Spousal beneficiary 401k and NUA
Deceased spouse was born December 1953, died December 2021 before her 68th birthday and before her RBD. Her surviving spouse was born June 1945, so chose to inherit the 401k as a spousal/beneficiary 401k so he can wait to take RMDs based on his wife’s age and schedule. 401k is $2.8 million.
However, the 401k has an NUA opportunity he’d like to take advantage of: $76,000 cost basis in company stock, FMV $509,000 today. We realize the 401k has to be emptied to take advantage of the NUA. His goal is to sell the stock at the more favorable long term capital gains tax once he holds the shares in a NQ account. He realizes the withdrawal of the stock from the 401k is subject to ordinary income tax.
So the question is, does he have to roll over the 401k into an IRA and make it his own, subject to an RMD schedule based on his age, or would it be possible to roll the 401k into a spousal IRA so he could wait to take RMDs based on his wife’s schedule?
The 401k is held at Fidelity, and they say he has to roll the funds into an IRA in his name and then be subject to RMDs based on his age.
Permalink Submitted by Alan - IRA critic on Tue, 2024-09-24 19:57
While he does not have to start RMDs until the year his spouse would have been 73 (2026), by deferring these RMDs to fewer years he may face higher marginal rates for his remaining years. So if he does the LSD this year he will be taxed on the 76k cost basis at ordinary income rates, and the required direct rollover of the rest of the 401k to his own IRA will be tax free. His IRA RMDs will then begin in 2025 based on age 80, and the 2025 RMD will be roughly 114k. This will spread the tax over more years, starting in 2024 rather than in 2026.
Of course, with NUA he must have a qualified LSD, with no distributions taken from the 401k after her death and prior to the LSD year. His 1099R for the shares must show the “total distribution” box checked, and by the end of the LSD year there can no balance left in the 401k or an ESOP plan, if she had one.
Permalink Submitted by Delia Fernandez on Tue, 2024-09-24 20:26
Ahh…is LSD Lump Sum Distribution?
Permalink Submitted by Delia Fernandez on Tue, 2024-09-24 20:25
Thanks for your quick response. What does “LSD” mean?
Permalink Submitted by Alan - IRA critic on Tue, 2024-09-24 20:56
Lump Sum distribution. Fidelity should be able to provide a cost basis quote and confirm that the beneficiary qualifies for NUA before requesting the distribution. There will be one 1099R for the distribution of shares to a taxable brokerage account and another for the direct rollover of the rest of the plan to an IRA.
If there happens to be any after tax (non Roth) balance in the plan, that presents additional variables to consider. Let me know if that is the case.
Permalink Submitted by Delia Fernandez on Wed, 2024-09-25 20:17
There is an after-tax account balance of 19.21%, or $547,666.90. We believe the contribution amount to that part of the account was $64,913.87. The rep said something about post ’86 contribution and perhaps pre 1987 contributions? I admit I didn’t catch all of it.
Permalink Submitted by Alan - IRA critic on Thu, 2024-09-26 00:10
Those are unusually high amounts of after tax contributions. The pre 1987 contributions can come out without the associated earnings, but that is not a factor in an LSD year. The plan provisions may automatically apply the after tax amount amount of 65k to reduce the taxable cost basis for the NUA shares, but also may give the participant a choice of that not applying it and allowing the participant to directly roll over the 65k tax free to a Roth IRA.
As you can see, if there are after tax contributions coupled with NUA, there are many moving parts. The participant should find out what the plan accounting requires, and if there is a choice decide whether to have the 65k reduce the taxable cost basis to 11k, or whether they prefer to have it rolled to a Roth IRA. And they may also be able to split the 65k in any combination between cost basis reduction and a direct rollover to a Roth IRA.
It is also possible that the participant has a Roth 401k balance as well, and that balance must be directly rolled to a Roth IRA.