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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.

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Can NUA in employer stock count towards an RMD?

“Can the portion of a distribution from a 401(k) plan that takes advantage of NUA tax treatment be used to satisfy the receiving participant’s RMD for the year?”

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Colorado is representative of a common inquiry involving net unrealized appreciation (NUA) and required minimum distributions (RMDs).

Highlights of discussion

  • Yes— amounts excluded from income at the point of distribution, such as NUA on employer securities, are amounts a plan participant may count toward satisfying an RMD under Internal Revenue Code Section (IRC §) 401(a)(9). (NUA is eventually included in the participant’s income as taxable long-term capital gains when the employer securities are eventually sold.)
  • According to Treas. Reg. 1.401(a)(9)-5, Q&A 9, with a few, limited exceptions, all amounts distributed from a qualified plan are amounts that are taken into account in determining whether an RMD is satisfied for a participant, regardless of whether the amount is includible in income.
  • For example, amounts that are excluded from income as recovery of “investment in the contract under IRC§ 72” (i.e., after-tax contributions) are taken into account for purposes of determining whether an RMD is satisfied for a year. Similarly, amounts excluded from income as NUA on employer securities are counted towards satisfying an RMD of the participant.
  • The following amounts are not taken into account in determining whether a participant’s RMD is satisfied for the year:
  1. Amounts returned to a participant to correct plan excesses;
  2. Loans treated as deemed distributions;
  3. The cost of life insurance coverage (i.e., PS 58 costs);
  4. Dividends on employer securities; and
  5. Other similar amounts as deemed by the IRS and published in the Internal Revenue Bulletin from time to time.

Conclusion                                                   

The IRS is clear that NUA on employer securities is a distribution amount that a plan participant may count toward satisfying his or her RMD for the year.

© Copyright 2018 Retirement Learning Center, all rights reserved