New IRA SEPP or Keep 401k Plan

L1: New IRA SEPP or Keep 401k Plan
I’m thankful I discovered this site 18 months ago. What a blessing! I’ve learned so much reading the various posts. I plan to retire Jan 11, 2019, the year I turn 55 (DOB 10/19/1964) and likely setup a new SEPP.
I have $2.7M in a 401k, with most ($2.6M) in company stock. The company is an S Corporation KSOP and has had strong retained earnings reinvestments resulting in a high stock cost basis of about $2.5M. I also have a Roth IRA with $180k and Variable Annuity with $150k.
I originally planned to retire last spring and to do a trustee-to-trustee transfer from the 401k (with Schwab) to an IRA with Vanguard and setup a new SEPP. However, after following this site, I learned about the Rule of 55۝ and decide to delay retirement until 2019, the year I’ll turn 55. My 401k plan requires I sell my company stock when I retire, but does allows me to keep investments in the 401k, where there are good, but fairly limited investment options. The 401k plan does allow up to two withdrawals per year, with each at least $50k.
Given the high stock cost basis in the 401k, I don’t think a NUA distribution is something to pursue. So I’m considering, if allowed, doing a trust-to-trust transfer of 80% of the 401k to an IRA with more investment choices, but leave 20% in the 401k for emergencies, etc. Is that typically allowed?
The SEPP Calculator shows that if I start a SEPP with $2,120,000 (80% of the $2.7M) on 3/15/2018 – using 3.65% interest (for now) – the annual SEPP Payment would be $117,212.18 (amortization method). I understand I could take the full amount the first year or 10/12ths (10 months). I’d have a 59.5 year plan۝ that would end 4/19/2024. Are my calculations/assumptions correct?
What am I missing? Are there alternatives I should consider?
2018-11-06 22:47, By: KirkPatrick, IP: [199.168.243.252]

L2: New IRA SEPP or Keep 401k Plan
Not sure I understand why the cost basis of the employer shares is so high, but that does not matter if you will be diversified out of these shares, and the plan provides for distributions that are very similar to your calculated SEPP distributions. If this is the case, it seems to be a simple choice to retain at least enough in the plan to tide you over until 59.5 under the age 55 separation penalty exception, thus avoiding an inflexible SEPP.
If the 401k allows you 2 withdrawals with a min of 50k each, the least you can withdraw is 100k per year. But you did not indicate how much you will actually need from this plan to live on until 59.5. If it is far less than 100k, then you will lose tax deferral and your tax bill will be increased.
Therefore, the question is how much do you need annually to live on given a reasonable increase for inflation?
2018-11-07 01:29, By: Alan S, IP: [72.24.226.251]

L3: New IRA SEPP or Keep 401k Plan
Thank you for your quick response. My current income needs will likely be around $100k/yr. If I understand your comments correctly, I could potentially leave enough in the 401k to get through 59.5 (plus some extra for inflation and emergencies). The rest of the 401k could then be transferred to an IRA via a trustee-to-trustee transfer. This would provide me more investment choices without having to set up an inflexible SEPP. I like that concept!
One clarification, the SEPP amount I used in the calculator was $2,100,000, not the more exact number I’d stated in my original post. I wanted to mention this in case any one checks the numbers and wonders why they don’t match.
2018-11-07 02:12, By: KirkPatrick, IP: [64.33.112.137]

L4: New IRA SEPP or Keep 401k Plan
Yes, you could take a 50k distribution every 6 months, so roughly 500k before reaching 59.5. If you wanted to you could roll over the balance in excess of 500k now, the only downside being if some emergency resulted in your running through the 500k before 59.5. You would then have to tap the IRA subject to penalty for any IRA distributions before 59.5. You should carefully assess how much you should leave in the plan now, given the trade offs between IRA investing and having larger amounts left in the plan to avoid any potential penalties.
2018-11-07 16:55, By: Alan S, IP: [72.24.226.251]

L2: New IRA SEPP or Keep 401k Plan
Your NUA comments do not make any sense to me. You said that the company had “strong retained earnings reinvestments resulting in high cost basis”.
Possibly you do not understand how NUA works. The “cost basis” is the amount paid by the company for its contributions of company stock to the plan, usually as the company’s matching, and/or the purchase of company stock with your contributions. The usual situations for growth companies, like Apple, Amazon, Google, Microsoft, etc., this has been maybe $ 250K that has grown to $ 2.6 million over the years. Did you mean that dividends paid by the company was used to reinvest in the company by buying additional shares ? Even then, this would probably have been over many years at ever rising prices, but the primary purchases would make up the majority of the shares. The fair market value as of the date you retire is immaterial to the “cost basis”.
The NUA procedure is for these shares to be distributed to you into a non-retirement account at a broker. You pay taxes at ordinary tax rates on the $ 250K. Then, as you sell those shares, either the same day, or over a period of years, you pay taxes at LONG-TERM CAPITAL GAINS RATES of 15% or 20% depending upon your taxable income. The “holding period” is automatically “long-term” by IRS regulation.
I understand that this closely-held S Corp wants to keep the ownership “within the company family”, but you should see if they would agree to some arrangement whereby you would agree to sell the shares back to the company over a long period of time so as not to be hit with a large tax bill all at once.
By the way, I do not know what a KSOP is. Is that a typo, and you meant an ESOP, i.e. Employee Stock Ownership Plan ?
2018-11-08 06:01, By: dlzallestaxes, IP: [173.59.46.223]

L3: New IRA SEPP or Keep 401k Plan
A KSOP is an ESOP that is incorporated into a 401k plan, and therefore allows the employer to operate only a single plan. There is no difference in the potential to generate highly appreciated employer shares, and while there are diversification options for the participant, if not exercised the potential for even higher concentration in employer shares exists.
Using NUA presents another opportunity to avoid a SEPP, although tax deferral is hammered if the shares are sold right away, despite the lower LTCG rate, and with a high cost basis the tax bill would be much higher. That said, there is always the option of using only a portion of the shares for NUA rather than all of them.
2018-11-08 15:39, By: Alan S, IP: [72.24.226.251]

L3: New IRA SEPP or Keep 401k Plan
Thank you dlzallestaxes (and Alan) for your reply. I appreciate it. There is a definition of a KSOP on the investoropedia site, if interested.
I work for an employee-owned company, and I’m required to sell all of the stock back to the Company at the next annually buy/sell period following retirement, or implement a NUA of the entire stock sale which would be heavily taxed. So I believe the best option is to re-invest the stock sale into the other available 401k funds, and then do a trustee-to-trustee transfer of a large portion the 401k to a Vanguard IRA so I have more investment choices. I’ll leave enough in the 401k to fund retirement until 59.5 plus a cushion for inflation, emergencies, and some fun.
Schwab manages the Company’s 401k plan. Schwab recently gave a presentation on NUA which discussed our Company’s uniqueness, and the pros/cons of NUA’s. Due to our company’s long-term growth and re-investments in the company, the stock “cost basis” has increased each year, nearly matching the stock price. It sounds like that is a fairly unique situation.
Here are some points made about our S-Corporation KSOP:

As an S-corporation, is exempt from taxation at the corporate level. Instead of the corporation paying annual income tax on any earnings, the shareholders of the S-corporation pay tax on their share of the S-corporation’s income.
The corporation’s earnings are the portion of company revenue that’s left after deducting expenses for the year.
Any earnings that the company keeps (for example, to grow the business) are called retained earnings.
While the ESOP holds the stock, it is exempt from tax at the shareholder level.
The tax is passed to participants through an annual adjustment, up or down, to the stock’s cost basis.
The S-corporation status allows for any earnings to be taxed only once at the shareholder level when you leave the company and receive the company and receive the cash equivalent to the stock allocated to your account.

Thanks again for sharing your insight.
2018-11-08 17:04, By: KirkPatrick, IP: [199.168.243.252]

L4: New IRA SEPP or Keep 401k Plan
Thank you for your response.
I have practiced for almost 60 years, and had never heard of a KSOP. The concept makes a lot of sense for closely-held companies, but may not be the best choice for employees because of the concentration, and lack of diversity, of the investment for retirement.
It explains why the cost basis is so much higher than in traditional 401-K NUA plans.
2018-11-09 02:03, By: dlzallestaxes, IP: [173.59.46.223]