NUA for someone who turns 55 in the year separate from service

Submitted by Megan Jones on Fri, 2016-12-16 02:42

I have a client who is 54, and is turning 55 next year in 2017. As of Jan 1st, he is also losing his job. We are able to take distributions from his 401k prior to rolling it and are utilizing the §72(t)(2)(A)(v) tax code, separation from service in the year he turns 55 to get around the 10% early distribution penalty. However, he has considerable gains in company Stock and is interested in using Net Unrealized Appreciation as a option in moving out is stock into a Brokerage account. His current FMV is
$263,640 and his Cost Basis is around $16,000. I agree it makes sense to use NUA, however, in looking at the IRS Publication 575 on the topic, it says that you have to reach age 59 ½ for NUA….is that how you read the code? I think that there would only be a 10% early distribution penalty on the cost basis, correct?

M Jones

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Permalink Submitted by Alan - IRA critic on Fri, 2016-12-16 03:16

First, the client needs confirmation of his separation date. The separation date is the last date as an employee, not the first date of his unemployment. For year end separations at age 54, this will eliminate the penalty exception for distributions taken directly from the plan including the taxable cost basis for NUA purposes. A simple question he should ask is whether any distributions taken next year will have code 2 on his 1099R.
He has an extremely low cost basis which makes NUA compelling. His triggering event for NUA will be separation from service. Re check the paragraph in Pub 575. Age 59.5 is just one of the triggering events for NUA. If he were to defer the LSD and take other distributions from the plan (if he qualifies for the penalty exception) he will have made intervening distributions which will cancel out the NUA opportunity. But even if that happened he gets another triggering event at 59.5, so could again use NUA after 59.5 as long as he does not take other intervening distributions. The point is to be careful with distributions from the plan if he is not going to do that LSD in 2017.
If the age 55 separation does not apply, he would only owe the 10% penalty on the cost basis, NOT on the NUA when he sells the shares. As always with NUA, diversification should have priority over tax benefits, so he should be careful of holding too much employer stock. Never forget Enron and Lehmas Bros.