IRS Rules for a 457 Rollover to a Roth IRA

Government and nonprofit employers can set up 457 retirement plans that allow employees to contribute pretax earnings. The contributions can grow tax-deferred within the plan. You must pay taxes on 457 plan withdrawals at your marginal tax rate, but, unlike with other employer savings plans and individual retirement accounts, there are no penalties for removing money before age 59 1/2. The Internal Revenue Service has rules that govern a 457 plan rollover to a Roth IRA.

TL;DR (Too Long; Didn't Read)

There are zero penalties for withdrawing from a 457 plan early, but you must pay taxes on the money withdrawn, possibly higher than you want to pay.

Taxes on Rollovers to a Roth IRA

The IRS calls the amount of your rollover into a Roth IRA a "conversion contribution." Such contributions are not tax-deductible and normally incur taxes. When you roll over a 457 plan, portions of the money may have already been taxed.

You must include only the untaxed portion of the rollover money in your ordinary income for the rollover year. In addition to cash, you may roll over property as long as it’s the same property you held in the 457 plan. You use IRS Form 5329 to figure the taxable amount of your rollover.

Different Rollover Methods

The IRS allows two rollover methods for rolling over a 457 plan to a Roth IRA. You can siphon amounts from your 457 plan and, within 60 days, contribute them to a Roth IRA. Your employer must withhold 20 percent of this amount for taxes. The second method is the direct rollover option. All 457 plans must allow a direct transfer of the rollover amount to your Roth IRA trustee. This method requires no tax withholding and is not subject to the 60-day deadline.

Roth 457 Plans

Thanks to the Small Business Jobs Act of 2010, employers can set up Roth-style 457 plans. Contributions to these plans are not tax-deductible, and you don’t create taxable income when you rollover a Roth 457 plan to a Roth IRA. When you make this type of conversion, you become liable for a 10-percent penalty on withdrawals of earnings prior to age 59 1/2.

On the plus side, you're no longer required to take required minimum distributions after age 70 1/2.

Items to Consider

You need to prepare for an income bump and higher taxes when you convert from a tax-deferred 457 plan to a Roth IRA. The taxable amount of the bump includes the deductible contributions and earnings portions of the rollover. If you are doing a partial rollover, you must prorate the percentage on non-deductible contributions to the conversion amount, using IRS Form 5329. You cannot roll over any amounts needed for a required minimum distribution from your existing plan.

Qualified withdrawals from your Roth IRA are tax-free, and you never need to make withdrawals.

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