#irarollover

Remember, you can make only one tax-free, 60-day rollover from any IRA you own (traditional or Roth) to any other IRA you own in any 12-month period, regardless of the number of IRAs you own. This limit does not apply to direct rollovers or trustee-to-trustee transfers or to Roth IRA conversions.

While it may be tempting to give yourself a free 60-day loan, there’s no need to taunt the rollover gods by risking inadvertent violation of the 60-day limit. If you do take a distribution from your IRA intending to make a 60-day rollover, but for some reason the funds don’t get to the new IRA trustee in time, the tax impact can be significant. In general, the rollover is invalid, the distribution becomes a taxable event, and you’re treated as having made a regular, instead of a rollover, contribution to the new IRA.

But all may not be lost. The 60-day requirement is automatically waived if all of the following apply:

• A financial institution actually receives the funds within the 60-day rollover period.
• You followed the financial institution’s procedures for depositing funds into an IRA within the 60-day period.
• The funds are not deposited in an IRA within the 60-day rollover period solely because of an error on the part of the financial institution.
• The funds are deposited within one year from the beginning of the 60-day rollover period.
• The rollover would have been valid if the financial institution had deposited the funds as instructed.

If you don’t qualify for this limited automatic waiver, the IRS can waive the 60-day requirement “where failure to do so would be against equity or good conscience,” such as a casualty, disaster, or other event beyond your reasonable control.  However, you’ll need to request a private letter ruling from the IRS, an expensive proposition — the filing fee alone is currently $10,000.

Thankfully, the IRS introduced a third way to seek a waiver of the 60-day requirement: self-certification. Under the procedure, which has no IRS fee, if you want to make a rollover but the 60-day limit has expired, you can simply send a letter (IRS Revenue Procedure 2016-47 contains a sample)  to the plan administrator or IRA trustee/custodian certifying that you missed the 60-day deadline due to one of the following 11 reasons:

1. The financial institution receiving the contribution, or making the distribution to which the contribution relates, made an error.
2. You misplaced and never cashed a distribution made in the form of a check.
3. Your distribution was deposited into and remained in an account that you mistakenly thought was an eligible retirement plan.
4. Your principal residence was severely damaged.
5. A member of your family died.
6. You or a member of your family was seriously ill.
7. You were incarcerated.
8. Restrictions were imposed by a foreign country.
9. A postal error occurred.
10. Your distribution was made as a result of an IRS tax levy, and the proceeds of the levy have been returned to you.
11. The party making the distribution delayed providing information that the receiving plan or IRA needed to complete the rollover, despite your reasonable efforts to obtain the information.

To qualify for this procedure, you must make your rollover contribution to the employer plan or IRA as soon as practicable after the applicable reason(s) above no longer prevent you from doing so. In general, a rollover contribution made within 30 days is deemed to satisfy this requirement.

The downside of self-certification is that this self-certification process is not an automatic waiver by the IRS of the 60-day rollover requirement. The self-certification simply allows you and the financial institution to treat and report the contribution as a valid rollover. If you’re subsequently audited, the IRS can still review whether your contribution met the requirements for a waiver. For this reason, some taxpayers may still prefer the certainty of a private letter ruling from the IRS.

Prepared by Broadridge Advisor Solutions. Edited by BFSG. Copyright 2022.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

If you participate in a 401(k), employee stock ownership plan, or other qualified retirement plan that lets you invest in your employer’s stock, you need to know about net unrealized appreciation — a simple tax-deferral opportunity with an unfortunately complicated name.

When you receive a distribution from your employer’s retirement plan, the distribution is generally taxable to you at ordinary income tax rates. A common way of avoiding immediate taxation is to make a tax-free rollover to a traditional IRA. However, when you ultimately receive distributions from the IRA, they’ll also be taxed at ordinary income tax rates (special rules apply to Roth and other after-tax contributions that are generally tax-free when distributed).

But if your distribution includes employer stock (or other employer securities), you may have another option — you may be able to defer paying tax on the portion of your distribution that represents net unrealized appreciation (NUA). You won’t be taxed on the NUA until you sell the stock. What’s more, the NUA will be taxed at long-term capital gains rates — typically much lower than ordinary income tax rates. This strategy can often result in significant tax savings.

What is Net Unrealized Appreciation?

A distribution of employer stock consists of two parts: (1) the cost basis (that is, the value of the stock when it was contributed to, or purchased by, your plan) and (2) any increase in value over the cost basis until the date the stock is distributed to you. This increase in value over basis, fixed at the time the stock is distributed in-kind to you, is the NUA.

For example, assume you retire and receive a distribution of employer stock worth $500,000 from your 401(k) plan, and that the cost basis in the stock is $50,000. The $450,000 gain is NUA.

How Does it Work?

At the time you receive a lump-sum distribution that includes employer stock, you’ll pay ordinary income tax only on the cost basis in the employer securities. You won’t pay any tax on the NUA until you sell the securities. At that time the NUA is taxed at long-term capital gain rates, no matter how long you’ve held the securities outside of the plan (even if only for a single day). Any appreciation at the time of sale in excess of your NUA is taxed as either short-term or long-term capital gain, depending on how long you’ve held the stock outside the plan.

Using the example above, you would pay ordinary income tax on $50,000, the cost basis, when you receive your distribution (you may also be subject to a 10% early-distribution penalty if you’re not age 55 or totally disabled). Let’s say you sell the stock after 10 years, when it’s worth $750,000. At that time, you’ll pay long-term capital gains tax on your NUA ($450,000). You’ll also pay long-term capital gains tax on the additional appreciation ($250,000), since you held the stock for more than one year. Note that since you’ve already paid tax on the $50,000 cost basis, you won’t pay tax on that amount again when you sell the stock.

If your distribution includes cash in addition to the stock, you can either roll the cash over to an IRA or take it as a taxable distribution. And you don’t have to use the NUA strategy for all of your employer stock — you can roll a portion over to an IRA and apply NUA tax treatment to the rest.

What is a Lump-Sum Distribution?

In general, you’re allowed to use these favorable NUA tax rules only if you receive the employer securities as part of a lump-sum distribution. To qualify as a lump-sum distribution, both of the following conditions must be satisfied:

• It must be a distribution of your entire balance, within a single tax year, from all of your employer’s qualified plans of the same type (that is, all pension plans, all profit-sharing plans, or all stock bonus plans); and
• The distribution must be paid after you reach age 59½, or as a result of your separation from service, or after your death

There is one exception: Even if your distribution doesn’t qualify as a lump-sum distribution, any securities distributed from the plan that were purchased with your after-tax (non-Roth) contributions will be eligible for NUA tax treatment.

NUA Works for your Beneficiaries

If you die while you still hold employer securities in your retirement plan, your plan beneficiary can also use the NUA tax strategy if he or she receives a lump-sum distribution from the plan. The taxation is generally the same as if you had received the distribution (the stock doesn’t receive a step-up in basis, even though your beneficiary receives it as a result of your death).

If you’ve already received a distribution of employer stock, elected NUA tax treatment, and die before you sell the stock, your heir will have to pay long-term capital gains tax on the NUA when he or she sells the stock. However, any appreciation as of the date of your death in excess of NUA will forever escape taxation because, in this case, the stock will receive a step-up in basis. Using our example, if you die when your employer stock is worth $750,000, your heir will receive a step-up in basis for the $250,000 appreciation in excess of NUA at the time of your death. If your heir later sells the stock for $900,000, he or she will pay long-term capital gains tax on the $450,000 of NUA, as well as capital gains tax on any appreciation since your death ($150,000). The $250,000 of appreciation in excess of NUA as of your date of death will be tax-free.

Some Additional Considerations

• If you want to take advantage of NUA treatment, make sure you don’t roll the stock over to an IRA. That will be irrevocable, and you’ll forever lose the NUA tax opportunity.
• You can elect not to use the NUA option. In this case, the NUA will be subject to ordinary income tax (and a potential 10% early-distribution penalty) at the time you receive the distribution.
• Stock held in an IRA, or an employer plan is entitled to significant protection from your creditors. You’ll lose that protection if you hold the stock in a taxable brokerage account.
• Holding a significant amount of employer stock may not be appropriate for everyone. In some cases, it may make sense to diversify your investments.*
• Be sure to consider the impact of any applicable state tax laws.

When is it the Best Choice?

In general, the NUA strategy makes the most sense for individuals who have a large amount of NUA and a relatively small cost basis. However, whether it’s right for you depends on many variables, including your age, estate planning goals, and anticipated tax rates. In some cases, rolling your distribution over to an IRA may be the better choice. And if you were born before 1936, other special tax rules might apply, making a taxable distribution your best option.

If you’re expecting a distribution of employer securities from a qualified retirement plan, make sure you speak with your financial professional at BFSG or tax professional before you take any action so that you can fully explore and understand all the options available to you. Only then can you be assured of making the decision that best meets your individual tax and non-tax goals.

*Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

Prepared by Broadridge Advisor Solutions. Edited by BFSG. Copyright 2022.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.