Defaulted 401k Loan and NUA
Hello.
I have a client who has a $15K outstanding loan balance on his 401k, is retiring in June, and plans to take advantage of NUA on some low cost basis shares. As he does not intend to repay the loan before he retires, we plan on doing a complete lump sum distribution from the plan this year by rolling the majority of his assets into an IRA rollover, while distributing the “NUA” shares into a brokerage account. Since we’ll be completing a lump sum distribution of the plan, the loan balance will then automatically be considered in default.
My question is this: will this negatively impact the special NUA tax treatment because the loan will be considered a previous distribution, or does the fact that a triggering event and a complete lump sum distribution in the same tax year still qualify him for the NUA treatment?
The company’s SPD is rather vague, and states that a defaulted 401k loan, a withdrawal, etc. “could” disallow the NUA option, but I’m assuming that only would apply if the distributions occurred in a previous tax year, correct? (i.e. employee retires in 2017 at age 62, defaults on 401k loan in 2017, but wants to take advantage of NUA in 2018).
We’ve worked with employees of this company for many years, and have successfully completed NUA distributions while “defaulting” on 401k loans before, but the company has since changed plan service providers. Our client was told by a colleague that his financial adviser told him to pay off the loan before he retires, otherwise he won’t qualify for the NUA treatment. Needless to say, I’m therefore anxious to reevaluate/refresh my understanding of the rules before proceeding
Thanks in advance for any input/advice.
Robin
Permalink Submitted by Alan - IRA critic on Sat, 2018-04-21 02:21
NUA should still be available if client completes the LSD in 2018 since the loan offset distribution can be considered part of the LSD. However, if the LSD is not completed in 2018, then client would have an intervening distribution after the separation triggering event and in a year prior to the LSD year. Client should inquire about the 1099R showing the NUA in Box 6 because if he distributes the shares and gets an unfavorable 1099R more than 60 days after the distribution of shares, he could not rescue the distribution by a 60 day rollover.
Permalink Submitted by Robin Ross on Mon, 2018-04-23 23:22
Thank you! This is how I’ve always understood it, but I’d rather be very certain than be unpleasantly surprised. What’s unfortunate is that the other financial advisor (who also works with many clients of this company) is telling his prospective clients that they have to pay off their loans BEFORE they retire, or it will negate the preferential NUA tax treatment. Of course, this “could” be true depending on LSD rules, triggering events, etc. But as long as the client is completing the LSD in the year of the triggering event, his advice is not correct. I will confirm with the administrator at time of rollover that the NUA will be reported in box 6 before we proceed, but this has always been the case in my past exerience with this company.Thanks again. You are fantastic!
Permalink Submitted by Alan - IRA critic on Mon, 2018-04-23 23:37
If this advisor works with many participants in this plan, the advisor may know how the plan interprets LSD compliance, even if the plan administrator is not correct. A 1099R that omits Box 6 NUA may be very difficult to get changed and the IRS tends to think the plan is correct. To play is safe, the participant should seek confirmation from the plan that the advisor is incorrect and the loan offset will be treated as just part of the LSD.
Permalink Submitted by Robin Ross on Mon, 2018-04-23 23:48
Thank you. We too work with many employees of this company, and my guess is that the other advisor is simply being precautionary because of the vagueness in the SPD, but we will be sure to confirm with the plan.