Ed Slott: Why a Lump Sum Beats an IRA Rollover for Some Clients

Who qualifies for this?

Advisors, Slott said, need to ask clients two questions: First, does the client have company stock in their plan?

“Most people do,” Slott said. “You work for IBM, they probably have been piling on IBM stock or whatever company you’re working for. It’s a common thing, a common thing that people do, they invest where they work.”

Second: Is it highly appreciated?

“This is where it’s a big thing again now because the market has run up like crazy,” Slott said. “Longevity on the job. You’ve been at a job in some of these big tech companies, for example, for 20 or 30 years ….”

For instance, Slott continued, “Let’s say you have Apple stock, a million dollars’ worth, but over the years you only paid $100,000 for it when you put it in the plan. That difference between a million and the $100,000 cost is called net unrealized appreciation, or what we call NUA, in employer securities.”

If the client qualifies for a lump-sum distribution — and there are four qualifiers — the client could roll the other noncompany stock assets over to their IRA, and that would leave just the million dollars of this Apple stock, Slott said. “But it has to be a lump-sum distribution. So, the plan has to happen in one calendar year after what we call a triggering or qualifying event, that’s age 59.5 or separation from service.”

The other qualifiers are death and disability.

“If you take the stock down, that would empty the account because the other funds from the 401(k) were rolled over,” Slott continued.

“You take it. You don’t sell the stock. That’s one of the mistakes — people blow it. You take the stock out in-kind as stock and transfer it to a taxable account, that million dollars, you only pay tax on the cost, $100,000, that original cost. That other $900,000 comes over to your taxable account absolutely tax-free. And whenever you do take that money out, you sell the stock, you automatically get long-term capital gain rates.”

Added Slott: “So, this applies to a lot more people because more people have company stock, longevity at the job, and the market runup. Now any advisor that doesn’t ask that question may have really blown it.”