NUA & after tax money

Submitted by Alyssa McMahon on Wed, 2017-07-05 20:57

We have a client who retired from Colgate this year. She had pre-tax money of $1.7MM (all non-company stock), Colgate stock with a low cost basis ($12k) with a market value of about $230,000. In the plan she has $94,000 of after tax contributions.

Our plan was to rollover the pretax money to her IRA, then use NUA for the company stock and apply $12,000 of the after-tax money towards the Colgate cost basis of $12,000 so that the distribution of shares would not be currently taxable and then have her receive the net amount of remaining after tax money $82,000 in a check payable directly to her.

Mercer (the plan administrator) & Colgate say that this cannot be done – they cannot site anything specifically but they are saying that the remaining $84k of after money has to be used to reduce the Net Unrealized Appreciation of the stock (essentially increasing the cost basis of the shares from $12k to $94k). They said if there was after tax money remaining above all of the Unrealized appreciation, then she would be able to receive a check for the remaining after tax money.

I asked them for a copy of the Colgate plan document but they indicated that this is not a provision in the document but that this is “how NUA works”. I do not believe this to be the case.

The issue is that they would not allow her to only use a portion of her after tax money to use against her cost basis of the NUA shares and then receive a check outright to her for the remaining difference.

They are insisting that all after tax money has to be used to reduce the unrealized appreciation of the stocks that she is taking via NUA. Is this correct? Any references you can provide from the IRS website would be appreciated.

Thank you
Alyssa



Submitted by Alan - IRA critic on Wed, 2017-07-05 21:46

  • The IRS has some rules, but the choice of how the plan applies after tax contributions is up to the plan. This plan could have adopted this restriction at some point in the past before the portability options were broadened into what we have today. I believe that the plan cannot refuse to provide a complete copy of the plan document if client is willing to pay a reasonable fee for copying the entire plan. But even given receipt of a complete copy, the plan is allowed to adopt operating procedures that are not specified in the plan document, therefore such a copy might not clarify the options.
  • Does client need the bulk of the after tax money for expenses?  If not, the client might consider Plan B which would be to request a split rollover per Notice 2014-54 under which the pre tax value less company stock was directly rolled into a rollover IRA, the 94k of after tax value was rolled into a Roth IRA, and the company stock was distributed to a taxable brokerage account. Or course, this would result in current taxable income of 12k since none of the after tax amount is available to reduce the cost basis. However, depending on the structure of client’s Roth IRA, the tax could be paid for by taking a tax free distribution from the Roth IRA. The end result would be very close to that of your original plan, but a different way of getting there. Since this is also a deviation from what the Mercer Rep has indicated as well it may not fly. 
  • NUA with after tax amounts in the plan are the most complex planning situation that exists. Once you know what client wants, it should be placed in writing with a request that Mercer’s most senior resource considers the request. The current Mercer rep may not even totally understand the request or the plan document, but could be trying to oversimplify a complex situation.
  • NOTE: Notice 2014-54 includes 3 examples and while none of them involve NUA, it is clear that the participant is allowed to split the plan into different destinations, eg one portion to a new employer’s plan, one to a Roth IRA, and the remainder in a distribution to the participant. Therefore, the challenge here is this plan, not the IRS guidance.

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