Defaulted 401K loan when I was laid off in 2020. Am I out of luck for a NUA?
I was laid off from my employer in 2020 at the age of 45. I have approximately $1.5 million of company stock in my 401K with a cost basis of about $400K. I had a 401K loan when I was laid off that went to default and and I received a 1099- R with a Gross Distribution (box1) of $8000, a Taxable Amount (box 2a) of $8000, and a Distribution Code (box 7) of M1. I recently went to roll my 401K over to an IRA and was advised of a possible net unrealized appreciation (NUA) strategy. Am I out of luck?
Thank you,
Permalink Submitted by Alan - IRA critic on Wed, 2022-04-13 19:28
The plan reported a loan offset distribution (Code M). Since the offset distribution occurred after your triggering event for NUA (separation from service), the distribution is considered an “intevening distribution” for NUA purposes which “erases” your triggering event. That does not permanently erase NUA potential, but you will need to establish a new triggering event, which would normally be waiting until 59.5 to do your lump sum distribution. Other more remote events that would enable NUA would be to be rehired by the employer and having a new later separation from service, or becoming disabled. Also, your death would enable NUA for your beneficiary with a proper LSD made to the beneficiary.
The rollover to an IRA would eliminate all future possibility for NUA with a total rollover. However, since you already have an intervening distribution (loan offset), you could still roll the non employer share balance to an IRA and leave the employer shares, or a portion of them, in the plan. Those shares remaining in the plan would then become eligible for a qualified LSD at 59.5 or other new triggering event, and may well appreciate further in the meantime. The current cost basis of 27% of FMV is not overly attractive, but if the stock appreciates 50% over time, the cost basis would drop under 20% of FMV in the event of a new triggering event.
If you retain the employer shares, check your options for dividends if the shares pay dividends. Perpetual reinvestment of dividends in more employer shares will increase your cost basis %.