Using NUA for RMD

Submitted by Sherry Wilson on Fri, 2024-11-15 14:53

I’m a 74-year-old (October) recently displaced employee (June) and am currently receiving severance pay, due to end in June 2025. The separation from service triggered the requirement to start receiving RMDs from my 401k, either one RMD this year and one next year, or delay until next year (since it’s my first) and receive two RMDs, with each RMD being roughly $75,000. With the single RMD and the severance pay, my income will be effectively double through 2025 when the severance ends. I’m trying to understand if using NUA to satisfy my RMD is a beneficial strategy for me. I’d appreciate any guidance. The current value of my employer stock is $207,687, cost basis $159,365, and net unrealized appreciation $48,322. Does it make sense to do a partial NUA transaction in the amount of my RMD this year, since I’ll be paying ordinary taxes on that amount anyway? I would lose the opportunity to take the remainder of the NUA since it has to be done in the same year, but if I delay until next year, the extra $150,000 would be a much bigger tax hit than the extra $75,000. Also, do I understand correctly that I would pay ordinary taxes on the cost basis of the stock and not on the RMD amount which is based on the current value? If so, doesn’t that mean the amount I would pay in taxes would actually be less than what I would pay if just taking the RMD and not using the NUA strategy?

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Permalink Submitted by Alan - IRA critic on Fri, 2024-11-15 19:33

The general plan of deferring the first RMD and doing an LSD in the second year to have the shares distribution satisfying both RMDs is beneficial. However, your cost basis for the shares is unusually high (76.7%), so even if you sold 28% of the shares in the plan, leaving about 150,000 of value to match the 2 year RMD amount, the taxable amount of those 2 RMDs would still be 115,000. and added to 5 months of severance.

You can defer all or part of the 2024 RMD, but you can only utilize NUA in the LSD year (2025) and therefore there is no option for a partial NUA in 2024.

Melding NUA with initial RMDs is complex, but would be even more so if you had any non Roth after tax balance in the plan.

There might also still be enough time to do the LSD this year, and apply it to the 75,000 2024 RMD, but if you wanted to keep the taxable cost basis low, you could sell 64% of the shares in the plan, which would reduce the value of the remaining shares to around 75,000, enough to satisfy the 2024 RMD.

Another thing to consider is that a qualified LSD for NUA purposes will require a total distribution from the 401k, with amounts in excess of the NUA shares rolled to an IRA. But passing on NUA would allow you to keep the 401k intact if you prefer to. The 401k RMD for 2024 could still be deferred entirely or partially to 2025 to limit your taxable income in 2024, which already will include 12 months of salary.

If you decide on NUA, you also need to determine when you will sell the distributed shares and pay the LTCG on those shares. You also might be exposed to IRMAA at this income level.

The amount of your salary in relation to the other income (12 months in 2024, 5 in 2025) will also affect the math.

Permalink Submitted by Sherry Wilson on Mon, 2024-11-18 00:04

My apologies, but this is all new to me and much of it is over my head!

First, let me make some comments about my 2024 and 2025 salary. By maxing out my 401k contributions in 2024 before the layoff, I was able to contribute all but $1300 of the maximum allowed to my 401k. In 2025, I will not be able to contribute anything to my 401k; all will be taxable. There should be no more than $15,000 extra in taxable wages in 2024 than for the six months in 2025.

Next, I don’t understand the suggestion to sell the shares in the plan. From what I’ve read, to take advantage of the NUA strategy when an RMD is due, the first step is to transfer the appropriate amount of NUA shares out to a non-qualified brokerage account to cover the RMD. Next, you would transfer all the non-NUA stock investments to an IRA. Finally, the last of the NUA stock would be journaled to the regular non-qualified brokerage account. Is it possible to transfer any remaining stock after satisfying the RMD to an IRA rather than the non-qualified brokerage account, so that tax could be deferred? Is selling the extra shares in the plan a better option (or the only option)?

My 401k custodian/advisor tells me there is time to do an NUA in 2024, and we are to meet and decide which option is best on 11/19/24. I do realize if I go forward with NUA, it will require a total distribution from the 401k. I was resisting that at first because of the lower fees in the 401k, but I don’t know if the lower fees would offset any tax savings on my RMDs I might get by utilizing NUA.

I actually do have about $7800 in non-Roth after tax money in my 401k.

I would like to take advantage of the NUA strategy if beneficial but also don’t want to create a nightmare for my tax preparer (or myself).

These are possible scenarios I’ve come up with, but there may be more (and my calculations may not be correct):

Options 2024 RMD 2025 RMD

(taxable amt) (taxable amt)

No NUA – keep 401k intact $75,000 $75,000

1st Year NUA – total 401k distribution $57,500 $75,000

– sell 64% of shares

2nd Year NUA – total 401k distribution $0 $115,000

– sell 28% of shares

Any additional comments or suggestions would be very much appreciated!

Permalink Submitted by Alan - IRA critic on Mon, 2024-11-18 13:40

Specific plans may handle things differently than others. Since your NUA cost basis is so high the taxes on the LSD will be higher than normal and your gain taxable at the lower LTCG rates will be less, the advantage of NUA will apply as much for taxable RMD reduction than for the lower CG rates in the future. And the distributed share amounts would also lower your future IRA RMDs by not being included in the year end IRA balances. The rationale behind reducing the NUA shares to the amount that would meet your RMDs but not exceed them is based on the high cost basis. Also, most plans use average cost basis for all NUA shares, but there are a few plans that track the cost basis of different lots. If this applied to your plan, it would be beneficial to sell the higher cost basis shares, and use NUA for the lower cost basis shares that remain.

As for the 7800 in after tax, many plans will automatically apply this amount to reduce the taxable cost basis for the shares distributed, e.g 57,500 less 7800 = 49,700 taxable. Other plans will allow the 7800 to be allocated to a non taxable Roth IRA direct rollover if you preferred that. Some plans allow you to make the choice, others do not. Hopefully, for a complex scenario such as this, you can discuss your options with the plan administrator, better if it is a large professional firm familiar with this degree of complexity. If you already have a Roth IRA, adding 7800 to it will be attractive, but if you don’t you should probably avoid this option for such a modest amount.

As for the partial use of employer shares for NUA, there are 3 options for doing so. First, sell the shares in the plan that you do not want to use for NUA or second, if you want to keep them you could include them in the IRA rollover. The first option allows you to diversify sooner out of the shares (which have not performed that well in the past), and would make the LSD simpler because all the remaining shares would be distributed to your taxable brokerage account for NUA use. Under the third option, if you had not calculated correctly and you distributed all the NUA shares, you actually have 60 days to change your mind and roll as many of the shares you wish to your IRA to reduce the number of shares actually used for NUA. In this latter case, you would have to be careful not to roll over more shares than were necessary to complete your RMD. If you have any concerns regarding communicating your distribution/rollover requests to the plan, you should probably choose the simpler options such as passing on NUA altogether.

Note that if you take ANY distribution from the plan in 2024 that is not a total distribution (LSD), you will not be able to use NUA in a later year because the 2024 distribution is treated as an intervening distribution (a distribution taken after your triggering event (separation from service) but prior to the LSD year. Therefore, your choices are 1) LSD in 2024 with or without NUA 2) Nothing in 2024, deferring 2024 RMD and LSD to 4/1/2025. If you pass on NUA, you still must complete the 2024 RMD by 4/1/2025, but could take the 2025 RMD later in the year. If you opt for a direct rollover of the entire balance to an IRA, you must distribute both RMDs prior to that rollover.

Permalink Submitted by Sherry Wilson on Mon, 2024-11-18 16:19

I appreciate your advice, Alan. It’s becoming clearer. 😊

If my goal is to reduce the taxes on my RMDs over the 2024-25 timeframe, it sounds like the option that would produce the most overall tax savings is to use NUA in 2025 for my first and second RMDs. I am not tied to the shares, and as you’ve said they have not performed well, so I would probably want to sell any amount over what is needed for the RMDs, which would also make the LSD simpler, as you mentioned. Do you agree with this approach for my stated goal?

My plan uses average cost basis for NUA shares, unfortunately. The plan administrator is Empower, so I’m hopeful they can handle this complex scenario.

I do have a Roth IRA, but I don’t know if my plan allows direct rollover of the $7800 after tax amount, but I can find out. I might be just as well off using the $7800 to further reduce the taxes on the 2-year RMD.

Permalink Submitted by Alan - IRA critic on Mon, 2024-11-18 17:59

For some reason, you last post is showing in a separate column to the right of the other posts……

Your plan should allow you to request a split direct rollover, sending the pre tax amounts to a rollover IRA and the post tax amount (7800) to your Roth IRA. There would be no taxes due. Should the plan instead require a distribution directly to you of the 78oo, you can do a 60 day rollover of that amount to your Roth IRA. There would be no withholding on the after tax distribution, and of course no withholding is possible for the appreciated share distribution to your brokerage account.

I suggest that if you proceed with NUA, that you do NOT reinvest any dividends in these shares as that would complicate tax reporting when you sell the NUA shares due to having more shares that are not NUA shares.

Other than that, you probably have limited time if you choose to request a total distribution before year end, as every dollar must be out of the plan by the end of the year to have a valid LSD. I assume that there is no ESOP plan in place. If so, that must be distributed as well. Any DB plan is exempt from the LSD requirement.

As for the actual math, I think you have a good handle on that.

Permalink Submitted by Sherry Wilson on Mon, 2024-11-18 19:11

I don’t know why it’s throwing my reply in another column, although I did notice the same behavior on another post I read. At any rate, I think you may have misinterpreted or not seen my intention, which is to do the LSD and NUA next year (2025) to maximize the tax savings on the first and second RMDs. If you see a problem with this, let me know. Thanks for the tip on the dividends. I very much appreciate your advice and suggestions. It is taking me down a totally different plan than I was thinking of!

Permalink Submitted by Sherry Wilson on Mon, 2024-11-18 19:15

And I think I know what’s going on with the formatting. If you click on “Reply,” the verbiage continues at the bottom. If you type in the “Add Comment” box, the verbiage goes in the right panel.

Permalink Submitted by Alan - IRA critic on Tue, 2024-11-19 12:36

Re formatting – thanks, I have not seen an “add comment box”. In either case, the post does not move the thread to the top of the list, in some cases leaving it several pages behind new threads.

Even without the NUA factor, every first year RMD taxpayer faces their most complex option – whether to defer any portion of the first RMD to year 2 or not. When NUA options exist, deferral more often works out best. The best time to crunch the numbers is right now, when you know your current year taxable income and may better be able to estimate next years taxable income. Therefore, deferral becomes a question of whether the tax savings in year 1 is offset by the tax increase in year 2 or not. The lower tax over the 2 years is the goal.

If you have decided to defer the 2024 RMD to 2025, then you might want to sell enough NUA shares to reduce the remainder to the value that will meet the 2 years of RMDs or only slightly more, to keep total 2025 taxable income under control. And it will be simpler to complete the full LSD prior to 4/1, first determining if the plan will assign the 7800 after tax amount to reduction of the taxable cost basis, then distributing the NUA shares to your taxable brokerage account as the first dollars out are treated as the RMD (two years worth). Finally, the direct rollover of the balance to your IRA, but if the plan does NOT assign the 7800 to reduce cost basis, the direct rollover should be split so that the 7800 goes to your Roth IRA.

Reporting the 1099R forms on your 2025 return will be easy, but the later sale of NUA shares is tricky, more so if you sell any shares in the first 12 months after the distribution that have additional gains after distribution. Form 8949 will have to split the sale into ST for the additional gain and LT for the NUA per share, and each will have to show the correct cost basis. If the NUA shares have a loss when you sell, the loss just reduces the NUA per share that will be taxable at the LTCG rate.

Permalink Submitted by Sherry Wilson on Wed, 2024-11-20 21:37

I met with my 401k consultant yesterday and told him of my decision to defer the 2024 RMD to 2025 and to sell the NUA shares not needed to satisfy my 2 years of RMDs plus a little more. I am able to use the 7800 after-tax amount to reduce the cost basis, so that is good news. Good news also is that the market value has increased from 207k to 258k! I’m also due to get matching contributions and possible profit-sharing at the end of the year, so that will have some effect.

To try to make this an uncomplicated as possible, I plan to open a separate brokerage account for the distributed NUA shares and not have the dividends reinvested. I have no need to sell them in the first 12 months.

My challenge, now, is that the 401k consultant seems to think the RMD amount comes from the cost basis and not the market value. Obviously, if the 1099R is not completed correctly, I will be paying much more in taxes than I should. I have scoured the web for information about using NUA for RMD but have found nothing other than the many very informative entries on the Ed Slott Discussion Forum. I also can’t find anything specific in the IRS guidelines. Can you point me to any additional information or examples specifically using NUA for first RMD? I did review the 1099R Instructions. Would these be the right entries considering a 2-year RMD of $150,000?

Box 1 – 150,000 (FMV of distributed shares – to be applied to RMD)

Box 2a – 93,329 (Cost basis of shares)

Box 5 – 7859 (after-tax amount)

Box 6 – 56,671 (NUA)