Lump Sum Distribution and NUA
I separated from my previous employer in Sept. ’09 at age 55 with three plans tied to my retirement, 1) 401K, 2) defined benefit pension, and 3) leveraged employee stock ownership plan in which the shares were purchased by the company. I am now allowed to take all of my shares in the LESOP or use half to fund an increased pension benefit. I want to take all of the LESOP shares in kind to take advantage of NUA. I have been told by someone with the plan trustee that in order for the stock to qualify for a lump-sum distribution I also need to roll over my entire 401K into either an IRA or my new employer’s 401K. Can anyone clarify this -I can’t find any information that confirms what he is telling me.
Permalink Submitted by Alan Spross on Sat, 2010-01-30 19:25
The advice is correct. Following is a copy of the definition of a qualifying lump sum distribution for NUA purposes, and also the triggering events that allow for such distributions:
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(D) Lump-sum distribution
For purposes of this paragraph –
(i) In general
The term “lump-sum distribution” means the distribution or payment within one taxable year of the recipient of the balance to the credit of an employee which becomes payable to the recipient –
(I) on account of the employee’s death,
(II) after the employee attains age 59 1/2 ,
(III) on account of the employee’s separation from service, or
(IV) after the employee has become disabled (within the meaning of section 72(m)(7)), from a trust which forms a part of a plan described in section 401(a) and which is exempt from tax under section 501 or from a plan described in section 403(a). Subclause (III) of this clause shall be applied only with respect to an individual who is an employee without regard to section 401(c)(1), and subclause (IV) shall be applied only with respect to an employee within the meaning of section 401(c)(1). For purposes of this clause, a distribution to two or more trusts shall be treated as a distribution to one recipient. For purposes of this paragraph, the balance to the credit of the employee does not include the accumulated deductible employee contributions under the plan (within the meaning of section 72(o)(5)).
(ii) Aggregation of certain trusts and plans
For purposes of determining the balance to the credit of an employee under clause (i) –
(I) all trusts which are part of a plan shall be treated as a single trust, all pension plans maintained by the employer shall be treated as a single plan, all profit-sharing plans maintained by the employer shall be treated as a single plan, and all stock bonus plans maintained by the employer shall be treated as a single plan, and
(II) trusts which are not qualified trusts under section 401(a) and annuity contracts which do not satisfy the requirements of section 404(a)(2) shall not be taken into account.
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Note that your triggering event was separation from service, but you also must avoid what are known as intervening distributions from these plans before your lump sum distribution (LSD) year. For example, if you took a distribution that was not part of an LSD, you would then have to wait for another triggering event, which would probably be turning 59.5.
Also, since you meet the age 55 separation exception, there will be no early withdrawal penalty on the taxable cost basis for the shares on which you are taxed in the LSD year. The DB plan is a different type of plan, therefore, you still meet the LSD definition without distributing the DB plan. Make sure you get a cost basis quote on these shares. NUA works best if the cost basis on which you will be taxed is 30% of less of the share market value.
Permalink Submitted by Robert Mueller on Sat, 2010-01-30 21:19
Alan, thank you for your reply. At this point the stock basis is 50% of the current market value. I would like to take it out due to its volatility over the last couple of years. I’m interested in knowing why NUA works best at
Permalink Submitted by Alan Spross on Sat, 2010-01-30 22:04
The 30% is more of a long term rule of thumb if you want to hold the shares. The higher the cost basis %, the more tax is paid up front in the year of the LSD at ordinary income rates vrs the amount of NUA to be taxed at LT cap gain rates down the road. This causes loss of tax deferral, and future dividends will also be immediately taxable. The low qualified dividend tax rate might also go away in the near future.
But, other than sales of NUA shares, if you are need to raise current cash from your retirement accounts, you would pay ordinary income tax on the entire amount (barring after tax contributions). But from the NUA shares, you would pay the LT cap gain rate, which has a cap on it regardless of income. In this situation, there is an advantage at much higher %s of FMV than 30, since loss of tax deferral would not be an issue.
Diversification should always trump tax benefits, and is often a problem with large amounts of employer stock. The two options of using an IRA rollover and then selling tax deferred or using an LSD and selling at the LTCG rate both solve the diversification problem, but taking the LSD and holding the NUA shares does not. There is also no basis adjustment for heirs on the NUA stock.
So if you need to raise funds from your retirement accounts now, selling NUA shares is a good way to do it with a lower after tax cost, and the % of FMV is not an issue since any portion of the distribution taxed at less than ordinary income rates is a plus.