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Hello -

I have 457(b) deferred compensation plan from a previous (government) employer that I would like to rollover/convert into an existing Roth IRA account.

To the best of my knowledge, this 457 plan is “an eligible state or local government section 457 deferred compensation plan,” and therefore a “qualified retirement plan” for purposes of addressing eligible rollovers (per IRS Publication 575). My research indicates that I should be able to rollover/convert directly from a qualified employer sponsored plan to my Roth IRA custodian account via a “trustee to trustee” transfer. In other words, move the 457(b) funds directly into a Roth IRA without having to go through any additional interim steps. The amount transferred would be fully taxable as income (since the 457 funds were initially pre-tax). My understanding of this capability is based on the rollovers discussion in Pub 575, as well as from this chart (http://www.irs.gov/pub/irs-tege/rollover_chart.pdf) and other miscellaneous articles found from goggling the topic. I recall reading somewhere too that the rollover to Roth option is relatively new (2010?), as the original option to rollover that was established in 2001/2002 was limited to traditional IRAs at the time.

However, I contacted my Roth IRA custodian who told me that a direct rollover/conversion is not possible according to IRS rules, and that a 3-step process (i.e., 457 > Rollover IRA > Roth IRA) is required. While I can understand that certain custodians may not be set-up to handle the more direct 2-step process (and thus not allowed through that institution), the rep insisted that it is not allowed due to IRS restrictions. I next contacted the 457 plan custodian, who also said that the funds could only be rolled over to an IRA. But he also went on to say that I would need to recharacterize the funds and that these would count as contributions, blah blah...so I don’t think the 457 rep really knew what he was talking about.

My goal is to consolidate accounts by closing out the 457. I’d prefer the funds to go into my Roth IRA, rather than Traditional IRA. I don’t mind having to pay taxes on the 457 funds as income, but don’t want to pay any penalties (as for early withdraw, my age is under 55). Ultimately, I want the funds going into the Roth to be counted as a rollover or conversion (no limits) rather than a contribution (subject to annual contribution and income limits).

Can someone please clarify the tax rules on a 457 plan rollover or offer any insight for the conflicting information from account custodians?

Also, if I do have to go through the 3-step process, does the 457 rollover into the Traditional IRA (or even the Roth IRA) then use up my one rollover per year limit (assuming that I have only a single account for each type)? Also, is there any reason that I would want to track these rolled over funds separately (such as in a separate rollover IRA/Roth IRA under a different custodian)…any guidance?

TIA

MakingTrax
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But he also went on to say that I would need to recharacterize the funds and that these would count as contributions, blah blah...so I don’t think the 457 rep really knew what he was talking about.

Conversions and rollovers are not counted as contributions.

Also, if I do have to go through the 3-step process, does the 457 rollover into the Traditional IRA (or even the Roth IRA) then use up my one rollover per year limit (assuming that I have only a single account for each type)?

The one rollover limit only applies for non-Trustee to Trustee transactions. As long as you don't take control of the funds, they can be moved an unlimited number of times during a year.
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I have 457(b) deferred compensation plan from a previous (government) employer that I would like to rollover/convert into an existing Roth IRA account.

To the best of my knowledge, this 457 plan is “an eligible state or local government section 457 deferred compensation plan,” and therefore a “qualified retirement plan” for purposes of addressing eligible rollovers (per IRS Publication 575). My research indicates that I should be able to rollover/convert directly from a qualified employer sponsored plan to my Roth IRA custodian account via a “trustee to trustee” transfer. In other words, move the 457(b) funds directly into a Roth IRA without having to go through any additional interim steps. The amount transferred would be fully taxable as income (since the 457 funds were initially pre-tax). My understanding of this capability is based on the rollovers discussion in Pub 575, as well as from this chart (http://www.irs.gov/pub/irs-tege/rollover_chart.pdf) and other miscellaneous articles found from goggling the topic. I recall reading somewhere too that the rollover to Roth option is relatively new (2010?), as the original option to rollover that was established in 2001/2002 was limited to traditional IRAs at the time.


The timeline of changes in the law isn't important. Your understanding of current law is correct.

However, I contacted my Roth IRA custodian who told me that a direct rollover/conversion is not possible according to IRS rules, and that a 3-step process (i.e., 457 > Rollover IRA > Roth IRA) is required. While I can understand that certain custodians may not be set-up to handle the more direct 2-step process (and thus not allowed through that institution), the rep insisted that it is not allowed due to IRS restrictions.

Ah yes, blame the gummint. Back when I had to travel by air, yet still pre "treat all passengers as criminals" days, I got to the ticket lift at my connecting gate at DFW only to be informed that I had to check in again at the gate counter to have my ID checked. This even though I had been issued a boarding pass for the connecting flight at my originating airport.

Moi: "They could have told me this when I checked in at DCA."

Airline functionary: "It's a new government requirement."

Moi (loudly): "It's a new government requirement that American Airlines surprise its customers with the news when they've already stood in line to board? Show me that in writing."

I digress. The rep's performance is just validation of their fine print that you shouldn't rely on them for tax advice. What they leave out is the reason--they don't know their butts from second base.

I next contacted the 457 plan custodian, who also said that the funds could only be rolled over to an IRA. But he also went on to say that I would need to recharacterize the funds and that these would count as contributions, blah blah...so I don’t think the 457 rep really knew what he was talking about.

You're catching on.

My goal is to consolidate accounts by closing out the 457. I’d prefer the funds to go into my Roth IRA, rather than Traditional IRA. I don’t mind having to pay taxes on the 457 funds as income, but don’t want to pay any penalties (as for early withdraw, my age is under 55). Ultimately, I want the funds going into the Roth to be counted as a rollover or conversion (no limits) rather than a contribution (subject to annual contribution and income limits).

You have no need for concern. Do a direct rollover from the 457 to a traditional IRA at your Roth custodian. Then convert from the traditional IRA to the Roth. The premature distribution penalty doesn't apply to conversions. Contributions don't count against your contribution limit, and none of these actions counts as a rollover against the 1 in 12 months limit.

Also, is there any reason that I would want to track these rolled over funds separately (such as in a separate rollover IRA/Roth IRA under a different custodian)…any guidance?

Tax law doesn't care. There are some cases in which it might be to your advantage to parcel the money around If you tell us more about your plans for investing the money we could fine tune this for you.

Phil
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I found this subject very interesting, and had not heard of this as a possibility for 457 plans.

Thanks for bringing up this topic.
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Thanks for your input, Phil & vkg.

I'll make one more try through the Roth custodian so see if another rep might validate the 2-step process....otherwise, I'll go the 3-step approach as Phil suggests. Was just trying to avoid the additional (unnecessary) paperwork and move things along faster.

*************

From Phil's response:

Me: Also, is there any reason that I would want to track these rolled over funds separately (such as in a separate rollover IRA/Roth IRA under a different custodian)…any guidance?

Phil: Tax law doesn't care. There are some cases in which it might be to your advantage to parcel the money around If you tell us more about your plans for investing the money we could fine tune this for you.



Well, I don't foresee any possibility of rolling the 457-Roth funds into a future employer plan in the future....so no need to track that. Also, I don't anticipate any need to pull out the rolled/converted funds within in the next 5 years...so no need to track the holding time. Are there any other cases that would be relevant?



MakingTrax
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Well, I don't foresee any possibility of rolling the 457-Roth funds into a future employer plan in the future....so no need to track that. Also, I don't anticipate any need to pull out the rolled/converted funds within in the next 5 years...so no need to track the holding time.

Tax law doesn't care even if you were. I asked what you are planning to do, not what you aren't planning to do.

Let's say you're going to invest in five stocks. You buy them in the traditional IRA then convert into five Roth accounts, one for each stock. Come 10/1/2013 you see that three are winners and two are big losers. You can recharacterize only the losers, thus eliminating the "phantom" income from only those conversions. If everything's in one account you can't isolate just the loss for recharacterization.

Phil
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Oops. Forgot we're in 2013 already. Make that 10/1/2014.

Phil
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Phil -

Phil writes: I asked what you are planning to do, not what you aren't planning to do. Let's say you're going to invest in five stocks. You buy them in the traditional IRA then convert into five Roth accounts, one for each stock. Come 10/1/2013 you see that three are winners and two are big losers. You can recharacterize only the losers, thus eliminating the "phantom" income from only those conversions. If everything's in one account you can't isolate just the loss for recharacterization.

Ahh....that's the kind of stuff I'm interested in knowing about; it would not have occurred to me otherwise to consider multiple Roth IRAs. Can mutliple Roth accounts be held under one custodian or would those have to be established through separate custodians?

Anyway, to your question. My plan was to roll the cash (via the Traditional) into the Roth, and then purchase 3 or 4 stable dividend paying stocks within the Roth brokerage account. However, I may rethink my approach now. I already hold some stocks within my Traditional that I would prefer be held in my Roth. Your point makes me see two things: 1) there is no need to track the 457 funds beyond the intial rollover into a Traditional IRA, as the real tax strategy issue is associated with the conversion to Roth (which may include additional funds beyond the 457 amount); and 2) there is some benefit to opening a new Roth account (with the Traditional custodian) and moving/holding stocks/assets there for a year in case it makes sense to recharacterize at the end of the year. I can consolidate multiple Roths after the recharacterization window closes to simplify bookkeeping. (The custodians must hate people doing this!!) I had intended to convert other Traditional funds to Roth this year as well (in addition to the 457 funds). Rethinking it in these terms makes me not so grumpy about the additional step for the 457 rollover.

I need to revisit the mechanics of my plan. Thanks!


MakingTrax
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Can mutliple Roth accounts be held under one custodian or would those have to be established through separate custodians?

You can do it all with one custodian. They key is that in a recharacterization only the specific account's performance is part of the equation.

The unquoted part of your response tells me you've got the gist of it enough to analyze your particulars, but feel free to come back for more help or a sanity check. You commented that custodians must hate this, which raises the point to make sure you check about fees, both transaction and maintenance. My custodian charges no maintenance fees or fees for conversions or recharacterizations, but these can eat up a lot of gain in a hurry with some custodians. Checking up on that beforehand is part of your due diligence.

Phil
Rule Your Retirement Home Fool
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I can consolidate multiple Roths after the recharacterization window closes to simplify bookkeeping. (The custodians must hate people doing this!!) I had intended to convert other Traditional funds to Roth this year as well (in addition to the 457 funds).

There is no legal reason why an IRA custodian could not open multiple ROTHs for a customer, but they may not allow it.

Check the fees involved.
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vkg -

Yes, I've already had the run in with what is "legally" allowed versus what the custodians are willing to do...as witnessed with the whole 457-straight-to-Roth process.

As a side note, maybe it was a good thing that the custodians were initially uncooperative ....otherwise I would not have probed further and would have overlooked these other options/strategies. Lemonade in January!

MT
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