NUA before 59 1/2
Client is currently 58 and is considering retiring next spring when he will be 58 1/2. He has worked with his company for about 37 years and has accumulated about $1.5 million in his 401(k), about $450K of that balance is company stock with a basis of $185K. Since the stock basis is over 40% of the market value of the stock, is it even worth considering NUA? If so, if he separates from service next year before age 59 1/2 is there way he can avoid the 10% penalty on the distribution of the $185K stock basis. If he takes the $185K distribution next year, he will likely be over the $250K married filing joint limit and have some investment earnings subject to the new 3.8% medicare tax. Will this distribution of basis also be subject to the 3.8% tax or just push them into a bracket where other investment earnings are subject to it? Did I understand that if his company allows it that one viable strategy might be to rollover to a traditional IRA all but the company stock at separation from service at 58 1/2. Wait a year until another trigering event at 59 1/2 and consider doing the NUA then if it makes sense to do at that time? Of course, the uncertainty of capital gains tax rates for the NUA portion after this year is another perplexing variable. Any suggestions? Thanks. EK
Permalink Submitted by Alan Spross on Thu, 2012-09-20 22:03
Since the client will have separated from service at age 55 or later, there is no 10% penalty for any distributions taken directly from the plan, including any NUA cost basis.
His cost basis is somewhat high for NUA, but if he needs the funds for other purposes in the next couple years, LT cap gain rates will save him tax money vrs taking funds from a retirement plan at full ordinary income rates. Of course, in his situation reducing the concentration of company stock should be done soon to get to a proper amount of diversification.
With respect to the 2013 Medicare tax on investment income, the cost basis for the NUA shares would not be investment income, but would increase MAGI and possibly expose more investment income to the new tax. The sale of NUA shares WOULD BE investment income and MAGI could expose the cap gains to the new tax.
If the plan allows the client to distribute all but the company shares, client could roll the other assets to an IRA next year. Since that would be the same year as separation it is not clear whether that would be an intervening distribution or not. It would probably be safer to wait until 59.5 which is a new triggering event to do the LSD.
Since the NUA value is questionable with basis over 40% of FMV, if he determines that NUA is viable, he can apply it for only some of the shares and roll the rest over or sell them in the plan. If his plan allows for separate lot accounting instead of the usual average share value, he would obviously select the lowest cost basis shares for the partial NUA. That would also reduce his exposure to future LTCG rate increases for his bracket by having fewer NUA shares.