Like plans for lump sums

“My client has a 401(k)/profit sharing plan and a defined benefit plan at work. He wants to take advantage of the special tax treatment for net unrealized appreciation (NUA) in employer stock that is part of a lump sum distribution. For this purpose, does he have to withdrawal the balances from both plans in order to have a true lump sum distribution?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from New Jersey is representative of a common inquiry related to the definition of lump sum distribution for special tax purposes.

Highlights of the Discussion

No; in order to meet the definition of lump sum, the IRS requires that only “like plans” of the same employer be combined when determining whether the participant’s entire balance has been paid out within one taxable year. A pension plan and 401(k)/profit sharing plan are not considered like plans in this case.

The term ‘‘lump-sum distribution’’ means payment within one taxable year of the balance to the credit of an employee that becomes payable as a result of an employee’s death, attainment of age 59 ½, separation from service, or disability. The IRS clarifies in IRC Sec. 402(d)(4)(D)(ii)(I) that “balance to the credit” means all pension plans maintained by the same employer are grouped together and treated as a single plan; all profit-sharing plans maintained by the same employer are grouped together and treated as a single plan; and all stock bonus plans maintained by the same employer are grouped together and treated as a single plan.

Conclusion

Although defined benefit pension plans and profit sharing plans are both types of qualified retirement plans under IRC. Sec. 401(a), they are not considered like plans for the purpose of taking a lump sum distribution.