The Eli Lilly Dilemma

For employees who have built up significant company stock in their 401k, the Net Unrealized Appreciation (NUA) strategy can be one of the most powerful tax planning tools available. But how does the NUA strategy work, and how can employees with Eli Lilly stock save thousands of dollars in taxes by using this approach?

Net Unrealized Appreciation (NUA)

Last year, my colleague wrote about the benefits and mechanics of utilizing the NUA strategy (Retiring with Employer Stock in your 401K?). To reiterate, it’s a strategy to move highly appreciated employer stock from an employer-sponsored plan to a brokerage account at favorable tax rates.

Upon an in-kind transfer of the employer-stock portion of the plan, the basis (or what you paid for the stock) is taxed as ordinary income in the year of the transfer, and the NUA (the growth of the stock) grows tax deferred until sold. At time of sale, it receives capital gain tax treatment.

If you were to leave the company stock in the employer-sponsored retirement plan, you would pay ordinary income tax on each distribution.

The NUA strategy is appealing because of the capital gains tax treatment on the gains; however, the main drawback is that the entire cost basis is subject to ordinary income tax when the stock is distributed. Depending on the size of your cost basis and your current tax situation, this can create an undesirable tax bill.

After-Tax 401k Contributions

In an article I wrote last December (Mega Backdoor Roth? What is this?), we touched on the ability to save above and beyond traditional 401k limits through “after-tax” contributions. These contributions are made, as the name implies, with after-tax dollars, usually after an employee has maxed out salary deferral limits, while factoring in any employer contributions.

You might be asking what NUA and making after-tax contributions into your 401k have in common. Let’s explore.

The Eli Lilly Dilemma

Take Eli Lilly as an example. In August 2020, Eli Lilly’s stock price was around $150 per share. By August 2025, it had grown to approximately $880 per share, a nearly sixfold increase! If you are an employee who has been saving over that duration, the tax impact could be substantial when you need to tap into the assets.

Imagine an employee who accumulated 2,000 shares of Eli Lilly stock in their 401k during their career. Suppose the average cost basis of those shares (the price the plan originally paid) was $150 per share, or $300,000 total.

By 2025, those shares are worth $1.76 million (2,000 × $880). If the employee implements the NUA strategy and distributes the shares in-kind to a taxable brokerage account, the following will apply:

• Cost basis: $300,000 - taxed as ordinary income. At a 35% marginal tax bracket, taxes owed will be approximately $105,500
• NUA: $1,460,000 - taxes are deferred until sold, at which point it is taxed at long-term capital gains rates.

While NUA defers and reclassifies much of the gain, that $105,500 is a difficult pill to swallow come tax time.

This is where after-tax 401(k) contributions play a critical role. The IRS allows you to apply after-tax contributions toward the cost basis of your employer stock. Every after-tax dollar you’ve accumulated offsets one dollar of taxable basis.

For example, if you have $100,000 in after-tax contributions, you can apply them against your $300,000 basis noted above, lowering the ordinary taxable income to $200,000.

If, instead, you have $300,000 in after-tax contributions, you can apply the full amount and reduce the taxable basis to $0. In this scenario, the entire stock value is now composed of NUA, meaning all of it will be taxed at the lower capital gains rate when sold.

Considerations

This strategy should not be applied blindly, as there are many other caveats to consider. While it might seem like a no-brainer to utilize this option and remove as much tax liability as possible, it may be wise to pay the ordinary tax (if you will be in a lower tax bracket in the year in which the distribution/transfer would occur) or a portion of it and move the entire after-tax contribution portion to a Roth IRA since those assets would then grow and be distributed tax free.

This, coupled with the complexity of implementing this strategy, should not be undertaken without a comprehensive discussion with your financial and tax advisors.

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