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NUA AND EMPLOYER 401(K) PLANS: TODAY’S SLOTT REPORT MAILBAG

By Sarah Brenner, JD
IRA Analyst

Question:

If I convert Trad IRA funds to a Roth IRA, does the ratio of After-Tax Contribution to Total IRA holdings include 401k holdings or only IRA holdings.

I am a recently retired pilot and want to make Trad to Roth IRA conversions this year and in the next four or five years before I’m required to begin RMDs. I have about $80k in after-tax Trad IRA contributions.  I also have a 401k to which I always contributed the max and that has grown nicely.

My question: Is it to my benefit to keep the 401k separate for this 2019 tax year (it’s still w employer although I just retired and don’t want to leave it there too long).  Is the 401k included in the cost/earnings ratio on which I will pay income tax, or are only IRA holdings considered?

Thank you.

Answer:

This is an area where we get many questions. When you convert, all your IRAs are treated as one BIG IRA account. Because all your IRAs are treated as one account, you generally cannot segregate the after-tax contributions. Any conversion done from any IRA account will be deemed to consist of some pre-tax funds and some after-tax funds. This is the pro-rata rule.

The good news for you is that any funds you have in a 401(k) are NOT considered for purposes of the pro rata rule. As long as those funds stay in the plan, they will not be considered when determining the taxation of your conversion.

Question:

I understand many of the requirements related to the withdrawal of an employer’s compony stock that has been accumulated in an employee’s 401(k) plan. I know that several conditions must be met in order to take capital gains treatment on the NUA portion.

However, I am now reading in some posts that if the withdrawal is due to a separation f service that withdrawal must be made within one year of separation of service. I was under the impression that there was no 1 year requirement. Can you confirm or deny that information as it is found on several websites?

THANKS

Gregg

Answer:

The rules for NUA can be complicated. One requirement is that there be a lump sum distribution in one tax year. This does not mean that all the funds must be distributed within one year of separation from service. It would be possible to wait a year or even several years before taking the lump sum distribution.

The key here is that once a “triggering event” occurs (such as a separation from service), any subsequent distribution starts the NUA clock. That means if you are looking to take advantage of NUA, you must ensure that the entire account is emptied within that tax year. If not, NUA is lost and you have to wait until another “triggering event” occurs.

https://www.irahelp.com/slottreport/nua-and-employer-401k-plans-todays-slott-report-mailbag

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