By David L. Dunn, CPA/PFS, CFP®, CPWA®
Watch the video below to see what every executive with company stock in a 401k should consider before selling.
Selling company stock inside a 401k can feel like the responsible move. Reduce concentration risk. Lock in gains. Rebalance the portfolio. For many assets, that logic holds. But when that highly appreciated company stock sits inside your 401k, that sale may be one of the most expensive decisions you never saw coming.
That’s 401k Critical Mistake #4, and it catches executives off guard.
The Sale That Can’t Be Undone
401k company stock can represent a large, concentrated position. Advisors recommend diversification. Markets feel uncertain. So the decision gets made, and often no one pauses to question it.
What rarely comes up in that conversation is this: selling company stock inside a 401k can permanently eliminate a significant tax advantage that might exist on those specific shares. In over 30 years of working with executives, I’ve made it my practice to raise this question before the sale is made, because once it’s done, the NUA opportunity on those original shares is permanently lost.
What the Sale Actually Costs
Consider Michael, a 60-year-old executive with a 37% ordinary income rate and a 20% long-term capital gains rate, with a $1,000,000 401k that includes company stock he originally purchased for $100,000. That $100,000 is his cost basis. The stock has grown to $1,000,000, meaning $900,000 in gains.
Michael decides to sell the stock inside his 401k to rebalance.
Years later, when he begins withdrawing from the account, he’ll pay ordinary income tax on every dollar. At a 37% rate, that’s $370,000 in taxes on the million dollars.
There’s another option many executives never hear about, but only if the stock hasn’t been sold first.
Under a provision in the tax code called Net Unrealized Appreciation, or NUA, Michael may have been eligible to transfer that company stock directly to a taxable brokerage account without selling it first. Had he done so, only his $100,000 cost basis would face ordinary income tax. The $900,000 in gains could be taxed at the long-term capital gains rate instead.
The math: $37,000 on the cost basis, plus $180,000 on the gains, equals $217,000 total. The potential savings? $153,000, compared to selling inside the 401k.
These figures are illustrative. Additional federal and state taxes may apply depending on your situation.
Understanding Net Unrealized Appreciation
NUA refers to the growth in value, above the original cost basis, of company stock held inside a 401k. If certain conditions are met, 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 can apply to company stock held inside a 401k. Once that company stock is sold inside the 401k, the NUA opportunity on those original shares is permanently lost.
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.
Why Selling First Feels Right
Reducing concentration risk can be a sound strategy. Selling inside a 401k to do it may not be.
Many executives make this decision without ever having a conversation about NUA. Not because their advisors are careless, but because portfolio decisions and tax strategy don’t always happen in the same conversation. And for company stock inside a 401k, that gap can be extraordinarily expensive.
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. The greater the gap between what was originally paid and what the stock is worth today, the greater the potential tax savings.
Executives nearing a triggering event, retirement, separation from service, or reaching age 59½, are particularly time-sensitive. Once that event occurs and decisions get made without evaluating NUA, the opportunity on existing shares can close permanently.
That said, this strategy requires careful planning and may not be suitable for everyone. The complexity here is real. An advisor who genuinely understands NUA, not just one familiar with the concept, can make the difference between capturing the opportunity and losing it. And that conversation needs to happen before any 401k company stock is sold.
Closing Perspective
401k Critical Mistake #4 is avoidable, but the opportunity exists only as long as those 401k company shares remain unsold. For executives who qualify, the potential tax savings can be substantial.
The question isn’t only whether to sell. It’s whether you’ve evaluated what selling first might cost you.
The tax consequence is significant. And it’s triggered by a decision that feels entirely responsible.
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.