By John Carl
The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Missouri is representative of a common inquiry related to distributions of employer stock from qualified retirement plans. The advisor asked:
“If my client takes a distribution in-kind of the employer stock in his 401(k) plan, will the plan withhold 20% for federal tax purposes?”
This is a great question because, typically, if a plan participant receives a distribution from a qualified retirement plan that is otherwise eligible for rollover, but he or she retains the distribution (i.e., does not directly roll it over), the plan administrator is required to withhold 20% of the distribution for remittance to the IRS pursuant to Section 3405(c) of the Internal Revenue Code (IRC).
However, there are exceptions to this general rule when a distribution includes employer stock or securities. Employer securities that are part of an eligible rollover distribution that is not directly rolled over must be included in the amount used to calculate the 20% withholding; however, the actual amount to be withheld cannot be more than the sum of the cash and the fair market value of property (excluding employer securities and plan loan offset amounts).
For example, if the only part of an eligible rollover distribution that is not directly rolled over is employer securities (or a plan loan offset amount), no withholding is required. However, any cash that is paid in the distribution must be used to satisfy the withholding on the employer securities (or plan loan offset amount).
In addition, if a distribution consists solely of employer securities and cash (not in excess of $200) in lieu of fractional shares, no amount is required to be withheld as income tax from the distribution.
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Generally, we tend to think of the 20% federal withholding rule that applies to otherwise eligible rollover distributions from qualified retirement plans that are not directly rolled over as immutable. But plan participants who hold employer securities within their workplace retirement plans need to be aware of a special exception that applies if they distribute the stock in-kind — which is required in order to use a tax strategy involving the net unrealized appreciation in the stock.
Financial advisors who are familiar with these withholding rules are better positioned to support their clients.
John Carl is the President of the Retirement Learning Center, LLC.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2012 Columbia Management Investment Advisers, LLC. Used with permission.
