“I recently took on a client who has stock of his employer in his retirement plan. Before he came to me, he took an in-service distribution of a portion of his account balance because he had turned age 59½. He continues to work. Does that early distribution eliminate his ability to take a lump sum distribution that includes the employer stock and take advantage of the net unrealized appreciation (NUA) tax strategy?”

ERISA consultants at the Retirement Learning Center (RLC) 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 California is representative of a common inquiry related to NUA in employer securities.

Highlights of the Discussion

The answer to this question hinges on the definition of lump sum.  A distribution made from a qualified plan is eligible for lump-sum treatment if it meets all three of the following requirements.

1. The distribution(s) is/are made within one taxable year.
2. The above distribution(s) represent(s) the “balance to the credit,” of the participant. In other words, the participant must receive the entire account balance (or balances of combined like plans of the same employer) in one taxable year. For this purpose, the IRS treats all pension plans maintained by the same employer as a single (like) plan.  Similarly, all profit-sharing plans maintained by the same employer would be considered a single (like) plan, and all stock bonus plans maintained by the same employer would be considered a single (like) plan [IRC Sec. 402(e)(4)(D)(ii)(I)].
3. Finally, the distribution(s) is/are made because of

• The participant’s death,
• Attainment of age 59 ½,
• Separation from service (not applicable for a self-employed participant), OR
• Total and permanent disability (only applicable for a self-employed participant).

In this case, despite using up the “age 59 ½” distribution trigger, your client could still apply the separation from service distribution trigger to qualify for a lump sum if he leaves employment and is not self-employed. Or, if he is self-employed, the total and permanent disability trigger may apply, if he meets the definition. And, his beneficiaries could, potentially, receive a lump sum distribution upon the participant’s death, if the other requirements are met.

Conclusion

A plan participant who is interested in the special tax rules surrounding NUA should discussion his or her situation with a trusted tax professional because the rules are multifaceted. For example, as was discussed here, there are several nuances to the definition of lump sum for purposes of qualifying for NUA tax treatment. Having expert guidance is essential.