401K Highly Appreciated Stock of Privately Held Company

Submitted by Nancy Schilreff on Thu, 2014-03-20 09:50

A 50 year old put $36,000 into her 401K twenty years ago. The 401K value, today, is $1M. The company has given her 30 days to let them know if she intends to rollover the 401K to an IRA or pay taxes to move it into a non-retirement account. She will continue to work for this company however, the company is starting an entirely new 401K account for the employees and closing the current plan.

These are my questions:

1. Will this employee qualify for the section of the Tax Code that would allow the NUA to be taxed at 20% Long-Term Capital Gains?

2. If so, she would like to move those funds into an IRA then, into a ROTH IRA, at the earliest, permissible date. Is this possible?

3. Is it true that the only portion of this 401K subject to regular income tax and the early withdrawal penalty (unless she elects the 72T), would be the basis of $36,000?

4. If she will not qualify for the exceptions in the tax code for the NUA, do you recommend rolling the full amount over to an IRA?

5. If she will not qualify for the exceptions in the tax code, how would you treat these funds if they were moved into a brokerage account?

6. Please document your response with the 2014 tax code.

I am extremely anxious to receive your responses. Thank you so very much.



Submitted by Alan - IRA critic on Thu, 2014-03-20 18:44

  1. Not until employee separates from service from the employer. If the company were to allow a rollover of these shares into the new 401k plan, the NUA potential will still be there upon separation from service. NUA potential will continue if the current plan assets are kept in the old plan, but if rolled to an IRA, NUA potential is eliminated. Sounds like the plan balance must be distributed and there is no option not to distribute it, but only employees that separate can utilize NUA.
  2. If NUA were allowed, the proceeds from the sale of the shares are NOT allowed to be rolled over to an IRA of any type. If NUA is not applied, the shares or the proceeds from selling the shares are allowed to be rolled over to an IRA within 60 days of the distribution. But a direct rollover would avoid the 20% withholding.
  3. That is correct if  NUA is utilized. The 10% penalty does not apply if employee separates in the year they reach 55 or later.
  4. An IRA rollover is usually the best solution if the plan balance cannot be transferred to the new plan to preserve NUA potential.
  5. Without NUA, the balance would be taxable if transferred to a brokerage account, and the 10% penalty will apply unless employee qualifies for a penalty exception (Such as separation in the year they reach 55 or later).
  6. NUA is described in Sec 402(e)(4). But plan options and strategy to apply those options are not in the tax code. If the plan will issue a 402f Notice, it will explain the options but will not include advice. Employee should determine if funds will be needed before age 59.5 or not. If so, distributions direct from the plan (but only after separation at 55) are penalty free, but if rolled to an IRA, a 72t plan would be needed to waive the 10% penalty on early distributions.


Submitted by Nancy Schilreff on Thu, 2014-03-20 21:44

Hi Alan,First of all, thank you immensely for your swift and precise response.  I have just a couple further questions to ask you, regarding this client:1.  This is an ESOP and, you are right, the company forced her to sell her shares.  She will continue to work for now with the same company, possibly stoppng at 55 will be an option for her.  This is my question…suppose she decides to take early distributions i.e., at 55, after she terminates her employement with this company.  Will her 72T be based on her original $36,000, the basis, or will it be based upon the entire amount?  And, if she has separated from her work at the age of 55, will she not be charged the 10% penalty on early distributions?2.  Due to her young age, I may advise her to begin with a small amount in safe money.    Please comment. 3.  If she moves her money to brokerage accounts, how will she be taxed, ultimately?  i.e. 20% on NUA and the basis of $36,000 taxed at her income tax level?  or, will 100% of her account be subject to income tax at her current level at the time of distribution?  I am trying to consider every scenario in an effort to give her the best planning advice.  Thank you again.



Submitted by Alan - IRA critic on Thu, 2014-03-20 22:47

  1. If the shares are being sold now and she does not terminate employment this year, the NUA potential is terminated because it cannot be used without separation from service. It seems the only choices now are limited to an IRA rollover or a taxable distribution. The IRA rollover is the only workable choice in this situation. The old plan will go to an IRA in a direct rollover and she will now be contributing to the new plan. Whatever balance she has in the new plan at 55 can be distributed without penalty at that time if she separates. But she will need to find out what distribution options will exist then, ie either flexible amounts as needed or just a lump sum. If the lump sum is required, then she would need a 72t from her IRA to enable penalty free distributions before 59.5. Her IRA by then could be composed of both the present rollover and the rollover from her new plan of the balance acquired from now to separation.
  2. Once funds are in a rollover IRA, she can convert whatever amount she wants to a Roth IRA, but probably would not want to do so while she is still working because her tax bill could include income from the salary plus the conversion. Conversions are not beneficial if the tax bill paid on the conversion is at a higher rate than it would be in retirement on her RMDs that would have been eliminated by those conversions.
  3. If she moves the funds to a brokerage account now instead of to a rollover IRA, she will be taxed in the current year and penalized 10% on the distribution. She might be able to split the distribution between the rollover IRA and a small amount to the brokerage account but only if she needs the money. Not sure if she needs money now or expects to within a short time.


Submitted by Nancy Schilreff on Fri, 2014-03-21 17:33

Hi Alan,The company she is employed with will not allow her to mix the funds from her first rollover with the new, current plan.  She must take rollover the entire account to an IRA or pay the tax/penalty.  She is planning to move her funds (for 30  – 60 days) into her bank to “sort thru” her options.Once those funds have been rolled over to her bank as an IRA, can she move a portion into safe money and a portion into the market?  Also, by rolling the funds into an IRA, does she forever lose the ability to be assessed on the original basis of $36,000 for future 72T considerations?  Also, will she be subject to the 72T rules on her first IRA, at age 55, should she termminate her employment with that employer or, could she take flexible distributions, as needed, without a 72T after age 55?Thank you so very much!



Submitted by Alan - IRA critic on Fri, 2014-03-21 18:30

  1. If the funds are rolled to the bank in a direct rollover, she can still transfer all or part of the funds to another IRA custodian such as a broker or mutual fund company. All movement of funds should be done by direct transfer, not by taking out the funds and rolling them over herself within 60 days.  60 day rollovers are going to be severely limited starting in 2015, so it is best to get into the habit of just moving funds by direct transfer. These are faster and non reportable as well. The IRA rollover will erase all possibility of NUA and the 36,000 figure will no longer matter since all distributions will be taxed at the full ordinary income rate.
  2. With respect to a 72t plan from the IRA account, the annual calculation must be the exact amount distributed every year. The only flexibility is a one time change to the RMD method that will reduce the distribution amount by 30-40%. The other option of taking flexible distributions from the old plan without penalty is not possible because the employer is requiring the entire balance of the old plan to be distributed. So if money is needed before age 59.5, she will need a 72t plan, even though these plans are generally a last resort because they are inflexible, and must be maintained for 5 years or until 59.5, whichever is longer.
  3. If she terminates from the employer at 55 or later, any funds she has in the new plan will be available without penalty and this could avoid starting a  72t plan IF the distribution options are flexible. If the plan requires a lump sum distribution like some do, then the new plan would also be rolled over to a different IRA and a second 72t plan could be started using the different IRA if required.


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