401(k) company stock rolled to IRA
I have a 69 yr old client who is being required by the 401(k) plan administrator to take a complete distribution by next week. She inherited the 401(k) from her husband who passed away over 10 years ago, and apparently was not required to make a distribution at that time. The 401(k) is 100% in company stock, has a market value of approx 900k and a cost basis of approx 100k. We discussed the obvious benefits of the NUA, but she has no children and doesn’t want to pay tax of any kind right now. Per the administrator she has after-tax contributions as follows:
Pre ’87 = 10k
Post ’86 = 17k
1) Can she simply take the after-tax $ as a distribution in cash (not rolled to an IRA), i.e. the 27k total, and roll the rest in-kind in the company stock? She’d like to separate out the after-tax $ now, if possible. What is the significance of the post ’86 and pre ’87 $ in this case?
2) Can she take a dist of the after-tax $ in the form of company stock with a current market value of 27k?
3) Just for my info, if she did elect to take dist of all stock to a non-qualified account (and NUA), what would be the basis on just the pre-tax stock?
Any other suggestions appreciated. Thank you for your input.
Tim
Permalink Submitted by Alan Spross on Sat, 2007-12-01 05:31
1) There is no significance with the pre 87 amounts when you must take a lump sum distribution. In a prior year she could have taken out the pre 1987 amount by itself because it is not subject to pro rating with pre tax amounts. But at this point, you can consider the 27,000 after tax contributions as a single amount. This amount can be rolled over or simply put in a taxable account. If there is no cash in the plan, then company shares could be sold to generate the cash.
2) The 27,000 may be in company stock if the plan will allocate the after tax amounts to specific shares rather than spread over all the shares.
3) NUA involves two types of basis, tax basis and plan basis. The plan basis of NUA shares is the fair market value less the NUA. That cost per share will be the basis whenever the shares are sold. However, to the extent that the shares were purchased with after tax dollars, the tax due as ordinary income in the year of the LSD is reduced. The savings from the after tax contributions is realized by not taxing that same amount in the year of distribution.
4) Note that diversification should be the #1 concern here unless she has several millions of other assets. NUA is not an all or nothing option. She could and should take a certain % of the shares as NUA, and the rest could be directly transferred to an IRA and sold right away to get the needed diversification.
5) If all this is not complicated enough, it is also possible that if her husband was born prior to 1/2/1936, further options under Form 4972 are available. These include the LSD options described in Pub 575, p 19.
All of above LSD related options mentioned may NOT be available if she has taken any distributions since she inherited the plan.
6) And IF her husband WAS born prior to 1/2/36, then she would have needed to take RMDs in the year he would have turned 70.5, so there would be RMD issues as well.
To have to deal with this case in one week strikes me as an incredible challenge. but a 10% cost basis for NUA should not be wasted for at least some of the shares if she qualifies.
Permalink Submitted by Tim Golden on Mon, 2007-12-03 02:43
Thank you for your reply. He was born in 1938 and thus wouldn’t be eligible for the averaging.
You also stated “All of above LSD related options mentioned may NOT be available if she has taken any distributions since she inherited the plan.” Here’s another twist: She has been taking dividends from the common stock for years (a distribution?), but she receives a 1099-DIV, not a 1099R (I’ve confirmed that the stock is almost all pre-tax in the 401(k)) which doesn’t seem correct, but that is the way it is reported. Would this disqualify here for NUA treatment on all or part of the stock? I had the same reaction as you had, that she needs to diversify since this represents about 75% of her liquid net worth. I also think that she should take advantage of NUA treatment, so I initially suggested 50%.
Based on your response to question #2, did I understand your explanation?:
Current market value of stock = 900k
Cost of stock purchased in 401(k) = 100k
Total after-tax contributions = 27k
If she elects 100% NUA treatment, taxable amount of distribution in 2007 would be 100k-27k = 73k?
I also read someplace that her heirs would not receive a step-up in basis on the FMV on date of distribution minus original cost upon her death since she inherited the 401(k), I.e. there would only be a potential step-up if the share price upon her death exceeds FMV date of distribution.
Thanks again for the excellent insights.
Tim
Permalink Submitted by Alan Spross on Mon, 2007-12-03 05:24
The dividend payouts reported on the 1099DIV are most likely ESOP dividends due to an ESOP plan being rolled into the 401k. If so, these dividends do not constitute distributions that would negate the use of NUA on the employer shares.
If the cost basis quote of 10% of FMV is correct, the taxable amount of a full NUA distribution should be 73,000 as you indicated.
You are also correct on the step up. Because NUA shares are considered IRD assets, there is no step up in basis for her heirs on the NUA portion. However, further gains above the FMV at distribution would receive the step up at her death. That would leave the shares with a basis equal to the FMV per share less the NUA per share.
However, when she sells shares, which should be soon for diversification purposes, her tax rate will be LT on the amount of NUA per share, and ST on additional gains if she sells in a year or less from date of distribution.
She could also diversify by taking only a portion of the shares as NUA and transferring the rest to an IRA. She could then sell the shares in the IRA without current tax consequences. There is no deadline for selling the NUA shares at the LT gain rate. However, it should also be noted that the current low LT gain rates technically expire in 2011.
Permalink Submitted by Tim Golden on Mon, 2007-12-03 18:34
Fantastic, again I appreciate your reply. One last question: if she elects NUA on 50% of the stock, would the taxable amount then be as follows?:
FMV of 50% of stock for NUA treatment = $450,000
50% of cost of stock = $50,000
Therefore, taxable amount = $50,000-$27,000 = $23,000
(50% of cost minus after tax contributions) or how would this be calculated?
Permalink Submitted by Alan Spross on Mon, 2007-12-03 19:55
That’s probably correct, but you would need to verify the accounting provisions of the plan on assigment of the 27,000 in basis to be sure it can be assigned solely to the 50% of shares being used for NUA.
Permalink Submitted by Tim Golden on Tue, 2007-12-04 15:13
great, thank you.