I have a client who has posed an interesting strategy about which I’d like to hear comments:

He is the owner of a business that sponsors a 401(k) plan. His account in this plan is worth about $800,000 (at least it was a couple days ago) and consists of a diversified array of mutual funds. He also has a personal brokerage account (non-qualified money) that holds a large list of dividend paying stocks. He anticipates that the favorable tax rates applicable to dividends will go away in the next few years, potentially around the time that he might retire (he’ll be 54 this August). He has stated as a goal to have his dividend paying stocks wind up in a qualified account, ultimately his IRA (essentially, he’d like to exchange the composition of his 401(k) account with the securities held in his personal brokerage account). He indicated that he’d consulted with several folks, all of whom said it could not be done. I came up with the following idea as a means to accomplish his objective: upon retirement, transfer his 401(k) balance into an IRA. Then, take a distribution from the IRA with the specific intention to repay it within 60 days. The repayment would be made to the IRA with the dividend paying stocks. Voila! Mission accomplished. Then I thought, “why would he want to do this, since he’d be losing his cost basis for income tax purposes in the stocks?” Maybe for a few highly appreciated stocks this strategy wouldn’t be so bad, but perhaps for all it might not be the best approach.

My questions: (1) Irrespective of the loss of cost basis, could this transaction actually occur?, (2) Do you think such a strategy makes sense, given that he’s doing it, at least in part to try to avoid trading costs?, (3) Would there be any other valid reason to want to consider such a strategy?

Thank you so much for considering this.