delaying NUA distribution after separation
I am 60 years. I have separated from service. I have 401(k) plan from my prior employer. I have a low cost basis ESOP in my 401k. Would it be beneficial for me to wait until I am 72 years to perform NUA type distribution. As I expect the ratio of ESOP basis to ESOP funds to decrease as the time goes on — making it more advantageous to take NUA as late as possible (72 years old). I understand that the ESOP basis would grow only due to the dividend distribution while the overall NUA funds expect to grow at higher rate due to expected increase of ESOP share price with time.
Permalink Submitted by Alan - IRA critic on Thu, 2021-06-17 03:25
Need to determine if you are still eligible for a qualified lump sum distribution (LSD) for NUA purposes. Your last triggering event was either separation from service or reaching 59.5. After the latest of those two dates, have you taken any distribution from the ESOP or from the 401k plan? Such a distribution would be treated as an intervening distribution and could disqualify you from NUA.
Permalink Submitted by abraham boznick on Thu, 2021-06-17 04:22
I should be qualified as there was no distrubution – the money are still in 401k intact. When I separated from service I was already over 59.5. Is there a specified maximum length of time I can keep my 401k after my separation (I could not find any of such restriction in the SPD)?
Permalink Submitted by Alan - IRA critic on Thu, 2021-06-17 15:02
There is no maximum time unless the balance is very small. You can delay your LSD as long as you wish providing you do not take any partial distributions. 404k dividends from the ESOP are an exception and do not disqualify an LSD. In fact, if you were to delay the LSD until 72 (and 72 is still the first RMD distribution year in 2033), you can use the distribution of shares to satisfy your RMD, and if you wait until 73 (RBD year) you could use the distribution of shares to apply to both the first and second year RMDs, essentially providing a double benefit. Since the 401k and ESOP RMDs are separate, being separate plans, the ESOP share distribution will not satisfy the 401k RMD. The important requirement is that you cannot roll over the 401k unless you also make that year your LSD for the ESOP shares.
Note that while the NUA gets LT cap gain treatment, so does additional gains after distribution that exceeds the NUA per share as long as you do not sell the shares in the first year after distribution.
In all your considerations, diversification should trump tax benefits, so you may want to sell at least some of the shares sooner rather than a decade later. Of course, shares rolled into an IRA can be sold immediately with no current tax impact.
Permalink Submitted by abraham boznick on Sun, 2021-06-20 05:43
Thank you for your reply. In my case diversification is not an issue as I have other IRAs and brokerage accounts which are not assoiciated with my prior company stock. Is there anyway you can help in answering my question in terms of delaying distribution from 401k to 72 -73 years time frame– as it seems too me that it would make NUA distribution more advantageous as the RATIO of basis to amount in NUA should be decreasing with time (and this is what you genearly want for NUA) — also you are delaying paying tax on the NUA basis at the time of distribution (as the basis remains essentialy the same except for the small increase due to the reinvestment of dividents). Is my thinking correct that I should be delaying the NUA distribution for as long as possible (if I do not care about diversification)? — as I searched the internet — but could not find any links to that regard.
Permalink Submitted by Alan - IRA critic on Sun, 2021-06-20 14:57
I did indicate that you can delay the distribution until 72-73 if you wish as long as you do not take any distributions from either the 401k or ESOP until the LSD year. But also note the second bullet point where it states that if you do not delay the LSD, any subsequent gains in the shares will be taxed at the same LT cap gain as the NUA, so additional gains (after 1 year) will be treated the same as NUA when you sell.
If you continue to have dividends reinvested you are watering down the NUA % since the reinvested dividends will be added to your cost basis, which is taxable as ordinary income at the time of the LSD. If you reinvest after the LSD, at least you will pay the lower LTcap gain rate on the dividends presuming they are qualified dividends.
If you wait until 72-73 the largest potential advantage is covering the first 2 years of ESOP RMDs with the distribution of shares, avoiding the additional tax on the RMDs for those 2 years. So if you are able to wait for the LSD for a long time, you might as well hold out to age 73 to be able to cover 2 RMDs with the LSD.
After you do the LSD, I would definitely stop reinvesting dividends because it will made tax reporting much more complex since the cost basis in your taxable brokerage will be constantly increasing and diversification will be further reduced. For now, you might see what options the plan offers for current dividends instead of reinvesting, since reinvestments are increasing your cost basis which will eventually all be taxable at the ordinary rate when you finally do the LSD.
The options are complex with trade offs for whatever you do. In addition, the tax laws could change. For example, NUA could be eliminated in a tax bill, forcing you to take the LSD immediately or losing that option. If the tax bill was retroactive, NUA could be eliminated with no chance to use it in the final year. So you would have to keep monitoring the status of NUA in future tax bills.