NUA of company stock and Roth IRA and after tax

Submitted by abraham boznick on Fri, 2019-11-08 23:31

I have company 401k. I am over 59.5. I have 3 different buckets in my 401(k): 1) ESOP (which is company match over years consisting of company stock ). 2) company stock that I bought myself 3) other equity based mutual funds. The 401(k) statement also says that I have
a) after tax
b) before tax,
c) roth 401(k)
d) company match.

When I rollover 401k, I would like to utilize NUA option as follows: use NUA for all my ESOP (company match) and put only 50% of my company stock that I bought myself into NUA. The rest of the money would go into IRA.

Considering that I have both “after tax” and Roth 401(k) how would my 1099R look like? I am a bit at loss considering that a NUA portion of the company stock that I bought myself includes both “after tax” money and Roth 401(k).



Submitted by Alan - IRA critic on Sat, 2019-11-09 04:43

  • You have the most complex combination possible. There are some issues here that are plan specific such as whether you will have the option of assigning the (non Roth) after tax amount to fund a non taxable Roth conversion or if it will be used to reduce the taxable cost basis of the employer shares. You will have to decide which you prefer, and then call them to see if it can be done.
  • You will get an H coded 1099R to report the direct rollover of the Roth 401k balance to a Roth IRA.
  • You will get a 7 coded 1099R to report the distribution of the NUA shares
  • Also a G coded 1099R to report the direct rollover of the rest of the account to a rollover TIRA.
  • Plan accounting will also determine if various lots of company shares have different cost basis per share or if the plan requires all of them to be reported with an average cost basis. Different lots may allow you to use NUA only on the lowest cost basis shares, meaning more cap gain. But you need to get a cost basis quote for these shares because NUA is only beneficial if the cost basis is low enough. Low enough is often 25% or less UNLESS you have current cash needs for expenses and need to tap the 401k plan for that cash. In that case, you could distribute the shares, sell them, and pay the lower LT cap gain rate on the NUA rather than ordinary income on the entire amount. Or you could also ask for the non Roth after tax money to be sent to you as cash, in which case the NUA cost basis would not be reduced and you could not do a non taxable Roth conversion. I would avoid try to override plan average cost accounting with your own breakdown, as that is very aggressive and risky since the reaction of the IRS to this is unpredictable.
  • So you have a real planning challenge here with many mix and match options on how to apply these options. If there are employer shares in your Roth 401k, I would not consider them for NUA, just include them in the H coded direct rollover, then sell them tax free once in your Roth IRA.
  • If you were able to eliminate the NUA option altogether, you could just roll the after tax non Roth amount to your Roth IRA along with the H coded Roth 401k balance, and the rest of the plan to a rollover TIRA. There would be no current tax due at all. This is much simpler, both in executing the rollovers, reporting the 1099R forms, and eliminating future Form 8948 reporting of NUA stock sales. The advantage of the LT cap gain rate is greater if your marginal ordinary tax rate is higher where there is a larger difference between the two rates.
  • Finally, diversification is more important than any tax benefits because lack of diversification could cost you principal which is many times worse than loss of a tax benefit.

Submitted by abraham boznick on Sun, 2019-11-10 05:15

Alan thank you very much. Your response as always is very prompt and on time. In my case my employer is using avearge cost basis — thus  I do not have a leeway in asking the employer to do it by lot. I also do not want to lose an option of converting all of my  “after cash” money into Roth IRA account. Just to clarify — I do have both “after tax” and Roth 401k in my employee shares. Thus when you say “If there are employer shares in your Roth 401k, I would not consider them for NUA, just include them in the H coded direct rollover, then sell them tax free once in your Roth IRA.” — how can I do I do this — would my plan adminstrator do it for me if I ask him to do it? Also how would my plan adminstrator handle “after tax” money which is also in my employer shares of 401k? Please notice that I only plan to utilize 50% of my employer shares in 401k for NUA and apply the rest for IRA. Please note that both Roth 401(k) and “After Tax” are substantialy less than 50% of my employer shares. 

Submitted by Alan - IRA critic on Sun, 2019-11-10 15:25

  • Very few plans will deny a Notice 2014-54 split rollover that would direct all your non Roth after tax funds to your Roth IRA and your pre tax non Roth balance to a rollover TIRA. The only place your Roth 401k money can go is to your Roth IRA. I expect that all 3 of the above rollovers will be provided. But when you add the NUA issue, various plan accounting rules come into play that you would have to understand before requesting the distribution of those shares to your taxable brokerage. For example, if the plan locks your after tax contributions to the employer shares, you would have to accept a reduction in the taxable cost basis for the NUA distribution, and you cannot use the after tax amount for both NUA cost basis reduction AND send any of the after tax money to your Roth IRA. It’s one or the other. 
  • When your plan indicated that they use average cost for the NUA shares, is it possible they use a different average cost for the ESOP shares than the others? If that was the case, if the NUA cost basis is low enough to justify it, you could utilize the lower cost basis average for NUA.
  • Have you received a quote on the NUA cost basis per share, broken down if there is more than one average (for example, average for ESOP and a different average for the others).
  • Even if the plan accounting has some restrictive characteristics, you will still likely have multiple choices on how to break down your LSD, particularly how the non Roth after tax money is applied or how many NUA shares you want to distribute. That would depend on just how low the cost basis of those shares is once the non Roth after tax balance is applied according to plan rules. It is possible that the plan will allow you to apply it as you wish.
  • While choices where you direct certain plan portions is important, the actual dollar amounts you have for each would also affect your choice. For example, if the plan has locked the after tax amount to the actual shares purchased, you could control how much is left over for a non taxable Roth rollover by limiting the number of NUA shares distributed, so your choice is very complex. If the gross amount here is high enough you might want to hire a qualified consultant to assist in making the best possible decision. However, locating one that really understands NUA and all these issues may be difficult, especially if you are not located in a large metro area. If you did find one, it is probably too late in 2019 to complete the LSD.

Submitted by abraham boznick on Tue, 2019-11-12 02:41

Alan, thank you again for your thorough answer. Yes I have an option with my company on whether to put my “after tax” money in Roth IRA or use it to reduce my NUA cost basis. You are also correct that I have two different average share prices for ESOP (very low average share price)  and for my other company shares (low but still higher than for ESOP). This is why I want to use NUA for all ESOP and only use NUA for 50% of my other company shares (I also consider to do by lot calculations and recomputation myself when preparing taxes, since I have documentations by lot, and apply the lower cost basis lots to my 50% of the NUA portion of the other company shares — I understand that it might be an agressive approach per my previous discussion with you). I have a pretty good feel on effect of amount of cost basis  on advantages of  NUA vs IRA (I have prepared Excel spreadsheet myself  which   in addition to considering the  componding effect of IRA, I also  take into consideration minimum RMD aspects,  inheritance aspects of IRA, and ability to delay taking capital gain distribution from brokerage account — this is something Kitces does not directly account for in his analysis — which makes his example favor IRA rather than NUA ).My questions deals more  with the mechanics of what the numbers in each box and codes would be on my 1099R. I know it is an extra work for you — but if you can provide what goes into each 1099R boxes — this  would be greatly appreciated. As I mentioned earlier  the NUA portion will consists of 100% ESOP,  and 50% of company stock that I bought myself. The rest goes to IRA. I would like to see 1099R under two scenarios: 1)use all my after tax money for NUA cost basis reduction 2)  send all  after tax money to my  Roth IRA. My breakdown is as follows (I am rounding numbers):1) ESOP — $500,000 with cost basis of $30,000   2) company stock that I bought myself — $350,000 with cost basis $90,000 3) other equity based mutual funds — $700,000 . My company statement is also broken down as follows:a) after tax –$45,000b) before tax — $950,000c) roth 401(k) — $55,000d) ESOP company match — $500,000

Submitted by abraham boznick on Sat, 2019-12-07 06:19

Alan, I do not know whether my last follow up/question to you  fell throught the cracks or may be it was too much for me to ask to see how 1099R would like. If it is too much too ask — I understand it too.thank you again for your excellent service to the community — you have the best insight into IRA issues.

Submitted by Alan - IRA critic on Sat, 2019-12-07 16:19

  • Scenario 1 – 1099R for the NUA shares:  Box 1 675k/  2a 30k/ 2b Total Dist checked / 5  45k/ 6 600k/ 7  7; 1099R for direct rollover:  Box 1 875k; 2a 0; 2b Total Dist checked; 7 G;  1099R for Roth 401k direct rollover:  Box 1 total Roth balance; 2a 0; 2b Total Dist box checked; 5 – 55k ($ you contributed to Roth 401k); 7  H;  NOTE: Your co statement figures are amounts you contributed, not current balances which I assume were shown in your first numbers prior to co statement. It is not clear what your total balance is for your Roth 401k, so it appears the total balance distributed will be 1,550,000 plus what your Roth 401k balance is.
  • Scenario 2 (all after tax to Roth IRA)    1099R for NUA shares:  Box 1 675k; 2a 75k; 2b Total Dist box checked; 7 7; 1099 R for direct rollover:  Shown if plan combines the direct rollovers to different IRA types on a single 1099R, but the plan might issue 2 1099R forms (less error prone), one for the amount rolled to rollover IRA and another for the 45k rolled to your Roth IRA. Box 1 875k; 2a 0; 5 45k; 7 G.  1099R for Roth 401k direct rollover – same as Scenario 1 above.
  • It is not clear how many 1099R forms you will get. It is possible that the ESOP portion will be issued separately, which would result in 2 1099R forms for the NUA shares. Also possible that the direct rollover split between TIRA and Roth IRA destinations will generate a 1099R for each. It is simpler to enter data into tax programs with these separated. 
  • It is important to remember that NUA cost basis is totally different from after tax contributions even though they affect the 1099R boxes in different ways. But neither one changes the gross amount actually distributed from the plan (Box 1), but they do affect the other boxes. 
  • There should be no withholding involved as long as the distribution to the taxable brokerage includes ONLY employer stock (even though the distribution is rollover eligible). In other words, within 60 days you could change your mind and roll some or all of the NUA shares over to an IRA instead of applying NUA to them. Of course this adds complexity since your return will include a 60 day rollover and you will not use all the NUA in box 6 or the cost basis in 2a. 
  • Perhaps DMx will check my numbers. It is pretty easy to make an error. Note that I split the 350k of company stock you bought yourself @ 175k distributed as NUA shares and 175k in the direct rollover to IRA.

Submitted by David Mertz on Sat, 2019-12-07 17:48

  • I think it was stated that the Roth 401(k) balance is $55,000 and appears to be included in the $1,050,000 non-ESOP total.  Company stock + mutual funds = $1,050,000 = after-tax basis + before tax + Roth.
  • I don’t think it’s been established how much of the company stock and NUA basis is in the Roth 401(k).  That portion would just get rolled over to a Roth IRA.  Only the company stock in the traditional 401(k) and its cost basis plus the $500,000 of ESOP shares and its $30,000 cost basis would be considered for NUA treatment.
  • I think I would expect as many as five Forms 1099-R, one for the direct rollover from the Roth 401(k) (code H), one for the direct rollovers (to traditional and Roth IRAs) from the traditional 401(k) (code G), one for the direct rollover (to a traditional IRA) of the ESOP shares (code G), one for the portion of the traditional 401(k) which is being distributed as NUA (code 7) and one for the portion of the ESOP shares being distributed as NUA (code 7), although I suppose it’s possible that the two code G forms could be combined and the two code 7 forms could be combined.  It depends on whether or not the ESOP shares are treated as an account separate from the traditional 401(k).
  • I think that minimum 20% withholding on the code-7 distributions would apply except that the withholding cannot exceed the amount of cash distributed, which in this case would be $0.

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