Age 50 & needing income
I have a client leaving her company. Her dob is 1/6/58. She has $202,000 in her pension plan & $715,000 in her 401(k), made up of $520,000 in company stock. She needs $3,500/mo a/t income starting in Jan. ’08.
I was thinking as a strategy to use a NUA distribution (she will have to pay a 10% penalty on the distribution, right?) to give her about 3 years of income by selling off the stock as needed and rolling over the rest. Then she will have to do a 72(t) in about 3 years. I thought this might be a better tax strategy than rolling everything over to an IRA and starting the 72(t) immediately. Any thoughts would be appreciated. Thanks.
Permalink Submitted by Alan Spross on Sat, 2007-08-25 01:32
That sounds viable if the cost basis is low enough, so client should get a cost basis per share quote from the plan. The early withdrawal penalty only applies to the cost basis, not to the NUA value.
Alot depends on whether she will go back to work or not, so the NUA could provide some insurance against being forced into a 72t and then deciding to go back to work. That would probably result in a busted 72t because the double income would result in a tax liability worse than the penalty. In addition, she might be able to take advantage of the -0- cap gains tax on NUA share sales for 2008-2010 for gains under the 25% bracket.
While her withdrawal ratio is only 4.6%, that may still be stretching things when starting at 50. And more important than anything, she probably needs to diversify out of much of the company stock. If the plan provides more than average cost basis accounting on the company shares, it may be worth considering taking the lowest cost basis shares for NUA and selling the rest in the plan. It is probably safer to sell those shares in the plan than to test the IRS on whether separate accounting can be used for shares both distributed as NUA and rolled into an IRA. That also achieves earlier diversification.
Permalink Submitted by [email protected] on Wed, 2007-08-29 17:52
I think I am OK on the separate accounting for the shares because we would be doing the NUA on the shares in her ESOP plan which have a separate cost basis than her shares in the 401(k). Can I do a rollover from her 401(k) this year and leave the ESOP shares in the plan and take the NUA distribution next year? This would then defer this tax until next year, or would I have to clean out the account this year?
Permalink Submitted by Alan Spross on Thu, 2007-08-30 01:35
It would be safer to process the entire LSD next year and take no distributions this year. If she separates, and then takes an intervening distribution from the 401k, the IRS may maintain that she must wait for another triggering event in order to process an LSD for NUA purposes. The next one is age 59.5. Of course, by the time the IRS inquired it would be too late to avoid serious taxable consequences.
You could process the LSD this year, but then the taxable cost basis would be added to all her other 2007 income and would probably be taxed at a higher rate than if she takes it next year when not working.
Incidentally, if she gets taxable ESOP dividend distributions, those are NOT considered intervening distributions and would therefore not present a problem.
Permalink Submitted by [email protected] on Thu, 2007-08-30 16:09
Thank you. I think that is the best strategy.
Permalink Submitted by [email protected] on Thu, 2007-08-30 17:48
One more question (I hope). She also has a pension plan that allows a LSD. Would it be safe to do the rollover on just the pension plan this year and leave the 401(k) nua distribution and rollover for next year?
Permalink Submitted by Alan Spross on Thu, 2007-08-30 21:46
Actually, this is a very good question because the definition of an LSD is not easy to digest, particularly in the current era of hybrid plans and plans incorporating prior plans such as an ESOP incorporated into a 401k. The tax code requires the LSD to include all plans of a single type, eg pension plans, profit sharing plans and stock bonus plans. Since an ESOP is a stock bonus plan, it is initially separate from a 401k profit sharing plan, but later can be incorporated into the plan. A defined benefit pension plan is a separate type of plan also, so generally a client could make DB pension plan decisions separately from NUA decisions. Therefore, the DB lump sum could generally be taken whenever she wishes or taken as an annuity whenever she wishes.
However, to play it safe in the era of hybrid plans, I suggest contacting the plan administrator here to clarify that the pension is separate and not a required portion of the LSD. It would be wise to get that in writing. The inclusion of NUA in Box 6 of the 1099R is most of the battle, since the IRS is not likely to second guess the plan administrator’s knowledge of the plan. Since she should be treating the ESOP and the 401k as part of the same LSD year, it should not matter whether those two plans are separate from each other or not.