NUA

One of the requirements for using the net unrealized appreciation (NUA) strategy is that the plan participant take a lump sum distribution. If a participant takes an LSD and does NUA at age 59 1/2 without separating from service, it's never been clear to me whether they can continue in the plan for years after the year the LSD is paid. Any thoughts? If the answer is no, any references where the IRS or a court has said this?

Thanks in advance.

NUA: Net Unrealized Appreciation – is a special provision from qualified retirement plans that allows the employee to elect to treat company stock differently from all other assets in the plan when making a distribution from the plan. Essentially, you pay ordinary income tax on the basis, original cost, of the stock in your employer’s (actually former employer’s) company, and then place the stock in a taxable brokerage account. At this point, any gains on the stock are subject only to capital gains tax (rather than ordinary income tax, which is a much higher rate). The trick is that you can only do this maneuver one time, and the distribution must be in a lump sum of all your 401(k) account holdings. Everything in the account that is not company stock can be rolled over into an IRA and maintain tax deferral as usual. It’s critical to note that this can be the only distribution of funds from the account. If you were to distribute any amount, even a small amount from the employer plan in a previous year, you are no longer eligible to use the NUA provision on this employer account.

Tip o' the hat to Jim Blankenship

Thank you for the response. But I'm not asking whether NUA can be done a second time. I'm asking whether the lump sum distribution requirement prohibits someone from continuing to participate in the plan (e.g., from making additional 401(k) elective deferrals) in years following the calendar year in which the LSD is taken.

This is one of those questions where you are looking for references to an explicit negative which likely doesn't exist.  Use of NUA is a taxation issue related to a distribution, and continuing to participate in the plan is a participation issue.  The NUA is not related to participation but is related to other distributions from the account to the extent of the NUA rules @fmsinc describes.

The tax treatment of the distribution cannot control/deny someone of future participation. However, it can affect tax treatment of future distributions. If the person takes a permissible LS (total distribution) under the terms of the plan and applies NUA, then any future distribution attributable to future participation would be precluded from using such. I would not think such would retroactively negate the prior NUA treatment but would seek qualified tax counsel for that. I would also be EXTREMELY careful on distribution timing, what constitutes a lump sum and future participation. I think you would need to avoid any contribution after the distribution but in the same tax year as such that creates a balance at year end. Get qualified tax counsel and/or financial planning assistance AND understand your plan's rules and it's administrative environment as any misstep could prove expensive.