401K NUA Question

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Topic Author
Colorado21a
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Joined: Thu Jun 08, 2023 7:12 am

401K NUA Question

Post by Colorado21a »

I've done alot of research on my 401K NUA Question and spoke to someone at Fidelity (who may be trying hard to get me to rollover my 401K plan into Fidelity). My situation is that I'm 49 years old and have $172K in a company stock fund at a cost basis of $130K. If I assume 5% growth over 11 years, I'll have $300K at 60 years old, or if I get aggressive and assume 10%, I'd have $500K. I also think it's possible for my former company's stock that it won't appreciate much at all and I'll have more like $175K to $200K.

The Fidelity advisor told me that if I do convert to NUA in 11 years, I'll pay the ordinary income tax rate, let's assume 37%, on the cost basis of $130K, and I'll pay the LT CG rate, let's say 20%, on the amount over the cost basis. Whereas, if I moved the money to Fidelity right now, or just never used the NUA benefit, I'd pay 37% on the full value someday. Is his explanation of this accurate?

So for my calculations, if I assume the 5% number, I would save about $29K in taxes 11 years from now. The annual fees I pay to Alight to hold this 401K is not significant, maybe $25 per year, and I have very low expense ratio index funds I use for the other 83% of my portfolio. So, to me, it seems like it's in my best interest to keep this money where it is and not roll it over, and I can always change that decision anywhere along the way if the company stock is decreasing or not accelerating much.

Would love confirmation of this plan or other/better ideas that folks have?

Thanks!!!
RyeBourbon
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Re: 401K NUA Question

Post by RyeBourbon »

The decision to roll the 401k to IRA and use the NUA is independent of choosing a custodian.

What is your planned triggering event for the NUA? Separation from service? Reaching 59.5?
Retired June 2023. LMP (TIPS Ladder/SS Bridge) 25%/Risk Portfolio 75%, AA = 60/30/10
Topic Author
Colorado21a
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Joined: Thu Jun 08, 2023 7:12 am

Re: 401K NUA Question

Post by Colorado21a »

I've already separated at 48 years old, and I don't need the money until retirement, so I would look to do it after 59.5 years old.
Alan S.
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Re: 401K NUA Question

Post by Alan S. »

Colorado21a wrote: Tue Jul 09, 2024 7:46 am I've done alot of research on my 401K NUA Question and spoke to someone at Fidelity (who may be trying hard to get me to rollover my 401K plan into Fidelity). My situation is that I'm 49 years old and have $172K in a company stock fund at a cost basis of $130K. If I assume 5% growth over 11 years, I'll have $300K at 60 years old, or if I get aggressive and assume 10%, I'd have $500K. I also think it's possible for my former company's stock that it won't appreciate much at all and I'll have more like $175K to $200K.

The Fidelity advisor told me that if I do convert to NUA in 11 years, I'll pay the ordinary income tax rate, let's assume 37%, on the cost basis of $130K, and I'll pay the LT CG rate, let's say 20%, on the amount over the cost basis. Whereas, if I moved the money to Fidelity right now, or just never used the NUA benefit, I'd pay 37% on the full value someday. Is his explanation of this accurate?

So for my calculations, if I assume the 5% number, I would save about $29K in taxes 11 years from now. The annual fees I pay to Alight to hold this 401K is not significant, maybe $25 per year, and I have very low expense ratio index funds I use for the other 83% of my portfolio. So, to me, it seems like it's in my best interest to keep this money where it is and not roll it over, and I can always change that decision anywhere along the way if the company stock is decreasing or not accelerating much.

Would love confirmation of this plan or other/better ideas that folks have?

Thanks!!!
The Fidelity explanation is correct, but NUA will not be viable unless the total value of these shares reaches around 450k, but if dividends are being reinvested over this period that will increase your cost basis with the new shares having much less time to grow. Most likely, being in a stock fund, the dividends are being reinvested. Another question is that of reduced diversification over this period if the shares do grow faster than the rest of your assets.

Assuming that your marginal rate and the LTCG rate at your taxable income level remains unchanged could also turn out to be incorrect. Once your take your qualified LSD from the plan for NUA purposes, you will no longer have tax deferral on the taxable cost basis (the 10% penalty goes away at 59.5), and if you sell the NUA shares soon thereafter and pay the LTCG rate, tax deferral on the NUA will also end.

But when you need the funds is also a factor. If you were to need most of these funds 10-15 years from now anyway for living expenses, paying the LTCG rate on the NUA will certainly be preferable to your ordinary marginal rate on the entire amount.

Since your current plan has low expenses and keeping the balance there might also facilitate back door Roth availability in the meantime, there is no real harm in waiting to see what develops, but if the shares tank at some point or tax law changes, you can always just do a direct rollover to an IRA.

Right now I would check into the dividend reinvestment issue, since that would just tend to increase your cost basis % with each reinvestment.
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retired@50
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Re: 401K NUA Question

Post by retired@50 »

Colorado21a wrote: Tue Jul 09, 2024 7:46 am ... I also think it's possible for my former company's stock that it won't appreciate much at all and I'll have more like $175K to $200K.
It's not really related to your question about NUA, but all your assumptions have this stock growing, by some amount, over the time period.

Have you considered that it might shrink?

Nobody ever thinks this sort of thing will happen to them... Look at Boeing (BA) stock over the past 5 years.

Regards,
"All of us would be better investors if we just made fewer decisions." - Daniel Kahneman
Topic Author
Colorado21a
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Re: 401K NUA Question

Post by Colorado21a »

In reference to the comment regarding a BackDoor Roth IRA option, my Fidelity advisor said that converting my wife's 401K's into a traditional IRA at Fidelity via rollover would not limit our flexibility to convert some of those funds next year to Roth if we chose to do so. I don't fully understand the difference between Roth Conversion and a Back Door Roth - is one better than the other? And why does leaving my 401K where it is give me that flexibility whereas rolling it over I assume would not?

Thanks.
Topic Author
Colorado21a
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Re: 401K NUA Question

Post by Colorado21a »

And yes, I did confirm all dividends are being reinvested into that stock account at about $5k per year, so another $55K of added cost basis at a minimum over 11 years.
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retired@50
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Re: 401K NUA Question

Post by retired@50 »

Colorado21a wrote: Tue Jul 09, 2024 9:28 am In reference to the comment regarding a BackDoor Roth IRA option, my Fidelity advisor said that converting my wife's 401K's into a traditional IRA at Fidelity via rollover would not limit our flexibility to convert some of those funds next year to Roth if we chose to do so. I don't fully understand the difference between Roth Conversion and a Back Door Roth - is one better than the other? And why does leaving my 401K where it is give me that flexibility whereas rolling it over I assume would not?

Thanks.
Backdoor Roth is a strategy that some high income earners engage in, which allows them to still get money into a Roth IRA, even though they have income above the normal limits for direct Roth contributions.

If your income is not above the Roth limits for a direct contribution, then it's moot.

More details here: https://www.bogleheads.org/wiki/Backdoor_Roth

The "gotcha" is what's known as the pro-rata rule, which considers IRA balances, but not 401k balances. So, some people who are using the backdoor Roth strategy will leave money inside the 401k wrapper so that it stays out of reach of the pro-rata rule.

All of this is discussed in the wiki page above.

Roth conversions are a different animal.
More detail here: https://www.bogleheads.org/wiki/Roth_conversion

Regards,
"All of us would be better investors if we just made fewer decisions." - Daniel Kahneman
Alan S.
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Re: 401K NUA Question

Post by Alan S. »

Colorado21a wrote: Tue Jul 09, 2024 9:28 am In reference to the comment regarding a BackDoor Roth IRA option, my Fidelity advisor said that converting my wife's 401K's into a traditional IRA at Fidelity via rollover would not limit our flexibility to convert some of those funds next year to Roth if we chose to do so. I don't fully understand the difference between Roth Conversion and a Back Door Roth - is one better than the other? And why does leaving my 401K where it is give me that flexibility whereas rolling it over I assume would not?

Thanks.
Your back door Roth question has been answered.

As to the advisor's statement, it is technically correct but also very misleading. A conversion can be done anytime from her TIRA, but taxes would be owed. For example, if she makes a 7000 non deductible TIRA contribution and there is no other balance in any of her non Roth IRAs, an immediate conversion would be tax free. That's a typical back door Roth.

But if she rolled a pre tax 401k balance of 93,000 into an IRA, then made the 7000 ND contribution and converted 7000, then 6510 of that conversion would be taxable (93k/100k). This is what the advisor neglected to explain.
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Re: 401K NUA Question

Post by RyeBourbon »

Alan S. wrote: Tue Jul 09, 2024 11:13 am
Colorado21a wrote: Tue Jul 09, 2024 9:28 am In reference to the comment regarding a BackDoor Roth IRA option, my Fidelity advisor said that converting my wife's 401K's into a traditional IRA at Fidelity via rollover would not limit our flexibility to convert some of those funds next year to Roth if we chose to do so. I don't fully understand the difference between Roth Conversion and a Back Door Roth - is one better than the other? And why does leaving my 401K where it is give me that flexibility whereas rolling it over I assume would not?

Thanks.
Your back door Roth question has been answered.

As to the advisor's statement, it is technically correct but also very misleading. A conversion can be done anytime from her TIRA, but taxes would be owed. For example, if she makes a 7000 non deductible TIRA contribution and there is no other balance in any of her non Roth IRAs, an immediate conversion would be tax free. That's a typical back door Roth.

But if she rolled a pre tax 401k balance of 93,000 into an IRA, then made the 7000 ND contribution and converted 7000, then 6510 of that conversion would be taxable (93k/100k). This is what the advisor neglected to explain.
Also, making the non-deductible contribution and converting it in July, followed by a 401k rollover to tIRA before the end of the year would also cause part of the conversion to be taxable. The pre-tax tIRA balance on December31 must be $0 to avoid pro-rata taxation.
Retired June 2023. LMP (TIPS Ladder/SS Bridge) 25%/Risk Portfolio 75%, AA = 60/30/10
RyeBourbon
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Re: 401K NUA Question

Post by RyeBourbon »

Colorado21a wrote: Tue Jul 09, 2024 8:06 am I've already separated at 48 years old, and I don't need the money until retirement, so I would look to do it after 59.5 years old.
You can do a lump-sum distribution with NUA to Fidelity prior to 59.5 if you want. The stock would go to taxable and the remainder to a tIRA. The basis would be taxed plus a 10% early withdrawal penalty. [Rule of 55 would not apply here. If separation from service was at 55+, then you could avoid the 10% penalty.]

If you take any distributions between now and 59.5, you would have to complete the LSD in that calendar year to use NUA prior to 59.5 - if you don't empty the account, at 59.5 you would again be eligible for NUA, but with no 10% penalty.

So, I think your understanding as stated in your first post is correct. It's just a risk to hold the company stock for so long. You will have to make the decision. 
Retired June 2023. LMP (TIPS Ladder/SS Bridge) 25%/Risk Portfolio 75%, AA = 60/30/10
Topic Author
Colorado21a
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Re: 401K NUA Question

Post by Colorado21a »

So taking this thread into more of the question on how to add more Roth $ to my portfolio, I remain confused unfortunately even after reading through the links that were provided on Roth and Back Door Roth options. I think I understand that the tax situations are unique on this for my wife and I even though we file taxes jointly, so let me start with me.

For me, I'm currently unemployed but due to a severance payout, in a very high tax bracket this year and potentially we will be in a much lower bracket next year. I have a Roth IRA account from decades ago worth $85K, I have no Traditional or Rollover IRA's of any kind, and I have a $1M 401K with my now former company that is 99% pre-tax dollars. So what is my best strategy, either now or in the future, to get more money into Roth?

1. Can I contribute to a Traditional IRA and then convert to a Roth IRA with cash I have on hand right now tax-free or will that be taxed at my ordinary income rate? What about next year?
2. Because I don't have a Traditional IRA, is there a way for me to convert some of my 401K pre-tax dollars into a Roth IRA tax free? (I assume if I do this, that negates my opportunity to take advantage of NUA, but I want to simplify this discussion just to the Roth back door / conversion / contribution decision.
3. I assume at any point I can "convert" 401K pre-tax dollars to a Roth IRA and pay ordinary income tax, correct?
4. In the end, what is my best strategy to get more Roth $ in play for me?

For my wife, until last week, she had a 401K at Fidelity with her new/current employer with $4K, plus a 401K with her last employer at Empower worth $2K, as well as a former $401K at Voya for $101K, a 403B with TIAA CREG worth $6K, a Roth IRA at Fidelity worth $32K, and a 401K at Fidelity from a past employer worth $770K, about 30% of which is Roth/After-Tax $, and zero $ in a Traditional IRA. However, the Fidelity rep assured me there would be no impact to our ability to move $ to Roth if we took her Fidelity 401K of $770K and rolled it over, so that has been done and is now $534K in a Rollover IRA and the other $200K+ was combined with her Roth IRA at Fidelity, now worth $280K including the original balance of $32K.

So the same 4 questions as above for her accounts. Is her best approach to investigate Roth 401K's or Roth contributions from her current salary? Maybe next year if we are in a lower bracket? From what I read on the Roth Back Door link, there is a way to convert/back door money into Roth tax free if she didn't have any T-IRA $, is that true? And if so, did Fidelity just screw that up for us? Am I able to do that on my accounts?

Sorry for all the questions but this is really confusing for me, thanks again.
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