ESOP Dividends in 401k
I will be retiring from my employer this summer, after over 30 years of employment. I have a substantial amount in my 401k account, which I plan to rollover to a self-directed IRA. However, I am 56 yrs old and will need non-tax-deferred resources for the next 3 years until I turn 59.5. I do have resources in other accounts but want to make sure I do everything right with the 401k.
There is a large chunk of company stock in an ESOP inside the 401k account. I do not plan to do the NUA treatment because the basis is not low enough for that to make sense. However, every time I get a 401k statement, there is an area that says “ESOP dividends”, in addition to the breakout area that shows my total ESOP stock. The ESOP dividend amount is about 1/3 of the total ESOP stock. I have been reading that ESOP dividends can be taken out of the account without the 10% early withdrawal penalty. Is that correct? If so, is that only if I elect the NUA treatment on the entire ESOP amount? If I want just the dividends without penalty, do I have to request that the ESOP dividend amount be distributed to me in a lump sum, as opposed to including them in the rollover to the IRA account?
I’m just confused about the special ESOP dividend treatment.
Thank you in advance for your help!
Permalink Submitted by Alan Spross on Tue, 2011-04-12 21:35
ESOP dividends paid to the employee are not subject to the 10% early distribtion tax regardless of NUA election.
But in your case, since you separated at 55 or later, any part of your 401k plan distributed directly to you carries the age 55 penalty exception. This benefit is great if the plan allows you to take flexible distributions until you are 59.5, but if you must take a lump sum, then your marginal rate will probably be inflated even without the penalty.
So check with the plan to see what flexible distributions options you will have until age 59.5 If the plan requires a lump sum distribution, then you will probably have to roll the balance over to an IRA and then set up a 72t plan from the IRA to avoid the penalty. The 72t plan must last for 5 years or until you are 59.5 whichever is longer. If you roll the plan over to an IRA the age 55 exception is forfeited, and that is why you would need a 72t plan. But the best situation is if the plan will allow you to take flexible distributions directly from the plan.
Permalink Submitted by Linda Taylor on Tue, 2011-04-12 22:31
Thank you so much for your help! I am still working and will retire at the end of May, so I have not separated yet. I believe I have adequate non-tax-deferred resources to get me through until after age 59.5, but I want to analyze all my options. I don’t think I need to do a 72t plan since I believe my other resources will be sufficient and I don’t want the complexity of keeping up with the 72t distributions.
The plan does allow partial lump sum payments. Per the documents I have received: “You may have a specified dollar amount of your account balance paid in cash (minus 20 percent for federal tax withholding) and the remaining balance paid in the form of a direct asset transfer (rollover) to an IRA or qualified plan”. That is one of the options, in addition to the usual others (rollover, LSD, etc…). So if I had $100k, based on this language, I could request that $20k be paid in cash (with $4k withholding) and $80k be rolled over to an IRA, correct? And the ESOP dividends would just get rolled over or proportionately paid out just as every other dollar, is that right?
Thank you!
Permalink Submitted by Alan Spross on Tue, 2011-04-12 22:55
Correct.
While a broader option would be preferable, you are probably Ok by taking the small lump sum penalty free payment and supplementing it with your other assets to get you to age 59.5 without the hassle and risks of a 72t plan. It sounds like the amount you need is small enough that it would not inflate your tax bill much in the year you take the distribution. The ESOP dividends then have no special advantage or need to be handled differently.
Permalink Submitted by Linda Taylor on Wed, 2011-04-13 00:25
Thank you very, very much 🙂