The Company Stock in Your 401(k) Gets One Tax Election. The Rollover Ends It.
You retired in the spring. The plan administrator sent the rollover paperwork, the receiving IRA is open, and the full balance — including the company shares you have held since the 1990s — is scheduled to transfer next week. For most of that account, this is routine.
For the company stock, it is a one-time tax election, and the rollover is the moment it closes.
This article explains net unrealized appreciation, the federal rule that allows appreciated employer stock to leave a qualified plan at long-term capital gains rates rather than ordinary income rates. It covers who is eligible in 2026, what the election costs up front, and why the arithmetic looks different for a California resident than it does in the national articles on the subject.
What Net Unrealized Appreciation Actually Does
Net unrealized appreciation is the difference between what the employer stock cost inside the plan and what it is worth on the day it is distributed.
Ordinarily, every dollar coming out of a 401(k) is ordinary income. The NUA rules carve out an exception for employer securities. If the shares are distributed in kind to a taxable brokerage account as part of a qualifying lump-sum distribution, you pay ordinary income tax on the cost basis in the year of distribution, and the appreciation is not taxed until you sell. When you do sell, that appreciation is taxed at federal long-term capital gains rates regardless of how long you held the shares after distribution.
Three conditions have to be met. The shares must move in kind, not be sold and transferred as cash. The distribution must empty your entire balance across all of the employer's plans of that same type within a single tax year. And it must follow a triggering event: separation from service, reaching age 59½, disability, or death.
The Two Paths, Side by Side
Consider a hypothetical 62-year-old who retired from a South Bay employer with $1.4 million in the plan, $600,000 of it in company stock carrying a $90,000 cost basis. The figures are illustrative and assume no other income in the distribution year.
Path one — roll everything to the IRA. Nothing is taxed today. The full $600,000 of stock value, along with the rest of the account, becomes ordinary income whenever it is withdrawn, and it joins the balance subject to required minimum distributions beginning at 73.
Path two — take the shares in kind and roll the rest. The $90,000 basis is taxed as ordinary income this year. The $510,000 of appreciation sits untaxed in a brokerage account until sold, then faces federal long-term capital gains rates of 0%, 15%, or 20% in 2026 depending on taxable income. That appreciation is also excluded from the 3.8% net investment income tax, though any further gain after the distribution date is not.
The federal spread between ordinary rates topping out at 37% and capital gains rates topping out at 20% is where the entire strategy lives.
How California Changes the NUA Math
California conforms to the federal deferral, so the appreciation is not taxed at the state level until the shares are sold. What California does not do is honor the rate distinction.
The state taxes capital gains as ordinary income, with no preferential long-term rate, at brackets reaching 13.3%. A California resident who executes this perfectly still pays full state ordinary rates on the appreciation when the shares are sold. The savings are federal. The state layer is the same on both paths.
That does not make the election a poor choice here. It means the federal benefit has to be large enough to justify accepting a concentrated single-stock position and a taxable income spike in the distribution year — and in a state taking up to 13.3%, the margin for a miscalculation is narrower than the national coverage of this topic suggests.
What Most People Miss About the Timing
The election fails more often on sequencing than on math.
Taking any partial distribution after a triggering event can disqualify the lump-sum treatment for that year. The entire balance has to clear within one tax year. And the basis recognition creates a single large income year that lands in the IRMAA lookback, raising Medicare premiums two years later for anyone at or near 65.
There is also an estate consideration. The NUA portion does not receive a step-up in basis at death. It passes to heirs as income in respect of a decedent, still carrying the embedded gain. Appreciation occurring after the distribution date does receive a step-up.
How the Decision Gets Made Well
This is a decision that has to be modeled across several years, not evaluated in the week the paperwork arrives. Our Tax Management Journey® exists for exactly this kind of sequencing question: it projects the distribution-year income spike against future bracket exposure, the IRMAA lookback, and the eventual sale year, so the comparison runs on your actual numbers rather than a rule of thumb.
The concentration question is separate and equally real. Holding a large position in one employer's stock outside the plan is a portfolio decision as much as a tax one, and The Bucket Plan® addresses it by assigning that position to a time segment with a defined purpose rather than leaving it to sit unexamined.
Both questions also require your CPA. The basis figure comes from the plan administrator and should be confirmed in writing before anything moves.
If You Are Approaching a Rollover
If you are already a client and hold employer stock in a qualified plan, this belongs in your next review. We can pull the basis figure and model both paths before any paperwork is signed.
If you are not, and you are within a year or two of leaving an employer where you have accumulated company stock, the question worth asking is a narrow one: what is the cost basis, and has anyone modeled the election against a straight rollover? We are glad to walk through how that comparison is built in a 20-Minute Due-Diligence Q&A Call.