One of the best lessons I learned as a young financial advisor came from someone I had never met before and have never spoken to again.
I was sitting with a client who had recently retired, and we were preparing to move his company retirement plan into a Rollover IRA. At the time, it felt like the natural next step. An IRA generally offered a broader investment menu than an employer retirement plan, which could provide more flexibility when building a portfolio and providing ongoing investment management.
This was years before the current rollover recommendation and documentation expectations. Today, advisors are generally expected to document why a rollover recommendation is in the client’s best interest, taking into account factors such as investment options, fees, services, and available planning opportunities. Looking back, I’m grateful that one simple question helped shape how I approach those conversations today.
We called the retirement plan custodian to begin the rollover. Everything was moving along exactly as expected until the representative asked a simple question.
“What would you like to do with the company stock?”
Without hesitation, I replied, “Let’s just roll everything into the IRA.” At the time, I thought that was the obvious answer. It turns out it wasn’t the only answer.
The representative paused for a moment before asking another question.
“Have you considered Net Unrealized Appreciation?”
I hadn’t.
Looking back, that was a humbling moment. Fortunately, instead of simply processing my instructions, she took the time to explain that company stock inside a retirement plan may qualify for special tax treatment that is generally no longer available once the shares are rolled directly into an IRA.
That short conversation changed how I think about retirement plan rollovers, and it reinforced a lesson I still carry with me today.
Sometimes the biggest planning opportunities come from asking one more question.
What Is Net Unrealized Appreciation (NUA)?
Net Unrealized Appreciation, commonly referred to as NUA, is a special tax rule that may apply when someone owns publicly traded employer stock inside a qualified retirement plan, such as a 401(k).
Instead of assuming those shares should be rolled into an IRA, an employee may have the option of transferring the company stock directly into a taxable brokerage account while rolling the remaining retirement assets into an IRA.
Why would someone consider doing that?
Assets distributed from an IRA are generally taxed as ordinary income. Under the NUA rules, however, the appreciation that occurred while the stock was held inside the retirement plan may qualify for long-term capital gains treatment when the shares are eventually sold. Depending on the amount of appreciation and the investor’s tax situation, that difference could be meaningful.
Like most tax strategies, though, this isn’t appropriate for everyone. It deserves careful analysis before making a decision.
A Fictional Example Using Meta Stock
This example is for illustration only and is not a recommendation to buy, sell, or hold Meta stock.
Suppose Karen spent more than twenty years working for Meta and accumulated company stock inside her 401(k). By the time she retired, her retirement account totaled approximately $800,000, including $150,000 of Meta stock that originally cost $40,000.
Like many retirees, Karen assumed the next step was simple: roll everything into a Rollover IRA.
That certainly remained an option. Before completing the paperwork, however, she and her advisor reviewed whether the Meta shares deserved a different approach.
One possibility would be to transfer approximately $650,000 of the diversified investments directly into a Rollover IRA while distributing the Meta shares in-kind to a taxable brokerage account.
Under the NUA rules, Karen would generally recognize ordinary income on the original $40,000 cost basis in the year of the distribution. The remaining $110,000 of appreciation that occurred while the shares were held inside the retirement plan would generally not be taxed immediately.
Instead, when Karen eventually sells the Meta shares, that $110,000 of appreciation would generally receive long-term capital gains treatment, regardless of how long she held the shares after the distribution.
For many investors, long-term capital gains tax rates may be lower than ordinary income tax rates. Depending on the individual’s circumstances, that distinction could create a meaningful tax planning opportunity.
Future Growth Is Treated Differently
Once the Meta shares have been transferred into the brokerage account, any future appreciation follows the normal capital gains rules.
Suppose the shares increase in value from $150,000 to $180,000 after the distribution. That additional $30,000 of growth occurred outside the retirement plan.
If Karen sells within one year of the transfer, that additional appreciation would generally be taxed as a short-term capital gain. If she holds the shares for more than one year, that future appreciation would generally qualify for long-term capital gains treatment.
Understanding these different layers of taxation helps investors make more informed decisions about both the distribution itself and the timing of any future sale.
When an NUA Strategy May Be Worth Considering
While the potential tax benefits can sound attractive, taxes are only one part of the decision.
Continuing to own a significant position in one company’s stock may increase concentration risk. An investor’s need for cash, expected tax bracket, charitable giving goals, estate planning objectives, overall investment strategy, and comfort with market volatility should be considered before deciding whether to use an NUA strategy.
In many situations, rolling everything into an IRA may still be an appropriate decision.
The key is evaluating the available options before the rollover is completed. Once company stock has been rolled into an IRA, the opportunity to use the NUA strategy is generally no longer available.
Over the years, I’ve found that important financial planning opportunities often aren’t about finding a new strategy. They’re about recognizing the opportunities that already exist before making an irreversible decision.
The Bigger Lesson
Whenever I hear someone say, “Let’s just roll everything over,” I think back to that phone call early in my career.
What seemed like a routine transaction turned into one of the most memorable educational experiences I’ve had as a financial advisor.
I’ve often wondered if that customer service representative realized the impact of our conversation. She probably moved on to her next phone call without giving it another thought. Meanwhile, I’ve told versions of that story for years because it fundamentally changed the way I approach retirement plan rollovers.
It also reminded me of something I’ve found to be true throughout my career: no matter how much experience we gain, there is often something new to learn. Sometimes the most valuable lessons don’t come from a textbook, a conference, or a continuing education class. They come from someone who simply asks one more question.
Today, whenever a client owns publicly traded company stock inside a retirement plan, we slow down before beginning the rollover process. Sometimes the analysis confirms that rolling everything into an IRA is still an appropriate choice. Other times, the Net Unrealized Appreciation rules may present an opportunity worth considering. Either way, the goal is the same: to understand the available options before making an irreversible decision.
If your retirement plan includes company stock, have you explored the available options before starting the rollover paperwork?
Employer retirement plans often represent one of the largest assets someone owns. Taking a little extra time to review the tax implications, investment strategy, and long-term planning considerations may help identify options that otherwise could be missed. This is often where families choose to work with a fiduciary financial advisor who can evaluate the broader financial picture, explain the potential tax implications, and support decisions made with a full understanding of the available choices.
Whether you’re weighing a 401(k) rollover for the first time or revisiting company stock you’ve held for years, a second look at your options may be time well spent. Contact our team to talk through what a thoughtful approach could look like for you.
Disclaimer:
The Net Unrealized Appreciation strategy has specific eligibility requirements and may not be appropriate in every situation. Tax laws and planning considerations are subject to change over time. Before making decisions regarding a retirement plan distribution, consult with your financial advisor and tax professional to evaluate how the rules apply to your individual circumstances.
The fictional example above is for illustrative purposes only and is not a recommendation to buy, sell, hold, or distribute any specific security.
Holding a concentrated position in employer stock involves risk, including the potential for significant loss. Diversification does not guarantee a profit or protect against loss in declining markets.
Marc C. Shaffer, CFP®, EA, is CFO at Searcy Financial®. With two decades of experience in financial planning and investment management, Marc works with clients and their families on goal-based financial planning, multigenerational planning, legacy planning, and wealth stewardship. Marc has completed 21/64 Certified Advisor Training, which focuses on family communication and planning conversations across generations.