NUA, after tax 401K contributions, basis adjustment

Submitted by David Carrell on Fri, 2022-07-08 18:19

I am working to rollover my 401K into IRA(s) and cash brokerage account (NUA). I will turn 59 1/2 later this year, but my separation from service was after 55 so I can distribute from 401K with no penalty prior to 59 1/2. (Or at least this is my understanding, as well as tax advisor and wealth advisor.

Some of my company stock (publicly traded) can be “offset” (not the correct wording I suspect) by my after tax contributions to 401K. This stock is not really an ideal NUA opportunity; basis is about $93K and CMV is about $158K (basis almost 60% of value). But 401K fund advisor mentioned my (small) after tax contributions can be used to ‘lower the basis’. The after tax contributions are about $25K.

Since this will be a relatively low income year, I intend to do some inside 401K Roth conversion also.

1. Advisor wasn’t completely clear on how does this cost basis reduction using after tax 401K contributions work. How does it work?

2. Can I NUA only $25K of the $93K basis (26% of those shares) and ‘apply’ the pre-tax $ so there is effectively no income generated from this NUA? What ‘happens’ to the $25K of after tax monies? (Does it just shift into the pre-tax part of the 401K?)

3. Would in plan Roth conversion for (say) $100K (total 401K is $2+ mi) impact this? Does it basically off set this when I do the Roth conversion? Does doing both of these mess things up? Since I am doing the Roth Conversion, does it make sense to apply the after tax to the NUA?

TIA,
DAC



Submitted by Alan - IRA critic on Sat, 2022-07-09 00:01

  1. This is a function of plan accounting. Some plans may allow you the choice of applying your non Roth after tax contributions (25k) to either reduce the employer shares taxable cost basis (from 93k to 68k in this case) OR to roll over an amount to your Roth IRA equal to the non Roth after tax contributions. But you would have to check with the plan to see what your options are. Unless you need funds relatively soon for living costs, I think you should pass on using NUA for high cost basis (60%) shares and instead apply the 25k of after tax contributions amount to a tax free Roth IRA rollover. 
  2. No. Each share that you want distributed for NUA purposes will have a cost basis per share and NUA per share. You cannot apply the cost basis in the aggregate, it must be per share. Of course, you are free not to utilize NUA on all the employer shares. You could use NUA on some and roll over to sell the others. That would reduce the taxable cost basis and the NUA, but not on a per share basis. Again, the 25k can be used either to reduce the taxable cost basis per share or it could be applied to other assets rolled to your Roth IRA to reduce the tax on a Roth rollover, but the plan may not provide both options.
  3. I would not attempt to do an IRR when you can simply roll the pre tax portion of your plan to your Roth IRA. A Roth IRA has more preferable tax distribution (ordering) rules than a Roth 401k, and eventually you would roll the Roth 401k over anyway to avoid RMDs. In addition, in order to use NUA, you need a qualified LSD for all plans of similar type. That means you cannot leave the Roth 401k behind or any ESOP plan behind, or you will not have a qualified LSD for NUA purposes. 
  4. Your variety of balances in this plan presents a very complex set of options including a pre tax, Roth, and after tax sub accounts with employer shares. It is very easy to get confused or to have your distribution requests misinterpreted by the plan. To the extent possible, you should simplify the distribution. For example, that means passing on NUA altogether and roll the 25k to your Roth IRA tax free, or applying the 25K to the reduce the taxable cost. If you want to use up more of your lower marginal tax rate for 2022, you could roll some pre tax amount to your Roth IRA to go along with the 25k which will be non taxable. 


Submitted by David Carrell on Mon, 2022-07-11 17:07

First, thank you for the detailed and thorough response.I definitely agree that the options I have and multiple steps allowed, could get confusing; at least certainly to me. For this very reason, since my plan allows partial rollovers, is to do the pieces one step at a time. This will keep clear in my mind (and hopefully their mind) and my records. I know I have to completely disperse these monies out of the plan all this calendar year.My biggest confusion is still about ” Again, the 25k can be used either to reduce the taxable cost basis per share or it could be applied to other assets rolled to your Roth IRA to reduce the tax on a Roth rollover, but the plan may not provide both options.” How this is done is what confuses me? I am not certain the plan allows me to use the pretax $’s to apply to other assets. I do know other than the company stock (technically two different company stocks due to spin off years ago), everything is sold and converted to cash upon roll over. So in my mind, it becomes two pools of “cash” (so no cost basis); a pretax pool of cash and an after tax pool of cash.Another point I am not clear on is your discussion of cost basis per share. For all of my stock transactions in my brokerage account and IRA (especially Roth IRA) is track my cost basis by purchase lot. But for these company shares in the 401K, all I have been provided is the total $ cost basis. I can obviously convert this to a average per share cost basis (all are already long term holdings) but I have not been provided a per lot price basis. Is this an issue?Ignoring the option to use the after tax $25K to reduce my taxable cost basis of the NUA (since I did not know about that and yet don’t understand it), my intention was to roll that from the 401K into my Roth IRA. But the in plan Roth conversion I mentioned is in addition to this I plan to convert additional pre-tax dollars into after tax/Roth $’s. Then rollover this additional amount of after tax $ from the 401K into my Roth IRA. I am working with my tax accountant (also my wife), to target a certain income/tax bracket for the year. But our combined W-2 income for the year is “in flux”.By the end of this year nothing will be left in any company plan account or 401K. And I am likely to do Traditional to Roth conversions for the next couple few years. I don’t plan on drawing any $’s for expenses soon and I am looking at new ‘career’ at a much lower compensation. So we should not need these monies.Again, thanks for sharing your knowledge.DAC



Submitted by Alan - IRA critic on Mon, 2022-07-11 18:32

  • Considering employer share lots with different cost basis introduces yet another variable in this process. Most plans will complete the 1099R using an average cost basis for all NUA shares, while a few maintain cost basis accounting for various lots, and then allow you to distribute only the lower cost basis shares for NUA utilization. You cannot control your taxable income without knowing the Box 2a taxable cost basis that the plan will report for the shares you distribute to your taxable brokerage account. Overriding the 1099R using your personal cost basis tracking is inviting trouble with the IRS. The IRS will be guided by the 1099R figures and if you report accordingly on your taxes, there should not be any IRS issues barring some audit of the plan itself by the IRS. Again, the simplest approach is to allow the plan to reduce your taxable cost basis for the shares you distribute.
  • Of course, you can always do a 60 day rollover of those distributed shares if you have a change of heart, but by the time you get the 1099R in late January, 60 days may have passed from the distribution date of the shares. While plan cooperation is not always possible, it would be nice to secure an explanation in advance of what will show in Box 2a. 2a plus any after tax amount applied to reduce 2a plus the NUA should equal Box 1, the gross distribution. 
  • If you use only a few shares for NUA, and the cost basis is less than 25k, applying the 25k will reduce the cost basis to 0, and the remainder should be available to apply to offset the taxable income for any Roth rollover. 
  • The 25k is a totally different type of cost basis from the cost basis for the employer shares. The latter applies to each share, while the 25k from after tax contributions floats over the entire pre tax account and is not locked to the employer shares unless the plan requires it to be. Thus the possible option you might have to direct where it is applied.  You have already paid taxes on that 25k, so it will not be taxed again wherever the plan requires it to be applied.
  • There will of course by other 1099R form reflecting any rollovers to your TIRA or Roth IRA. All of these 1099R forms should have the total distribution box checked, since the 1099R for the distribution of shares cannot show NUA unless there is a qualified LSD (total distribution) for all similar plan types. An ESOP is a is similar plan type, but a DB pension is not.
  • Therefore, you now have two variables governed by the  plans’s accounting rules. First, whether they maintain the cost basis as an average for all shares, which is the usual practice, or if they maintained accounting by various lots of shares acquired for your account over time. If the latter, you should be able to select an amount of the lower cost basis shares for NUA, and either roll over or sell the rest of the shares in the plan. The other accounting variable is how they apply your non Roth basis (the 25k). The usual practice here is to apply it to reduce the taxable cost basis (Box 2a), but the plan may instead allow you to have the 25k applied as the non taxable portion of a Roth rollover (either an IRR or out to your Roth IRA). 


Submitted by David Carrell on Wed, 2022-07-13 21:06

  • My plan only does average cost basis for company stock. 
  • I agree the 60% cost basis makes these shares not good candidates for NUA. But if I can use the $25K to basically make the cost basis for X (x=$25K worth of shares) shares giving them an effective cost basis of $0 and thus a income impact this year of $0, the picture changes maybe
  • At the same time, I am also going to do some $ amount of pretax 401K $ to Roth conversion. I think I can also use this post tax 401K $25K to offset some of this conversion tax impact.
  • Finally, I can (I think) convert the post tax 401K into Roth 401K and then rollover the Roth 401K to a Roth IRA (existing, no 5 yr holding issues)
  • So (I think) I have 3 options for the post tax 401K $. The last one presented (convert to Roth 401K) makes the most sense to me. But trying to make sure there isn’t some snag/detail I am missing. I suspect the reason the 401K advisor mentioned using these post tax $ to offset NUA basis
  • This is the first move being made so, she is trying to capture the tax savings up front
  • But maybe there is something really good about using them against some of the company stock to give is a basis of $0. This seems to mean the entire value when these shares eventually are sold would be taxed and cap gains. Is this advantage, disadvantage, doesn’t matter?


Submitted by Alan - IRA critic on Wed, 2022-07-13 23:13

  • Re your 3rd bullet point, you can only use the 25k one time. Most likely you could use it to reduce the NUA cost basis, or if the plan allows it, you could use it to reduce the cost of a conversion. Possibly, the plan may allow you to split the 25k as you please between the above two transactions. Since the plan could quote you the average cost basis of the shares, you can also elect just how many shares you want to use for NUA. If the number of shares is low enough, a 25k reduction of the taxable cost basis might reduce that cost to 0. Reducing the number of shares also reduces the NUA, and therefore the amount you will eventually owe in LTCG tax.
  • If you are going to convert and also use NUA, application of the 25k is just a trade off. Either way, the 25k will eliminate ordinary income tax in the LSD year. Same effect whether your conversion it out to a Roth IRA or an IRR inside the plan. 
  • It’s correct that your separation at 55 will waive the 10% penalty on whatever your taxable cost basis is for the employer shares. 


Submitted by David Carrell on Thu, 2022-07-14 01:38

  1. Yes, I have three options on how to use teh $25K of after tax 401K, but can only pick one
  1. Convert after tax 401K to Roth 401K
  2. Use $25K to reduce this years income (to zero) for some of the NUA eligible shares (about 27% of all)
  3. Use $25K to offset ordinary income tax on a Roth conversion (this makes least sense to do to me.)
  4. Only get to use the $25K total once
  5. Plan might allow me to split how much of the $25K is used for each option above, but why make it that complicated
  • If I use the $25K for $25K of stock NUA, that will reduce ordinary income tax on that NUA to $0 but those shares will carry the same average basis and the non-NUA’d shares (these will wind up in traditional IRA for now)

    •  

    • Now does THIS work??? I apply the $25K of NUA to $25K of basis shares (about 27% of all shares). This makes my ordinary income tax on this transaction $0. Assume those those shares have current market value of $40K (and current price does not change). If I then sell those shares, I would only owe capital gains tax on $15K (40K CMV less  25K actual cost basis). Correct? Is this better, worse or same as just converting the $25K into a Roth IRA? I believe it winds up being same since the $25K isn’t taxed when I sell the stock but it would not be taxed when I withdrew from the ROTH IRA either. Or am I missing something.


    Add new comment

    Log in or register to post comments