Life and Death Planning for Retirement Benefits

Chapter 2: Income Tax Issues

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For most retiring employees, rolling over, to an IRA, a lump sum distribution received from an employer plan is the best tax-saving and financial planning strategy. The opportunity for continued tax-sheltered growth of retirement assets inside an IRA offers the greatest financial value for most retirees. An LSD that includes appreciated employer securities often provides an exception to this rule of thumb. Since the NUA is not taxed currently anyway, rolling it over is not necessary to defer tax on the NUA. Furthermore, rolling over NUA will convert this unrealized long-term capital gain into ordinary income, since IRA distributions cannot qualify for NUA treatment. Reg. § 1.402(c)-2 , A-13(a), last two sentences. So which is better, taking an LSD of NUA stock and keeping the stock outside of any plan, to take advantage of the NUA deal? Or rolling over that stock to an IRA? The answer depends on multiple factors (as well as guesswork), and no one answer is right for everyone. Factors to consider include:  How old is the employee? If he is under 59½, the currently-taxable part of the distribution will be subject to the 10 percent penalty (see Chapter 9) unless it qualifies for an exception or unless the tax can be eliminated by a partial rollover ( ¶ 2.5.07 (B)). Also, the younger the employee is, the more attractive continued tax deferral through a total rollover becomes, because he has many more years to go before he must start taking required minimum distributions RMDs; see Chapter 1 ). If he is near or past age 70½, on the other hand, RMDs are starting or have started already, so an immediate distribution at a low tax rate becomes more attractive relative to the limited possibilities for continued deferral.  What other plans does the participant have? If the employee has substantial assets in other retirement plans, the chance to cash out some of his benefits at a relatively low tax rate can be appealing. But if this is the employee’s only retirement plan, rolling it to an IRA could be more attractive.  How much of the distribution is NUA? If the NUA is a substantial portion of the stock’s value, taking the NUA deal becomes more attractive, even irresistible. If the NUA is a small portion, rolling over becomes more attractive. Thus, the advice to a 45-year-old executive who is switching jobs, whose employer stock is only 10 percent NUA, and who needs to save for retirement, may be to roll over the entire distribution (and forfeit the NUA deal), while the advice to a 71-year-old whose stock is 90 percent NUA and who has other retirement plans that are funded beyond his likely needs would be the opposite. 2.5.07 NUA and partial rollovers Although it is a requirement, when claiming special averaging (see ¶ 2.4.06 ), that no portion of the LSD be rolled over, and indeed that no other qualifying distribution received in the same year be rolled over, no such requirement applies to obtaining the exclusion from income of the NUA portion of an LSD. For the effect of combining an NUA distribution and a partial rollover for a year in which a minimum distribution is required, see Elizabeth Example at ¶ 2.6.03 (A). A. Rolling over everything except the NUA stock. If the employee receives a distribution that (1) meets the LSD requirements ( ¶ 2.4.02 – ¶ 2.4.05 ) and (2) includes employer securities, the employee can exclude from his income the NUA inherent in the securities, while rolling over to an IRA the assets other than the employer securities, which otherwise would be included in gross income. See PLRs 2004-10023, 2001-38030, 2001-38031, 2000-38052, 2000-38057, 9721036. In PLR 2000-03058, this split was accomplished by