Tax planning opportunities for distributions of employer securities from qualified retirement plans.

• Author: Horvath, David S.

Many individuals today are faced with the decision of what to do with distributions from their employer's qualified retirement plans. Many choose to roll over the distribution to another qualified retirement plan or to an individual retirement account (IRA). Others decline to roll over the distribution and, instead, elect five- or 10-year income averaging if they are eligible. Generally, income averaging is available only if the individual had been a participant in the plan for at least five years before the year of the distribution and is at least age 59 1/2 at the time of the distribution.

Depending on the individual's circumstances, any of these could be the correct decision. For example, a rollover to an IRA is often a good choice if an individual can delay taking distributions from the IRA for a number of years, thus taking advantage of the tax-deferred growth. However, there may be another option, albeit sometimes overlooked, for individuals receiving a distribution of employer securities from the plan. This distribution option can be used on its own or in conjunction with rollovers or income averaging.

Generally, if the distribution is considered to be a "lump sum" distribution and includes employer securities, the portion of the distribution attributable to unrealized gain on the securities is not currently taxable. The "basis" in the employer securities (generally, the fair market value of the securities when they were contributed to or purchased by the plan) is currently taxable. On the subsequent sale of the securities, the realized gain will be taxable to the individual as capital gain. Therefore, even if an individual is not planning to receive a distribution of employer securities for a number of years, it is important for the individual or the plan sponsor to keep an accurate record of his basis if this capital gain treatment might later apply.

A lump-sum distribution is defined in Sec. 402(e)(4)(D) as a distribution of an entire account balance under the plan within one tax year of the recipient's death, attainment of age 59 1/2, termination of service or disability. For this purpose, all pension plans maintained by the same employer...