the NUA opportunity for future use
- We lower the future cost basis that would be subject to ordinary income tax
- We avoid the 10% penalty by waiting until 59½
When Amy turns 59½ in about three years:
- Cost basis taxed as ordinary income: $26,000 (instead of $61,000)
- No 10% penalty (saving $2,600)
- NUA amount eligible for capital gains: ~$114,000 (assuming stock value stays similar)
- Tax savings compared to IRA rollover: potentially $7,980 or more
Why This Matters
These moves can be complex, with many moving parts. Getting this right requires attention to details, an understanding of the rules, and matching this up with goals and needs.
The key takeaways:
For Sally: Even a small NUA opportunity ($800 cost basis, $24,200 appreciation) creates permanent tax savings through capital gains treatment. The strategy is simple when you’re over 59½ and the concentration risk is minimal.
For Amy: When you’re under 59½ with significant NUA potential but also concentration risk, you can manage both issues by rebalancing within the 401(k) before executing the strategy. This preserves optionality while reducing risk.
By focusing on a strategy that has income, investment, and tax planning in mind, these approaches can help pre-retirees and retirees have less worry, more enjoyment, and tax savings in retirement they wouldn’t otherwise have.