NUA and Inherited 401(k): Can Beneficiaries Use the NUA Strategy?

Your parent (or spouse, or other beneficiary-designated person) died holding employer stock in a 401(k). The stock has a very low cost basis — a 10-to-1 or higher appreciation ratio. You want to know: can you still do NUA, even though you didn't earn the stock yourself? The short answer is yes — but the mechanics and tax treatment are meaningfully different from regular NUA. This guide explains both.

Death as a qualifying event

The NUA election under IRC § 402(e)(4) requires two things: a lump-sum distribution of the entire plan balance within one tax year, and a qualifying triggering event.¹ There are four qualifying events:

• Separation from service
• Attainment of age 59½
• Disability
• Death of the participant

Death is explicitly listed. That means if the account holder died with employer stock still inside the 401(k), the beneficiary can use death as the triggering event for a lump-sum distribution — and elect NUA treatment on the in-kind stock transfer.²

The election is not automatic. You must proactively structure the distribution to take advantage of it. Most plan recordkeepers default to recommending a full rollover to an inherited IRA, which would convert every dollar (including the NUA appreciation) into future ordinary income. A beneficiary who doesn't know to ask about NUA will almost certainly be talked out of the only thing that could save them $100,000+ in lifetime taxes.

How the NUA election works for a beneficiary

The mechanics are structurally identical to regular NUA:

1. Request a lump-sum distribution triggered by the participant's death. Contact the plan administrator and use those exact words. The plan must distribute the entire account balance within the same tax year as the distribution request (or, for most purposes, the calendar year in which you're making the election).
2. Direct the employer stock in-kind to a taxable brokerage account. Do not liquidate it. The in-kind transfer preserves NUA treatment. You'll need to provide the plan with a receiving brokerage account number before the distribution.
3. Roll the non-employer-stock assets to an inherited IRA (non-spouse) or own rollover IRA (surviving spouse). The plan can distribute the employer stock in-kind to taxable and simultaneously transfer the remaining mutual funds, bonds, or other holdings to an inherited IRA via direct trustee-to-trustee transfer.³ Only the cost basis of the in-kind stock is taxable in the distribution year.
4. Document the cost basis. The plan issues a 1099-R with the NUA amount in Box 6. You'll need the plan's stated cost basis (what the plan paid per share, not market value at the time of your distribution) to calculate the ordinary income portion and your carryover basis for future LTCG.

IRD treatment: the key difference from regular NUA

When the original account holder takes NUA, the appreciation becomes long-term capital gain in their hands. If they hold the stock and die later, the NUA layer (from the original distribution price up to the fair market value at distribution) is Income in Respect of a Decedent (IRD) — it does not receive a step-up in basis under IRC § 1014(c).⁴

The same principle applies when a beneficiary takes NUA directly from an inherited plan. The NUA appreciation — the embedded gain inside the 401(k) at the time of the participant's death — is IRD. As the beneficiary, you:

• Receive the stock with a carryover basis equal to what the plan paid (the plan's cost basis — the same as the regular NUA case)
• Owe long-term capital gains tax on the NUA appreciation when you sell, at whatever rate applies to you in the year of sale²
• Do not receive a step-up in basis just because you inherited the stock
• May receive an offsetting deduction for estate taxes paid on the NUA (see §691(c) section below)

The key comparison: If instead you roll everything to an inherited IRA, every dollar of future withdrawal is ordinary income — both the cost basis and the $800K of appreciation. NUA converts that $800K layer from ordinary income to LTCG, which is still a major win even under IRD treatment.

For 2026, the federal LTCG rate is 20% for most high earners (plus 3.8% NIIT if applicable), versus ordinary income rates of 32–37% for the same income level.⁵ The spread — often 13–17 percentage points — is exactly what makes beneficiary NUA worthwhile on large, highly-appreciated positions.

The §691(c) estate tax deduction

If the decedent's estate was large enough to owe federal estate tax, you get an additional benefit: a deduction for the proportionate share of federal estate tax attributable to the NUA.⁶

Under IRC § 691(c), beneficiaries who receive IRD items (including NUA) can deduct the federal estate tax that would not have been incurred had the IRD asset not been included in the estate. The calculation:

1. Calculate the estate tax with all assets included (including the NUA stock at FMV)
2. Recalculate the estate tax excluding the NUA asset
3. The difference is the IRD deduction available to the beneficiary — claimed as a miscellaneous itemized deduction (not subject to any floor under current law) in the year(s) the NUA income is recognized

For most estates in 2026, this deduction is not available: the federal estate exemption is $15,000,000 per person (permanently raised under the One Big Beautiful Bill Act, July 2025).⁷ With portability, a married couple shields up to $30M. Unless the decedent's estate exceeded these thresholds, no estate tax was owed and no §691(c) deduction applies.

For beneficiaries of very large estates — say, a decedent who owned a business, real estate, and $3M in employer stock at a top-bracket estate — the §691(c) deduction can offset a meaningful portion of the LTCG tax owed on the NUA. A tax professional must calculate this on the actual estate return figures.

Surviving spouse: special options

Surviving spouses have a unique set of choices when inheriting a 401(k) with employer stock:

Option 1: Roll the entire plan to your own IRA

If you roll the inherited 401(k) to your own rollover IRA (most common default recommendation), the employer stock is liquidated and transferred as cash. The NUA opportunity is permanently eliminated. Once inside your own IRA, the stock is treated as any other IRA asset — future distributions are 100% ordinary income.

Option 2: Take an NUA lump-sum distribution first, then roll the rest to your own IRA

You can take the entire plan in a lump-sum distribution (death as triggering event), direct the employer stock in-kind to your taxable account, and roll the remaining assets to your own rollover IRA. This:

• Preserves NUA treatment on the employer stock (LTCG when you sell)
• Gets the rest into your own IRA (your own RMD timeline applies, not the inherited plan's)
• Recognizes ordinary income only on the cost basis in the year of distribution

Option 3: Keep it as an inherited plan (named beneficiary option)

Surviving spouses may elect to keep the account as an inherited plan rather than rolling to their own IRA. This is primarily useful if you are under 59½ and need distributions before that age — inherited plan distributions are not subject to the 10% early withdrawal penalty, while distributions from your own IRA would be. Once you no longer need that exception, rolling to your own IRA typically makes more sense for long-term planning.

Non-spouse beneficiary and the 10-year rule

For non-spouse beneficiaries (children, siblings, other named beneficiaries) inheriting plans from participants who died after December 31, 2019, the SECURE Act requires the entire account to be distributed within 10 years of the participant's death — with no option to stretch distributions over the beneficiary's lifetime (with narrow exceptions for disabled or chronically ill beneficiaries, minor children, and beneficiaries not more than 10 years younger than the decedent).⁸

Annual RMD requirement

Under final IRS regulations (T.D. 10001, finalized July 2024), if the decedent had already reached their Required Beginning Date (age 73 for those born 1951–1959; age 75 for those born 1960 or later, per SECURE 2.0), non-spouse beneficiaries must take annual RMDs during years 1–9 and empty the account by December 31 of year 10.⁹ If the decedent had not yet reached their RBD, the beneficiary can take any amount at any time within the 10 years (including nothing for years 1–9 and everything in year 10).

NUA election vs. 10-year spread: the key trade-off

The NUA election requires the entire plan to come out in one tax year. For non-spouse beneficiaries, this typically means electing NUA in year 1. The decision:

The rollover to inherited IRA route defers taxes but converts 100% of the appreciation to ordinary income over 10 years. NUA concentrates the cost-basis ordinary income in year 1 but converts the appreciation to LTCG at your control. For a $1M position with $100K cost basis, the difference is often $100,000–$200,000 in lifetime taxes. The NUA election for a non-spouse beneficiary is typically worth modeling seriously for any position with an appreciation ratio above 5:1.

Worked example: Inheriting $1.2M with $800K in employer stock

Robert, age 72, dies in 2026. His 401(k) contains:

• $800K of employer stock, plan cost basis $80K (10:1 ratio)
• $400K in diversified mutual funds
• Total plan value: $1,200,000

His adult daughter Sarah (age 45) is the sole beneficiary. Robert was past his Required Beginning Date (age 73), so Sarah must take annual RMDs during years 1–9 and empty by year 10. His estate was under $15M — no estate tax owed, so no §691(c) deduction applies.

Scenario A: Full rollover to inherited IRA (no NUA)

Sarah rolls everything to an inherited IRA. Over 10 years, approximately $120,000 per year comes out as ordinary income. In her 35% combined federal+state bracket, total lifetime tax on the account approaches $400K–$420K.

Scenario B: NUA election in year 1

Sarah takes a lump-sum distribution. The employer stock ($800K market value) transfers in-kind to Sarah's taxable brokerage account. The $400K in mutual funds transfers directly to an inherited IRA (trustee-to-trustee — not a taxable event).

Year 1 taxes: Only $80K (the cost basis) is ordinary income. At 35% effective rate: ~$28,000.

NUA appreciation ($720K): Sarah sells over 2–3 years to manage LTCG exposure. At 20% federal LTCG rate + 3.8% NIIT = 23.8%: $720K × 23.8% = $171,360. Versus the rollover scenario, which would tax the same $720K at ordinary income rates of 35%+: $252,000+.

Inherited IRA ($400K): Same as Scenario A — distributed over years 2–10, ordinary income.

Illustration only. Actual results depend on sale timing, bracket in each year, state taxes, IRMAA exposure, and investment performance on deferred assets. These figures assume flat portfolio values and a 35% combined rate on ordinary income; real-world results will vary.

When beneficiary NUA makes sense

The election is worth serious analysis when:

• High appreciation ratio (5:1 or above). The wider the spread between cost basis and market value, the larger the conversion from ordinary income to LTCG rates.
• Large position ($200K+ of NUA appreciation). Below this threshold, the professional fees and complexity may not justify the tax saving. Above it, they almost always do.
• Beneficiary faces high future ordinary income rates. If you'll be in a top bracket for the decade you're taking inherited IRA distributions, the LTCG rate spread is at its maximum.
• The beneficiary plans to hold the stock for some period (or tranche-sell it), rather than selling on day one of the 10-year window. Spreading sales gives flexibility on LTCG year and amount.
• Surviving spouse with strong NUA candidate. The spousal rollover to own IRA locks in the favorable RMD timeline — but costs the NUA. If the position is high-appreciation, taking NUA first and rolling the rest preserves both benefits.

When the rollover beats NUA for beneficiaries

• Low appreciation ratio (less than 2:1). The ordinary income hit on the cost basis in year 1 may not be justified by a small LTCG spread on modest appreciation.
• Beneficiary is in a low tax bracket. In the 12% or 22% brackets, the ordinary-to-LTCG conversion is smaller — possibly 0% LTCG if income is below $49,450 single / $98,900 MFJ (2026 thresholds).⁵
• No-LTCG state residency. CA, NJ, NY, and several other states tax LTCG as ordinary income, reducing or eliminating the federal advantage. See NUA and state taxes for the state-by-state analysis.
• The plan has low employer stock allocation. If the employer stock is only 10–15% of the total plan, the complexity of an NUA election may not be worth it relative to a clean rollover.

Common mistakes

• Accepting the plan recordkeeper's default. When you call to initiate distributions, the default script almost always goes to "roll it to an inherited IRA." The recordkeeper does not model NUA. You must initiate the conversation and explicitly request a lump-sum distribution with in-kind stock transfer to taxable.
• Rolling the employer stock as cash. If the recordkeeper sells the employer stock and wires cash to your account, NUA is gone. You need the shares transferred in-kind. Confirm this in writing before the distribution is processed.
• Surviving spouse rolling to own IRA without checking NUA first. This is permanent and irreversible. Model NUA first; roll to own IRA second.
• Missing the same-tax-year window. If you initiate a lump-sum distribution in November but the transfers don't all clear by December 31, you may have a split-year problem. Start the process early in the year if possible.
• Confusing the estate's cost basis with the plan's cost basis. The NUA cost basis is what the plan paid for the shares (often recorded at grant date or purchase price). It is not the stock's FMV on the date of death, which would apply to inherited stock in a taxable account. The plan's 1099-R Box 6 is your source of truth.
• Ignoring IRMAA and Social Security interactions. The cost basis distribution and future NUA stock sales both affect MAGI in ways that can trigger Medicare surcharges and Social Security income taxation. See NUA and IRMAA and NUA and Social Security.

Sources

1. 26 U.S. Code § 402(e)(4) — Taxability of beneficiary of employees' trust; lump-sum distribution rules (law.cornell.edu)
2. Qualified Plans and the Net Unrealized Appreciation Rules — Greenleaf Trust; covers beneficiary NUA treatment and IRD status
3. Retirement Topics — Beneficiary, IRS.gov; non-spouse rollover to inherited IRA under § 402(c)(11)
4. 26 U.S. Code § 1014(c) — Basis of property acquired from a decedent — excludes IRD items from the step-up rule
5. IRS Rev. Proc. 2025-32 — 2026 inflation-adjusted amounts; LTCG 0% threshold $49,450 single / $98,900 MFJ; 20% threshold $545,500 single / $613,700 MFJ
6. 26 U.S. Code § 691(c) — Income in respect of a decedent; estate tax deduction
7. IRS 2026 inflation adjustments including OBBBA amendments — $15M estate/gift exemption confirmed
8. IRS: Retirement Topics — Beneficiary; SECURE Act 10-year rule for non-spouse beneficiaries
9. Final RMD rules retain 10-year rule for inherited retirement accounts — Grant Thornton; T.D. 10001 annual RMD requirement when decedent past RBD

Values verified as of May 2026. Tax law is subject to change; verify current year amounts with IRS.gov or a qualified tax professional before making any election.