Don’t Try to Take a Lump-Sum Distribution from a Qualified Plan After Thanksgiving
By Joe Cicchinelli, IRA Technical Expert
Follow Me on Twitter: @JoeCiccEdSlott
If you’re able to take a lump-sum distribution from your qualified retirement plan (401(k), pension plan, ESOP, etc.) this year, you may want to hold off until next year. We generally advise clients never to try to take a lump-sum distribution after Thanksgiving; it’s better to start the process at the beginning of the next year. Here’s why.
Lump-sum distributions from a qualified retirement plan (QRP) may be eligible for special tax breaks. The special tax breaks include net unrealized appreciation (NUA) on company stock that’s highly appreciated in value over the years it’s been in your plan.
If your QRP includes highly appreciated company stock, consider withdrawing the stock and rolling the rest of the plan assets over to an IRA. This way you’ll pay no current tax on the NUA or the amount rolled over to the IRA. The only tax owed would be on the cost of the stock when acquired by the plan. The NUA (i.e., the gain on the stock from the time it was acquired by the plan until the time it’s distributed) is only taxed when the stock is actually sold, plus it’s always taxed at the long-term capital gain rate, which is oftentimes less expensive than paying tax at ordinary income tax rates.
To qualify as a lump-sum distribution, the distribution must occur in one tax year and your account balance must be zero by the end of that year. The distribution must also occur after any one of these four triggering events:
- Death
- Reaching age 59 ½ (plan is not required to allow distribution)
- Separation from service (not for self-employed)
- Disability (only for self-employed)
Also, if you have more than one QRP with that employer, a lump sum means that all the assets in all like plan accounts must be distributed out of those plans.
The entire distribution must take place within one tax year in order to qualify as a lump-sum distribution and thereby use the NUA tax break. However, distributions may take some time, especially when shares of company stock are involved. For example, in our experience, an NUA transaction can take several weeks from the time the employer makes the in-kind distribution of company stock to the time the transfer agent issues new shares. So we generally recommend that you never start a lump-sum distribution after Thanksgiving so you have some leeway if there is a delay in getting all the assets paid out this year. If there is any balance in the plan at the end of the year, you won’t get the NUA tax break. At this late stage in 2014, it might be safer to start the process early next year in 2015.