By David L. Dunn, CPA/PFS, CFP®, CPWA®
Click below to watch the video to see exactly how this mistake plays out, and what to do instead.
If you have company stock in your 401k and you’re planning a rollover to an IRA, stop.
Not because a rollover is wrong. In many situations, it’s the right move. But for executives with appreciated company stock, this decision, once made, cannot be undone. And the cost of getting it wrong can exceed $100,000 in unnecessary taxes.
That’s 401k Critical Mistake #3, and it starts with a well-intentioned rollover.
How Good Intentions Create an Expensive Oversight
Executives who have spent years building company stock inside their 401k often assume that rolling everything into an IRA is the smart move.
It can be, but not always, especially when highly appreciated company stock is involved.
Let’s put some numbers around this.
Consider Sarah, an executive approaching retirement with a $1,000,000 401k. Of that, $100,000 was used to purchase company stock. That $100,000 is her cost basis, and that stock has now grown to $1,000,000 in value. If Sarah rolls that entire 401k into an IRA and begins drawing from it in retirement, all $1,000,000 will be taxed as ordinary income. At a 37% tax rate, that means $370,000 in taxes over time.
There’s another option many executives never hear about.
Under certain circumstances, the IRS allows that stock to be taxed differently through a strategy called Net Unrealized Appreciation, or NUA. When implemented appropriately, the executive may only pay ordinary income tax on the cost basis of the stock, $100,000 in Sarah’s case, and long-term capital gains tax on the appreciation when the stock is sold. That could mean a total tax bill closer to $217,000. The potential tax difference? $153,000, compared to a traditional IRA rollover. These figures are illustrative. Additional federal and state taxes may apply depending on your situation.
What Is Net Unrealized Appreciation?
Net Unrealized Appreciation refers to the growth of company stock inside a 401k between the original cost and the current market value. The IRS allows that appreciation to be taxed at the long-term capital gains rate, often 15% or 20%, instead of at the higher ordinary income tax rate, which could be more than double depending on the executive’s situation.
This benefit is unique to company stock held in a 401k. It is not available for mutual funds, ETFs, or company stock held outside a retirement plan. And it is not automatic. Once that company stock is moved into an IRA, the NUA opportunity for those shares disappears.
Why This Mistake Happens Frequently
Executives face an overwhelming number of decisions as retirement approaches. The 401k rollover often feels like a box to check. Well-meaning advisors, HR departments, and online tools may all suggest a rollover without recognizing the unique implications of company stock.
In over 30 years of working with executives, I’ve rarely seen this flagged as a decision point. Not because people aren’t paying attention, but because it’s almost never framed as one. The rollover gets processed. The opportunity quietly closes.
A General Overview of the NUA Strategy
The Net Unrealized Appreciation strategy requires specific steps and precise timing. Get one detail wrong, and the IRS could disallow the entire strategy.
Here’s what typically needs to happen:
First, you need to qualify. There has to be what’s called a “triggering event.”
Second, everything in the 401k that’s NOT company stock typically moves to a new IRA through a direct rollover.
Third, the company stock itself gets transferred, in certificate form, to a taxable brokerage account, not your IRA.
Fourth, these transactions must meet the IRS definition of a “lump sum distribution.”
And fifth, everything must be completed so the 401k balance hits zero by December 31st of the same year.
Every situation is different. This is where working with a qualified advisor becomes critical.
What’s At Stake
The tax impact of mishandling this is not small. In high-income households, losing access to NUA treatment may increase the overall tax burden in retirement by tens or even hundreds of thousands of dollars, depending on the size and appreciation of the company stock.
While not every executive holds company stock, and not every case qualifies for NUA treatment, failing to evaluate this path may mean missing one of the most valuable tax advantages available to executives with company stock in their 401k.
Who Might Benefit From This Strategy
Executives whose 401k company stock has appreciated significantly relative to its original cost basis are typically the best candidates for NUA consideration. If the stock was acquired early in your career, has appreciated significantly, and still resides within the 401k, this approach warrants serious evaluation.
Executives anticipating a change in income brackets, an upcoming retirement, or a liquidity event may find the timing aligns well with an NUA evaluation.
That said, this strategy requires careful planning and may not be suitable for everyone. Working with a qualified advisor who understands the rules, the tax implications, and the coordination required is essential.
The Human Side of the Decision
What makes NUA so easy to overlook is that it doesn’t feel urgent. No flag. No warning. No second chance. Yet for executives who’ve spent decades accumulating company stock, this strategy often carries emotional weight.
That’s why this decision is worth a second look before acting. It deserves a pause. A conversation. A moment of strategic clarity before pressing the transfer button.
Closing Perspective
401k Critical Mistake #3 is avoidable, but not after the rollover is complete. For executives who qualify, the NUA strategy may offer meaningful tax advantages when implemented appropriately.
The goal isn’t to create complexity. It’s to reduce regret. And that begins by asking the right questions before irreversible steps are taken.
Disclosures
David Dunn Wealth LLC (DDW) is a member firm of The Fiduciary Alliance, LLC (TFA), a Securities and Exchange Commission-registered investment adviser. See full disclosure at DAVIDDUNN.COM. Information contained herein is for informational purposes only and should not be construed as a solicitation for investment advice or for the purchase or sale of any securities, insurance, or other investment products. DDW does not provide accounting or public accountancy services. While information contained herein is based on sources deemed reliable, accuracy and completeness aren’t guaranteed.