Rules for the Partial Conversion of a 457 Plan to a Roth IRA
Working for a government agency or a tax-exempt organization means you might have money squirreled away for retirement in a 457 plan. If you'd prefer to pay taxes now and get your retirement withdrawals out tax-free, you might be able to move your nest egg to a Roth IRA. Only eligible distributions can be converted, but there are no restrictions on how much or how little you can convert at a time.
Only eligible distributions from a 457(b) plan can be converted into a Roth IRA. Only distributions from your 457(b) taken after you've left the employer sponsoring the plan can be rolled over -- hardship distributions aren't eligible even if the hardship is taken care of first. Also, you're not allowed to roll over required minimum distributions. If you have a 457(f) plan, you're not allowed to convert those funds at all -- those plans are ineligible.
Your 457(b) plan offers pretax savings, which means you've never paid taxes on the money in your account. Roth IRAs, of course, are funded with after-tax dollars, because they offer the promise of tax-free distributions. So, when you make a conversion of part of your 457(b) plan to your Roth IRA, Uncle Sam requires that you pay taxes on that money. For example, if you convert $10,000, you must report an extra $10,000 in income that year on your taxes. So, it's often best to convert in a year you fall in a low income tax bracket.
In some cases, you might not want to sell your assets in your 457(b) plan before converting them to your Roth IRA. If so, that's not a problem. The IRS rules allow you to convert cash or property from your 457(b) plan to your Roth IRA. Even if you receive both cash and property in the distribution from the 457(b) plan, you're allowed to roll over all or a portion of the cash, all or a portion of the property or any mixture of the two. However, if you receive property as part of the distribution, you must roll over the same property. You're not allowed to roll over other property instead, even if it has an equal value.
You can convert your eligible 457(b) plan distributions to a Roth IRA with either a transfer or a rollover. For several reasons, the transfer is the simpler method. With a transfer, you tell your financial institution where to move the money, and it takes care of the rest -- and there's no withholding. With a rollover, you take a distribution from your 457(b) plan and then deposit it in your Roth IRA no more than 60 days later. Besides the danger of missing the deadline, 20 percent of your distribution is withheld for taxes, so if you want to roll over the entire amount, you have to come up with extra cash out of your own pocket.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."