From the January 2007 issue of Investment Advisor • Subscribe!

January 1, 2007

How Incorrect Advice Can Hurt

Employees lost a big chunk of their retirement savings to taxes after relying on incorrect advice after following their company's Summary Plan Description (SPD) and a financial advisor counseled company employees that partial distributions would qualify for a net unrealized appreciation (NUA) tax break. This advice was wrong.

Employees were told partial distributions would qualify for the NUA, which allows employees to receive an in-kind distribution of their company's stock from the retirement plan and pay income tax only on the average cost basis of the shares, rather than on the current market value. However, the distribution must have been a lump-sum distribution to qualify for NUA, not a partial distribution according to IRS rules (See IRS private letter rulings 200634017, 200634018, 200634019, 200634020, 200634021, 200634022 released August 28, 2006).

By not recognizing this devastating mistake, all of the stock withdrawn was taxable and all at ordinary income tax rates (plus a 10% penalty for any employees under age 59 1?,,2) causing a significant loss of these employees' retirement funds to immediate taxation.

Upon being informed that they did not qualify for the NUA tax treatment, the employees requested the private letter rulings from the IRS seeking relief under Revenue Procedure 2003-16, asking if they could have more time (to extend the 60 days) to roll the stock to an IRA. The employees told the IRS that they had relied on two different sources of advice that they believed were accurate.

However, even that appeal was not enough to bail them out. The IRS denied all of the requests, stating that there was never any intent on the part of the employees to do a rollover and therefore the employees did not qualify for relief. The employees lost a big chunk of their retirement savings to taxes--so you can only imagine the number of lawsuits likely to proceed against the company and the committee members for rendering improper advice or not following a prudent procedure to obtain competent advice.

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