Net Unrealized Appreciation (NUA) Rules - Is this a disqualifying situation?

Submitted by Sean Heidig on Thu, 2025-05-29 11:12

I am helping a client with implementing NUA of his former employer 401k plan.

For context, the client is 58 & separated from service.

We were planning to do a direct rollover of the non-employer stock assets in the 401k to a Rollover IRA.

As for the company stock, we were planning to initiate an in-kind transfer to a individual taxable account (with the cost basis being taxable in the current year).

However, during my last call with the client – to discuss implementing the NUA – I learned that he did a large partial account balance Direct Rollover from this employer 401k plan in 2022 – to an outside held rollover IRA.

Based upon what I’ve read from the IRS and other sources online, the NUA must be taken as a “lump-sum” distribution and all assets must leave the account in the same calendar year.

Will that 2022 Direct Rollover from the employer plan eliminate our ability to use NUA now (even if we were planning to empty what remains in 401k all in this calendar year as outlined above)?

My biggest fear is we proceed with the NUA transaction and the distribution of the stock via in-kind transfer will be fully taxable as ordinary income (no NUA long-term capital gains benefit).

Also, is this a question we should pose to the plan administrator?

I couldn’t find any clear & decisive answers on this particular situation. Any guidance is greatly appreciated.

Thanks!

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Permalink Submitted by Alan - IRA critic on Thu, 2025-05-29 11:46

Yes, if the 2022 rollover was distributed after the date of separation, the plan should treat it as an “intervening distribution” which would disqualify the LSD needed for NUA purposes. That said, when client reaches 59.5 they will have a new triggering event for NUA that would preempt that intervening distribution. Therefore, if the cost basis % will still be low enough to justify NUA treatment next year, the client only needs to wait until age 59.5 to complete the LSD and utilize NUA.

This decision should be confirmed with the plan before implementing distribution of the shares because the 1099R form for the share distribution issued must include the NUA amount in Box 6 and cost basis in 2a, and both 1099R forms must have the “total distribution” box checked.

Should the plan include non Roth after tax contributions, the situation is more complex with respect to how the plan will treat that balance, and whether the client will have choices on how to apply that balance.