457 Deferred comp plan: Withdraw or convert to IRA?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
Bambuk
Posts: 50
Joined: Sun Apr 05, 2015 9:34 pm

457 Deferred comp plan: Withdraw or convert to IRA?

Post by Bambuk »

Mother with a child, left her job last year, no income in 2021.
She has some $40,000 in her job's 457b plan.
I am pretty sure she can withdraw any amount without penalty.

What would be best strategy to withdraw the money and to pay as little taxes as possible?
The money then will probably be invested in some precious metals or commodity fund.

I played with the tax calculators and it looks like if she withdraws around $18-19K - the tax impact will be minimal.


So one of the option would be to withdraw $19K this year and the rest in 2022.

Another possibility is to transfer all the funds to IRA and then convert $19K to Roth IRA this year and the rest next year.

So my questions would be:
1. Will those two ways (withdrawing vs Roth IRA) result in the same tax bill or refund?

2. Will she be allowed to convert to ROTH without any income?

3. What am I missing or any other suggestions?

Thanks.
mhalley
Posts: 9066
Joined: Tue Nov 20, 2007 6:02 am

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by mhalley »

Does she need income? In most cases, letting retirement accounts grow until retirement is the way to go. I like the Roth conversion strategy. You don’t need income to convert to a Roth, only to contribute. Will she be re entering the work force next year?
Also, bogleheads are not too keen on commodity and metal funds. See the three fund portfolio.
https://www.bogleheads.org/wiki/Three-fund_portfolio
User avatar
willthrill81
Posts: 25449
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by willthrill81 »

The ability to make penalty-free withdrawals from a 457 plan should not be discarded by converting the funds to an IRA unless the 457 plan's fees are severe.

If she needs the money, then withdrawing just enough from the 457 plan to cover her standard deduction would result in zero federal income taxes. This could be done for future tax years also.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
User avatar
arcticpineapplecorp.
Posts: 8512
Joined: Tue Mar 06, 2012 9:22 pm

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by arcticpineapplecorp. »

Bambuk wrote: Tue Sep 14, 2021 10:21 am Mother with a child, left her job last year, no income in 2021.
She has some $40,000 in her job's 457b plan.
I am pretty sure she can withdraw any amount without penalty.

What would be best strategy to withdraw the money and to pay as little taxes as possible?
The money then will probably be invested in some precious metals or commodity fund.

I played with the tax calculators and it looks like if she withdraws around $18-19K - the tax impact will be minimal.


So one of the option would be to withdraw $19K this year and the rest in 2022.

Another possibility is to transfer all the funds to IRA and then convert $19K to Roth IRA this year and the rest next year.

So my questions would be:
1. Will those two ways (withdrawing vs Roth IRA) result in the same tax bill or refund?

2. Will she be allowed to convert to ROTH without any income?

3. What am I missing or any other suggestions?

Thanks.
1. if she converts from pretax 457b to pretax IRA there is no taxes owed.
2. she can convert from pretax 457b to Roth IRA (really 457b to rollover (pretax) IRA...THEN from rollover IRA to Roth IRA) but will owe tax on the entire amount converted because any amount converted will be counted as income in the year it's converted.
3. you can spread out the conversions over years to lessen the tax impact (if it results in a lesser overall amount of tax owed)
4. yes you can convert to Roth without any income. You need income to CONTRIBUTE to a Roth, not to CONVERT to a Roth. A conversion is not considered a contribution.
5. don't invest in a precious metal or commodity fund. Commodities have had higher risk for which was not rewarded in the past. In addition, how was the money invested in the 457b? If it was in stocks and bonds, why would you invest it differently just because it's in a Roth after conversion? Sure you could invest more in stocks in Roth than was true in 457b (if she doesn't need the money) for higher growth, but I wouldn't trade stocks for precious metals/commodities unless you have some compelling reason to do so that I'm missing.

if the goal is to pay as little as tax as possible, you'd roll over to pretax acct. No taxes owed! (until RMDs). Then you could convert at low rates depending upon what other income she has and how long you take to do the conversions (how much income you're creating through conversions).

does that help?
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events.
pizzy
Posts: 99
Joined: Tue Jun 02, 2020 6:59 pm

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by pizzy »

"The money then will probably be invested in some precious metals or commodity fund."

If that's the case, leave it in the 457
Topic Author
Bambuk
Posts: 50
Joined: Sun Apr 05, 2015 9:34 pm

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by Bambuk »

She has some savings that should pay for her expenses for several years - so these 457b money can be invested for long term.
So everyone seems to agree that converting to ROTH won't result in higher taxes and that she is allowed to do this.
Thanks everyone.

I am trying to figure out the optimum withdrawal or conversion amount for her situation (one dependent).
She lives in NYC and local deduction seems to be around $12K while Federal is around $18K.
Are there any Federal tax credits in play that would make withdrawing $19K and paying extra NYC taxes a better choice than withdrawing $12K and not paying local taxes?

Also, she is getting $300 monthly for a child. Will this income be included in her 2021 income?

Also will converting to Roth IRA be treated any different than simply withdrawing when calculating Tax credits?
pizzy
Posts: 99
Joined: Tue Jun 02, 2020 6:59 pm

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by pizzy »

I feel like you are trying to solve for a problem that doesn't exist.

Unless you are just trying to play financial advisor with someone else's 457, I don't see the reasoning behind withdrawing the money at all.

Can you elaborate on why this person wants to withdraw the money?
User avatar
willthrill81
Posts: 25449
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by willthrill81 »

Bambuk wrote: Tue Sep 14, 2021 10:49 am She has some savings that should pay for her expenses for several years - so these 457b money can be invested for long term.
So everyone seems to agree that converting to ROTH won't result in higher taxes and that she is allowed to do this.
Thanks everyone.

I am trying to figure out the optimum withdrawal or conversion amount for her situation (one dependent).
She lives in NYC and local deduction seems to be around $12K while Federal is around $18K.
Are there any Federal tax credits in play that would make withdrawing $19K and paying extra NYC taxes a better choice than withdrawing $12K and not paying local taxes?

Also, she is getting $300 monthly for a child. Will this income be included in her 2021 income?

Also will converting to Roth IRA be treated any different than simply withdrawing when calculating Tax credits?
Why this obsession with converting to Roth? Almost all of those without a pension would benefit from having some tax-deferred assets in retirement.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
Topic Author
Bambuk
Posts: 50
Joined: Sun Apr 05, 2015 9:34 pm

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by Bambuk »

pizzy wrote: Tue Sep 14, 2021 11:04 am I feel like you are trying to solve for a problem that doesn't exist.

Unless you are just trying to play financial advisor with someone else's 457, I don't see the reasoning behind withdrawing the money at all.

Can you elaborate on why this person wants to withdraw the money?
She left her job and she doesn't feel comfortable to keep the money there.
Topic Author
Bambuk
Posts: 50
Joined: Sun Apr 05, 2015 9:34 pm

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by Bambuk »

willthrill81 wrote: Tue Sep 14, 2021 11:18 am Why this obsession with converting to Roth? Almost all of those without a pension would benefit from having some tax-deferred assets in retirement.
She might be getting income when she retires.
Converting to ROTH IRA now and not paying any taxes on the conversion would mean she will never have to pay any taxes on investment income.
Unlike keeping them in simple IRA and then potentially paying some taxes later.
User avatar
willthrill81
Posts: 25449
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 457 Deferred comp plan: Withdraw or convert to IRA?

Post by willthrill81 »

Bambuk wrote: Tue Sep 14, 2021 11:33 am
willthrill81 wrote: Tue Sep 14, 2021 11:18 am Why this obsession with converting to Roth? Almost all of those without a pension would benefit from having some tax-deferred assets in retirement.
She might be getting income when she retires.
Converting to ROTH IRA now and not paying any taxes on the conversion would mean she will never have to pay any taxes on investment income.
Unlike keeping them in simple IRA and then potentially paying some taxes later.
If she can easily do a Roth (a name, not an acronym, so it shouldn't be capitalized) conversion and pay no income taxes on the conversion, that's perfectly plausible approach. But that might be a big 'if'.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
Post Reply