NUA and after-tax contributions

Submitted by Jessica Ness on Thu, 2016-02-25 21:30

Client is retiring and has a large number of “highly appreciated” company shares in their retirement savings plan worth over $800k. Client also has around $30k in after-tax contributions.

They would like to do an NUA transaction on about $490,000 worth of shares. The “basis” of which is about $90,000.

If we assume a federal tax rate of 28% and Virginia state at 5%, we have tax due of $28,800 on the NUA transaction. Can the after-tax contributions be used to pay that tax of $28,800, or do they have to be used to reduce the taxable distribution from $90,000 to $60,000?

The rest of the account will rollover to an IRA.



Submitted by Alan - IRA critic on Thu, 2016-02-25 22:46

  • It depends on the plan provisions where the 30k is allocated, so client would need to get this info from the plan administrator including what choices he has if any.  In most plans, the after tax balance will be used to reduce the taxable amount for the NUA shares from 90k to 60k and that will be reflected on the 1099R. That would reduce the tax bill of 28,800 by roughly 1/3.  In other cases, the 30k might be split proportionately or assigned entirely to the rest of the account. Some participants would rather have it assigned to other than the NUA shares because they could then split the IRA rollover with the pre tax going to a TIRA and the 30k to their Roth IRA as a tax free rollover. Alternatively, if the after tax amount is assigned to other than the NUA stock portion of the account, the client could request that it be distributed tax free along with the NUA shares. They can then spend it anyway they wish including paying the taxes with it. The balance left to roll to an IRA of any type would then be reduced by 30k.

 

Submitted by Jessica Ness on Fri, 2016-02-26 14:09

Thanks.  It seems to me that if the client had the option of taking it as a check, it would be more beneficial to them than simply lowering the cost basis.Ie. they take a check for the $30k, and can cover the $28.8k in taxes without a problem and have $1200 left over.If they choose to lower the basis from $90 to $60k, they’d still owe taxes on the $60k of $19,200 but have no after-tax money left to pay for it.Correct?

Submitted by Alan - IRA critic on Fri, 2016-02-26 16:20

Yes, you are correct. Short term the client gets more cash flow this way. But client also pays more taxes.

Submitted by Jessica Ness on Fri, 2016-02-26 20:24

So while the client may pay more in taxes in the first scenario, they end up well ahead in the second scenario? For instance, in the $90k example, the client only ends up paying $28.8k in taxes and gets to keep the $1200 remaining of after tax dollars. If the basis is lowered to $60k by using after tax dollars, the client effectively pays the $30k to lower the “taxable income” and then owes another $19,200 to Uncle Sam out of pocket.  Or $49,200 total. Am I missing something?

Submitted by Alan - IRA critic on Sat, 2016-02-27 02:59

  • This is very complex to explain. In the long run the taxes are roughly the same. If client needs this AT money to pay the taxes, he has no choice – if the plan allows the option to distribute the 30 to him. Conversely, if the plan automatically applies the AT amount to the cost basis, it will reduce the tax by 10k, but the 30 k remains in the plan. The plan balance other than the NUA stock is therefore 30k higher and the entire plan is pre tax. Over client’s lifetime this additional 30k which is taxable must be distributed and at the same tax rate he will pay the 10k that he saved up front. So total taxes are about neutral.
  • Your last question – client does not actually pay anything to lower the cost basis of the shares to 60k, since the plan balance stays the same. But the AT amount is applied to reduce cost basis instead of being used elsewhere in the plan and the plan balance stays 30k higher than if he actually withdrew the 30k. So there is no 49,200 actual payment. What there is a current tax bill of 19,200 and 30k of pre tax money left in the plan to be taxed several years later and at the same tax rate would generate around 10k of additional taxes. Total taxes then 29,200, essentially the same as in the other solution.
  • In summary, the actual tax bill is the same. What differs is when it is due. Again, if the plan allows the distribution of the 30k to him and he needs it to pay the tax due, that is what he should do. It costs him 10k more in tax now but saves him 10k in taxes down the road.

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