Pre-Tax Gov. 457B to Post Tax 457 Roth tax penalty question

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CluelessInvestor
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Joined: Wed Sep 10, 2014 1:18 am

Pre-Tax Gov. 457B to Post Tax 457 Roth tax penalty question

Post by CluelessInvestor »

Good evening,

I'm considering rolling a Gov. Pre-Tax 457B account into a newly offered plan by my employer called a Post-Tax 457 Roth account. What kind of tax penalties will I be facing? There's roughly 100K in pre-tax account. I would love to put it all in the Roth. I was told the rollover would be treated as taxable annual income for the year it was transferred. That would be a huge tax hit for me. If so, would it make more sense to let the old plan stagnate and start the Roth plan from scratch with future deferred compensation? Thank you.
Alan S.
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Re: Pre-Tax Gov. 457B to Post Tax 457 Roth tax penalty question

Post by Alan S. »

CluelessInvestor wrote: Mon Feb 03, 2025 7:31 pm Good evening,

I'm considering rolling a Gov. Pre-Tax 457B account into a newly offered plan by my employer called a Post-Tax 457 Roth account. What kind of tax penalties will I be facing? There's roughly 100K in pre-tax account. I would love to put it all in the Roth. I was told the rollover would be treated as taxable annual income for the year it was transferred. That would be a huge tax hit for me. If so, would it make more sense to let the old plan stagnate and start the Roth plan from scratch with future deferred compensation? Thank you.
You should not roll 100k of pre tax money into the 457b Roth even if you could, due to the tax hit you would incur.

However, the current 457b probably has an empty pre tax sub account with it. If so, and the plan allowed you could do a direct rollover of the former pre tax 457b into the pre tax account 457b in your new plan. From there, if the plan supports in plan Roth rollovers (IRRs), you could roll incremental smaller amounts each year into the Roth 457b. These IRRs would be taxable.

That said, if you do not need to do back door Roth IRAs for which a pre tax IRA balance would derail that option, it would be easier to roll the old pre tax 457b balance to a rollover IRA, from which you could do incremental Roth conversions while controlling your taxable income.

As you said, you could always leave the old 457b in place and make Roth 457b contributions to the new plan. But determine whether your MAGI will be too high for regular Roth IRA contributions or not. If not too high you do not need to do a back door Roth IRA.

There also may be other variables, such as determining if you can make pre tax 457b contributions since you probably would not benefit from going 100% Roth due to the impact of higher taxable income that will result.
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arcticpineapplecorp.
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Re: Pre-Tax Gov. 457B to Post Tax 457 Roth tax penalty question

Post by arcticpineapplecorp. »

Just a semantic correction: It's not a tax "penalty" per se. That penalty is for other plans (not gov 457bs) like 401ks where people might take money out of pretax 401k prior to 59.5 (some exclusions apply like the rule of 55, total disability, etc). This is just a tax (not penalty) that you'd have to claim the income converted from pretax to post tax just as you would have to pay the tax if you took money out of a 401k that was pretax (or converted from trad IRA to Roth IRA). In fact, the benefit of a government 457b is that actually there is NO 10% penalty for early withdrawals at all.

The question is "Is it worth it to convert ALL (or any) of the monies from pretax to Roth?"

You have to give more info to know.

For instance:

1. what is your marginal tax rate now (at which you'd pay the tax) vs. what would/could it be when you withdraw the money from pretax (via RMDs) later in life? If the marginal rate would be lower later on (as it is for most people) it doesn't pay to make the conversion now. It might make sense to make the conversion later (or some amount, or over time) when you're in a lower marginal tax bracket.

2. is it all or nothing? If you feel it's beneficial to convert, could you convert some amount (but not all)? Some people convert up to the top of their current marginal tax bracket, but not an amount that would push them into a higher bracket.

3. You can also leave the funds in pretax and do Roth conversions later while contributing new monies to Roth now (if that's better for some reason).

4. Often it's better to contribute to pretax rather than Roth (401k/45b, etc) and do Roth IRA contributions. That way you have the best of both worlds. It also let's you have tax diversification in retirement. And it allows for Roth conversions later on. If you convert now and decide it was a mistake (because you're in a lower tax bracket in retirement) you can't undo that. It's too late. But if you find the pretax money can be converted to Roth later (because it's more favorable then) you have that option.

5. It may not be a good idea to contribute to Roth 457b depending on your bracket now and also because while you have to take RMDs from your 457b (pretax) later, unless you will have millions in your pretax 457b in retirement, the RMDs are not likely to be of concern (i.e., they're not going to push you into a higher bracket). You do have to run the numbers to see what's more advantageous. For instance, I contribute pretax while I'm in the 22% bracket, but once I push my income down to the 12% then I contribute to Roth 457b (this is in addition to Roth IRA). I expect to be in a higher bracket in retirement due to SS and pension. But who knows? We don't know what tax rates will be decades from now, do we?

does that make sense?
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Topic Author
CluelessInvestor
Posts: 14
Joined: Wed Sep 10, 2014 1:18 am

Re: Pre-Tax Gov. 457B to Post Tax 457 Roth tax penalty question

Post by CluelessInvestor »

Thanks for the quick replies. It gives me a broader prospective to consider. I will have to evaluate my current and future marginal tax rate, MAGI and IRR options to make a more informed decision.
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