NUA Election in 2026: Employer Stock in Your 401(k), IRC §402(e)(4)(B), and the Six-Figure Tax Decision Most Rollovers Destroy

Most retirees roll their 401(k) into an IRA without a second thought. It is the boring, default, universally-recommended move. And for the ~90% of participants whose plan holds nothing but mutual funds, it is exactly right.

For the remaining ~10% — the participants who spent a 20- or 30-year career at a company that offered employer stock inside the plan and rode the stock from $8 to $180 — that default rollover is one of the most expensive tax mistakes in personal finance. In a single unread box on a distribution paperwork, they trade a 15% or 20% long-term capital-gains rate for a 32% or 37% ordinary-income rate on the same dollars. The delta on a $500,000 stock position is between $60,000 and $110,000 of federal tax the government cheerfully pockets. There is no waiver, no cure, no do-over. Once the stock lands in the IRA, the election is gone.

The rule that makes the smart move possible is buried in IRC §402(e)(4)(B) and clarified in IRS Notice 98-24.^[1][2] It is called the Net Unrealized Appreciation (NUA) election. This guide walks through the statute, the four triggering events, the lump-sum-distribution requirement, the 2026 bracket-arbitrage math with hand-checked numbers, three worked case studies, the estate-planning wrinkle where NUA becomes income in respect of a decedent, and every rollover mistake we have seen destroy the election. When you are ready to model your own numbers, the CalcLeap 401(k) calculator and capital-gains tax calculator handle the arithmetic.

What NUA actually is (and where it comes from)

Ordinary distributions from a §401(a) qualified retirement plan are taxed as ordinary income under IRC §402(a). That rule is the reason a $10,000 IRA withdrawal at a marginal 32% bracket costs $3,200 in federal tax, not $1,500 at long-term capital gains rates. Every dollar that comes out of a traditional 401(k), 403(b), 457(b), or traditional IRA is ordinary income, without regard to what generated it inside the plan.

§402(e)(4)(B) is the one statutory exception. When a lump-sum distribution from a qualified plan includes employer securities, the participant may elect to exclude the net unrealized appreciation on those securities from gross income in the year of distribution. The appreciation is instead taxed later, at long-term capital-gains rates, when the participant actually sells the stock. Only the plan's cost basis in the shares — the amount the plan paid to acquire them on the participant's behalf — is taxed as ordinary income in the distribution year.^[1]

The mechanics are simple. Assume the plan bought 1,000 shares of employer stock over the years for a total cost of $30,000 (average cost basis $30/share), and today those shares trade at $200 each — a market value of $200,000. The NUA is $200,000 − $30,000 = $170,000.

If the participant elects NUA treatment and takes an in-kind distribution of the shares to a taxable brokerage account:

• The $30,000 basis is included in the participant's ordinary income for the distribution year — taxed at whatever marginal rate applies (10% to 37% federal in 2026).^[3]
• The $170,000 NUA is not included in income at distribution. When the participant later sells the shares, the NUA is taxed at long-term capital-gains rates (0%, 15%, or 20% federal in 2026) — regardless of how long the participant has held the shares outside the plan.^[4]

The waiver of the ordinary-income treatment is what generates the savings. In the 32% bracket, ordinary tax on the $170,000 NUA would be $54,400. LTCG tax at 15% on the same $170,000 is $25,500. The NUA election saves $28,900 on this one position — and the saving grows in proportion to both the position size and the ordinary-vs-LTCG bracket delta.

The four triggering events (all four, exactly)

The NUA election rides on top of a "lump-sum distribution" defined by §402(e)(4)(D). That definition requires both that the distribution be the entire balance of all similar plans in one tax year (see the next section) and that it occur on account of one of exactly four events. Miss the triggering event and the entire NUA election is disqualified — the shares get taxed as ordinary income, and there is no cure.^[1]

The four events are:

1. Separation from service. The participant ceases to be an employee of the employer sponsoring the plan. Retirement, resignation, or termination all count. This event is not available to self-employed participants (owners of the sponsoring business); they must rely on a different trigger below.
2. Reaching age 59½. Available to any participant, including active employees, provided the plan permits in-service distributions at that age. A participant who is still working at 60 and takes an in-service lump sum of their entire plan balance can qualify on this trigger alone, without ever separating from service.
3. Death of the participant. The lump-sum distribution goes to the beneficiary. The NUA character survives the participant and passes to the beneficiary — but with the estate-planning wrinkle covered in Section 8: the NUA is income in respect of a decedent (IRD) and does not receive a step-up in basis at death.
4. Disability — but only for self-employed participants (under §72(m)(7)'s definition of disability). W-2 employees who become disabled must rely on separation from service or age 59½ instead.^[1]

Any other reason for distribution — hardship withdrawal outside these four events, an in-service withdrawal at 55 under the Rule of 55, a plan termination where the participant is not yet 59½ and has not separated, a QDRO distribution to an alternate payee before an alternate-payee-side triggering event, a required-minimum-distribution partial withdrawal — disqualifies the lump-sum characterization and therefore the NUA election.

The lump-sum-distribution rule (the second gate)

Even with a valid triggering event, the NUA election still requires the distribution itself to qualify as a "lump-sum distribution" under §402(e)(4)(D). The statutory definition has four parts, all of which have to be met:

1. Entire balance. The distribution must be of the participant's entire balance in the plan. Not "most of it." Not "everything but the employer stock." Not "everything but a residual pending-transaction amount." Every dollar has to leave.
2. Same tax year. The distribution must occur within a single tax year. A partial distribution in December followed by the rest in January destroys the lump-sum characterization.
3. All plans of the same type, from the same employer. If the same employer sponsors multiple qualified plans of the same type — for example, a 401(k) and a legacy money-purchase pension plan that was merged in but retained separate accounting, or two 401(k) plans from separate business units — all of them are treated as a single plan for lump-sum-distribution purposes. Every account has to be emptied in the same tax year.
4. Triggering event. The distribution must be on account of one of the four events above.

The trap most participants fall into is (3): they roll the mutual-fund portion of their 401(k) to an IRA in Year 1 and plan to take the employer-stock NUA distribution in Year 2. That's fatal — the mutual-fund rollover in Year 1 is a partial distribution, so no lump-sum distribution can occur in Year 2 because the plan is no longer holding a full balance.

The correct sequence is: in the same tax year, take an in-kind distribution of the employer-stock shares to a taxable brokerage account (the NUA-election piece) and a direct rollover of the remaining mutual-fund balance to an IRA (the ordinary rollover piece). Both happen within one calendar year, on account of the triggering event, and together they empty the plan. This is the sequence every reputable custodian's NUA-election paperwork walks through — but only if the participant knows to ask for NUA treatment before the paperwork is drafted.

The 2026 math: ordinary rates vs. LTCG rates

The value of an NUA election is exactly the delta between the participant's ordinary-income tax on the NUA portion (what happens under a rollover) and their long-term capital-gains tax on the NUA portion (what happens under an NUA election). Everything else — the ordinary-income tax on the plan-basis portion, state income tax, the 3.8% net investment income tax on high earners — is common to both paths.

The 2026 federal ordinary-income brackets (per IRS Rev. Proc. 2025-32) and 2026 long-term capital-gains brackets (per IRS Rev. Proc. 2025-32, §3.03) are:^[3]

For most retirees taking a lump-sum NUA distribution in the year of separation from service, the participant's ordinary bracket is at least 24% and often 32%, 35%, or 37% because the plan-basis piece of the distribution stacks on top of a final-year W-2. Their LTCG bracket on the NUA piece, when they later sell, is usually 15% (because their retirement income falls below the 20% threshold once the W-2 stops).^[4]

The federal delta per $100,000 of NUA, ignoring state tax and NIIT, works out to:

The 3.8% Net Investment Income Tax

High-income participants also face the 3.8% Net Investment Income Tax under IRC §1411 on long-term capital gains above the threshold ($200K single MAGI, $250K MFJ MAGI in 2026, unindexed).^[5] NIIT applies to the NUA gain when the participant sells the shares. It does not apply to the ordinary-income piece under either path — ordinary income is not net investment income. The correct comparison at high incomes is therefore:

• Rollover path (later IRA withdrawal): ordinary rate only (no NIIT on IRA distributions per §1411(c)(5)).
• NUA path (sale of employer stock): LTCG rate + 3.8% NIIT on the NUA.

The NIIT closes the gap slightly at the top: a 37%-bracket participant saves 37% − (20% + 3.8%) = 13.2% instead of 17% federal on each dollar of NUA sold. Still a large positive — but the math is worth doing exactly. The capital-gains tax calculator handles the NIIT stacking automatically.

How the plan calculates basis (the piece nobody tells you about)

The NUA amount is FMV minus plan cost basis. Different plans compute basis differently, and the choice can move the ordinary-income piece by a factor of two or more.^[6]

Two methods are common:

1. Average cost per share. The plan divides total dollars paid for all employer-stock shares over the participant's tenure by the total shares held. Every share carries the same basis. This is the most common method used by large plan recordkeepers.
2. Specific-lot identification. The plan tracks each share's actual purchase date and purchase price, and the participant can choose which specific lots to distribute. High-basis lots (recent purchases at high prices) can be sent to the taxable brokerage account for NUA treatment while low-basis lots (early purchases at low prices) get rolled to the IRA — the opposite of what most participants want.

The counterintuitive point is worth restating: for NUA purposes, high-basis lots are bad and low-basis lots are good. High basis means the plan-basis piece taxed as ordinary income is larger, so the NUA is smaller and the election converts fewer dollars from ordinary to LTCG. If the plan permits lot selection, the participant should NUA-distribute the low-basis lots (the ones acquired early, when the stock was cheap) and roll the high-basis lots into the IRA.

For plans that use average cost per share, the participant has no lot-selection control — every share carries the same basis, and the NUA election is all-or-nothing on the employer-stock balance. That's not fatal, but it means the election works best when the average basis is a small fraction of current FMV, which happens most often for long-tenured employees at companies whose stock ran up 5×–20× over their career.

Three worked case studies

Case A: Priya, 62, retiring from a Fortune 500 in 2026

Priya spent 28 years at a Fortune 500 manufacturer. Her 401(k) balance at retirement is $1,400,000, of which $600,000 is employer stock (3,000 shares × $200) with an average cost basis of $50,000 ($16.67/share). The remaining $800,000 is target-date-fund mutual funds. She and her spouse file MFJ with $180,000 of ordinary income in her retirement year (final-year W-2 + spouse's salary). She expects retirement-era taxable income of ~$140,000 MFJ.

Path 1 — full IRA rollover (default). The entire $1,400,000 rolls into an IRA. No current tax. Over the next 25 years, RMDs and discretionary withdrawals bring the money out at Priya's retirement-era ordinary rate. At 22% federal (the 2026 MFJ bracket that applies to the $95,000–$210,000 range) on the $600,000 that would otherwise be NUA-eligible: ~$132,000 federal tax when eventually withdrawn.

Path 2 — NUA election. In her retirement year, Priya takes an in-kind distribution of the 3,000 employer-stock shares to a taxable brokerage account and rolls the $800,000 of mutual funds directly to an IRA. Both happen in the same tax year, on account of separation from service (her triggering event).

• Current-year ordinary tax on the $50,000 plan basis: $50,000 stacks on her $180,000 of other MFJ income, landing entirely in the 22% bracket = $11,000 federal.
• Future LTCG tax on the $550,000 NUA: Priya sells the shares in retirement years when her total income is ~$140,000 MFJ. The 15% LTCG bracket runs to $613,700 MFJ, so all of the $550,000 NUA is taxed at 15% = $82,500 federal. She does not cross the $250,000 MFJ NIIT threshold on ordinary + gain basis in the sale years if she paces the sales, so NIIT is $0.
• Total federal tax under NUA: $11,000 + $82,500 = $93,500.

Path 1 total federal tax: $132,000. Path 2 total federal tax: $93,500. NUA savings: $38,500 federal. Plus a state-tax delta of roughly $8,000 in her state (Ohio, 3.5% top bracket) because Ohio taxes ordinary distributions but exempts capital-gains distributions from retirement account NUA at the same rate structure — see Section 9 for the full state map.

Case B: David, 66, deep-in-the-money Big Tech ISOs converted to plan stock

David spent 32 years at a Big Tech company that offered employer stock in its 401(k) starting in 1994. Some shares were acquired at $2.50; the current price is $310. His plan uses specific-lot identification. His employer-stock balance is $2,000,000 (roughly 6,450 shares) with an average cost basis of $77,400. He and his spouse's total 2026 income including his final-year W-2 is $520,000 MFJ (32% marginal). Their expected retirement income is $260,000 MFJ (24% bracket, above the $250K MFJ NIIT threshold on capital gains).

Path 1 — full IRA rollover. The entire $2,000,000 rolls into an IRA. RMDs starting at 73 (SECURE 2.0 §107 age) bring the money out over 20+ years at 24% federal on top of $260,000 base = ~$480,000 federal tax on the eventual withdrawals.

Path 2 — NUA with lot selection. David identifies his lowest-basis lots — the 1994–2000 acquisitions at $2.50 to $18 per share, totaling 3,000 shares with $22,000 of aggregate basis and $930,000 of FMV. He takes those 3,000 shares in-kind under NUA. The other 3,450 shares (higher basis, $55,400 basis, $1,070,000 FMV, $1,014,600 of would-be-NUA) roll to the IRA — those get taxed as ordinary income at IRA distribution.

• Current-year ordinary tax on the $22,000 plan basis: $22,000 stacks on his $520,000 base MFJ, landing in the 32% bracket = $7,040 federal.
• Future LTCG on the $908,000 NUA: David sells in retirement years when total income including gain is around $360,000 MFJ ($260K base + ~$100K of NUA realized each year for 9 years). 15% LTCG on $908,000 = $136,200. NIIT at 3.8% on the portion above the $250K MFJ MAGI threshold (roughly the whole NUA since base income already exceeds threshold): $908,000 × 3.8% = $34,504.
• Future ordinary tax on the rolled-over $1,070,000 (in the IRA): at his retirement 24% bracket = $256,800.
• Total under NUA: $7,040 + $136,200 + $34,504 + $256,800 = $434,544.

Path 1 total: $480,000. Path 2 (NUA on low-basis lots only): $434,544. Savings: $45,456 federal. If David had NUA'd the wrong lots — the high-basis 2015–2023 shares instead of the low-basis 1994–2000 shares — he would have paid roughly $18,000 more in current-year ordinary tax on the higher basis, and converted fewer dollars from ordinary to LTCG. Lot selection matters.

Case C: Marcus, 68, retired widower with modest total income

Marcus retired at 65 from a mid-cap utility. His 401(k) at retirement held $650,000, of which $180,000 was employer stock (5,000 shares at $36) with an average cost basis of $40,000 ($8/share). His widowed post-retirement single filing income is $58,000/year (Social Security + a small pension). His 2026 MAGI is far below the $200K single NIIT threshold and his total taxable income after the standard deduction is $41,900 — inside the 0% LTCG bracket ceiling of $49,450 for singles.

Marcus took NUA in his retirement year at 65:

• Current-year ordinary tax on the $40,000 plan basis: stacked on his final-year W-2 of $95,000, landing at the top of the 22% single bracket = $8,800 federal.
• Post-retirement LTCG on the $140,000 NUA: Marcus sold 833 shares/year for 6 years (~$30,000 of NUA realized annually). Because his other taxable income stays around $41,900, the first $7,550 of each year's NUA falls in the 0% LTCG bracket ($49,450 ceiling − $41,900 other income), and the remaining $22,450 falls in the 15% bracket = $3,367/year × 6 years = $20,205 federal.
• Total under NUA: $8,800 + $20,205 = $29,005.

Path 1 (rollover) alternative: Same $180,000 comes out of the IRA as ordinary income over 6 years at his 12%–22% single bracket = roughly $28,000. In this specific case NUA saves almost nothing on federal tax alone because Marcus's ordinary bracket is already close to the LTCG bracket. NUA still marginally wins on state tax (his state exempts LTCG on retirement-derived NUA at a lower rate than pension income), and the shares outside the IRA get a step-up on the post-distribution appreciation at his death — but Case C is the textbook example of when NUA is not automatic: when both brackets are already low, the delta shrinks.

The five mistakes that permanently destroy the election

Every mistake here has been catalogued in the NUA-planning literature repeatedly because they keep happening. The rule of thumb: if the mistake reaches the IRS, there is no cure.^[7]

1. Rolling the employer stock into an IRA first, then taking a distribution "for NUA" later. Once the shares are inside the IRA, the plan-cost-basis information is discarded and the entire IRA balance is ordinary income at withdrawal. No election. No exception. This is by far the most common way the opportunity is lost — a well-meaning custodian executes a boilerplate direct rollover of the whole 401(k) balance without asking whether employer stock is present.
2. Taking a partial distribution earlier in the same tax year. If a hardship withdrawal, an in-service withdrawal, or a QDRO payment came out of the same plan in the same calendar year, the year's distribution is not a lump-sum distribution and NUA is unavailable. Wait until the next tax year — but confirm no other event triggers a required split-year distribution.
3. Missing a related plan. If the same employer sponsors both a 401(k) and a legacy money-purchase pension plan (or two separate 401(k)s from a merged subsidiary), all of them are treated as one plan for the lump-sum rule. If the participant empties the 401(k) but leaves $2,000 in the legacy MPP, the lump-sum characterization fails. Check the plan document for all related-plan aggregation before initiating the distribution.
4. Liquidating the stock inside the plan and taking cash instead of shares. §402(e)(4)(B) applies only to distributions of the employer securities — the shares themselves have to be delivered in-kind to a taxable brokerage account. If the participant asks for a cash distribution and the plan sells the shares first, the NUA is realized inside the plan and then distributed as ordinary income cash. The election is lost.
5. Waiting past the sixty-day rollover window on the mutual-fund side. If the participant tries to take an indirect distribution of the whole 401(k) — with intent to roll the mutual funds to an IRA within 60 days — the plan is required to withhold 20% federal on the taxable portion (the mutual funds and the plan-basis piece), and any missed 60-day window creates ordinary income on the whole missed amount. The correct sequence is a direct in-kind stock transfer to the brokerage account paired with a direct rollover of the mutual funds to the IRA. Two separate trustee-to-trustee movements, both executed in the same tax year.

Estate planning: NUA is income in respect of a decedent

The single biggest asymmetry between NUA shares and ordinary appreciated stock is the treatment at the participant's death. Under IRC §1014, most inherited property receives a "step-up" in basis to fair market value on the date of death — the built-in gain is erased for the heir. A share of Amazon bought at $100 that is worth $2,000 at the owner's death has a stepped-up basis of $2,000 in the heir's hands; the heir owes no capital-gains tax if they sell immediately.

NUA does not get this treatment. Under IRC §691, NUA is classified as "income in respect of a decedent" (IRD) — income that was earned but not yet recognized by the decedent at death. IRD does not receive a §1014 step-up. When the heir sells the inherited NUA shares, they owe long-term capital-gains tax on the full NUA that would have applied to the decedent.^[8]

The wrinkle: post-distribution appreciation — the gain above NUA that accrued while the shares sat in the taxable brokerage account after distribution — does receive a step-up. If the shares were $200 (with $170 of NUA) at distribution and $300 at the participant's death, the heir inherits with:

• NUA portion ($170/share): IRD, no step-up. The heir owes LTCG on this at their own bracket when they sell.
• Post-distribution appreciation ($100/share): stepped up to $300 at date of death under §1014. No gain if the heir sells at $300 or below.
• Plan-basis portion ($30/share): effectively stepped up — the participant already recognized this as ordinary income at distribution, so this dollar amount was already in the participant's after-tax cost basis.

For a participant with a large NUA position, weighing the current-year ordinary tax on plan basis against the loss of a step-up on the NUA portion is the key estate-planning trade-off. In broad terms:

• If the participant expects to sell the shares during their lifetime — for diversification, income, or gifting — NUA nearly always wins because the character conversion happens on shares that would be sold anyway.
• If the participant expects to hold the shares until death and pass to heirs, the calculus shifts. An IRA-rollover-and-hold path lets the shares grow tax-deferred until the heir inherits the IRA (subject to the SECURE Act 10-year rule for non-spouse beneficiaries), while the NUA path locks in the IRD treatment on the entire NUA amount.
• The break-even usually depends on how long the participant expects to hold the shares before death. Shorter horizons favor NUA (less post-distribution appreciation to lose the step-up on); longer horizons favor the rollover-and-hold play.

State-tax overlay (the piece that moves the answer by 5–10%)

Federal tax dominates the NUA-vs-rollover analysis, but state tax can add or subtract a meaningful 3–10 percentage points depending on the participant's state of residence at the time of distribution and sale. The general pattern by state:^[9]

The Pennsylvania and Illinois cases are especially important. Both states fully exempt qualified-retirement-plan distributions (including IRA withdrawals) from state income tax.^[10] That means an IRA rollover produces $0 of state tax at distribution, forever. An NUA election, in contrast, produces state-taxable capital gains at PA's 3.07% or IL's 4.95% rate when the shares are sold. On a $500,000 NUA position, that's $15,350 (PA) or $24,750 (IL) of state tax the rollover path avoids entirely. For PA and IL residents with a moderate ordinary bracket (22% or 24%), NUA can be a net loss after state. Run both paths through the 401(k) calculator before committing.

The paperwork sequence, in order

Assuming the participant has confirmed a valid triggering event, a large-enough NUA position to make the analysis worthwhile, no other same-year distributions from the plan family, and no state that fully exempts qualified-plan distributions:

1. Open a taxable brokerage account at the custodian who will receive the shares. Confirm the account can accept an in-kind stock transfer from the plan trustee.
2. Open a rollover IRA to receive the non-stock (mutual fund) portion. Trustee-to-trustee direct rollover only.
3. Request the plan's NUA election paperwork from the plan administrator. Language to look for: "in-kind distribution of employer securities" and "election under §402(e)(4)(B)." Some plans use a specific "NUA election form"; others handle it inside a general lump-sum-distribution package. Ask for the plan's basis calculation method (average cost vs. specific-lot) and, if specific-lot, ask for the per-lot basis schedule.
4. Confirm same-year execution. The in-kind stock transfer and the IRA direct rollover must both settle within the same tax year. Initiate both requests together, and confirm settlement dates in writing before the distribution period runs into December.
5. Verify that the entire plan balance is being distributed. Check for related plans from the same employer that may need to be included. Confirm no residual amounts (pending dividends, unallocated match, forfeitures) will remain in the account at year-end.
6. Receive Form 1099-R for the current tax year, coded to reflect the NUA distribution. Box 1 shows the total distribution, Box 2a shows the taxable amount (should equal only the plan cost basis on the employer stock plus any amounts not eligible for NUA), and Box 6 shows the NUA amount. Verify these figures match the plan's basis calculation before the return is filed.
7. Report on Form 1040 for the year of distribution. The Box 2a amount is ordinary income on Line 5b. The NUA amount is not currently included in income — it will be reported as long-term capital gain on Schedule D in the year(s) the shares are eventually sold.
8. Sell the shares over time in a paced manner that manages the LTCG bracket. Selling everything in one year can push the participant into the 20% LTCG bracket or trigger NIIT. Selling $50K–$100K of NUA per year over several years often keeps the entire gain in the 15% bracket.

An action checklist for the NUA decision

1. Confirm you actually hold employer securities inside a §401(a) qualified plan. RSUs, ESPP shares, and stock from a nonqualified deferred-compensation plan (§409A / §457) are not eligible. Only shares held in a 401(k), ESOP, profit-sharing, money-purchase pension, or stock-bonus plan qualify.
2. Pull the plan's basis figure. Log into the plan portal or call the recordkeeper and ask for "the cost basis of the employer securities in my account, and the basis calculation method." Compute basis-to-FMV ratio. If it's above 50%, the election is probably not worth the complexity.
3. Confirm your triggering event. Separation, age 59½, disability (self-employed only), or death (via beneficiary). If none applies yet, the election is not currently available.
4. Model both paths in the CalcLeap 401(k) calculator and capital-gains tax calculator. Bake in your expected retirement-era income (which determines your LTCG bracket) and your state's treatment of retirement distributions.
5. Check for related plans from the same employer. Aggregate them and plan the lump-sum distribution to empty all in the same tax year.
6. Line up the two receiving accounts — a taxable brokerage for the shares and a rollover IRA for the mutual funds — before you request paperwork from the plan.
7. Request the NUA election form explicitly. Don't accept a generic distribution form; ask for the plan's §402(e)(4)(B) election documentation and confirm the in-kind delivery mechanic. If the plan administrator seems unfamiliar with NUA, escalate to a plan consultant before signing anything.
8. Model the estate outcome. If lifetime sale is the plan, NUA usually wins. If shares are meant to pass to heirs, run the IRA-rollover-and-hold alternative through the same model — the loss of the §1014 step-up on the NUA portion can flip the answer.

Frequently asked questions