IRS Rules for a 457 Rollover to a Roth IRA

by Michael Keenan
Though you pay taxes on the conversion, future withdrawals might not be taxed at all.

Converting from a 457 plan to a Roth individual retirement account lets you shift your money from a pretax plan to an after-tax plan, which makes a lot of financial sense if you're expecting to pay a higher tax rate in retirement. The Internal Revenue Service has rules both for when you're allowed to make the conversion and for the taxes you must pay when you do convert.

Eligible Distributions

You're only allowed to roll over money from your 457(b) plan to a Roth IRA after you leave your job. If you're still working for the organization, you're usually not allowed to take distributions. Some 457(b) plans allow you to take hardship distributions while you're still working, but these withdrawals aren't eligible to be rolled into another plan, like a Roth IRA. If you have a 457(f) plan, you're not allowed to roll it into a Roth IRA because a 457(f) plan isn't a qualified plan.

Conversion Methods

If you're eligible, you can use either a rollover or a direct conversion to move your money to your Roth IRA. The downside to using a rollover is that your financial institution is required to withhold 20 percent of the distribution for taxes, even if you just want to roll the entire amount into your Roth IRA. So, to complete the transfer, you have to come up with that extra 20 percent out-of-pocket. Sure, you get the money back when you file your taxes, but that won't be in time to redeposit the money within 60 days. With a direct conversion, all the money is transferred straight to your Roth IRA.

Tax Implications

Converting money from your 457(b) plan to a Roth IRA means you're going to owe some taxes. Your 457(b) offers tax-deferred savings, which means that your distributions are taxable income. When you move the funds to a Roth IRA, you're moving it to an after-tax account. So, the amount of the conversion counts as taxable income. But, on the bright side, your future withdrawals from your Roth IRA won't be taxed at all, as long as you meet the two requirements to take a qualified withdrawal. First, you must have a Roth IRA that's open for at least five years before you take a distribution. The second criteria is usually met simply by turning 59 1/2, but you also meet it if you have exceptional situations, such as that you're permanently disabled or taking out up to $10,000 for a first home.

Tax Rates

The IRS doesn't have a separate tax rate for conversion income from moving money from a 457(b) plan to a Roth IRA. Instead, it just gets added to your other income for the year and taxed at your marginal rate. Therefore, you're usually better off converting in a year that you have a lower income. For example, if you're converting $10,000 in a year you fall in the 35 percent tax bracket, it'll cost you $3,500 in taxes. But, if you're only in the 15 percent bracket, it'll only cost you $1,500.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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