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Deferred Compensation: Governmental 457 Plan Rollovers

Prior to the Economic Growth & Tax Relief Reconciliation Act (EGTRRA), if you wanted to keep your 457 savings growing tax deferred after you left your job, you only had two options: a) leave your plan with your former employer, or b) transfer it to another 457 plan if you want to work for another government employer. 

In 2001, EGTRRA was signed into law providing portability provisions for governmental 457 plans (the new portability provisions did not include non-governmental 457 plans).

If you have a 457 deferred compensation plan with a government employer, you are now eligible to roll over distributions tax free to a traditional IRA, as well as to a 401(k), 403(b), or 457 governmental plan that accepts rollovers.

EGTRRA also allows you to roll over eligible distributions tax free from a 401(k) or 403(b) plan to your governmental 457 plan, providing your 457 plan accepts rollovers. The law allows you to roll over taxable amounts from your traditional IRA (but not any nondeductible contributions you made) to your governmental 457 plan.

Frequently asked questions:

Q: What distributions are eligible for rollover from my governmental 457 plan to a traditional IRA, or 401(k), 403(b) or 457 governmental plan that accepts rollovers?
A: In general, you can roll over distributions from your governmental 457 plan when you change jobs or retire, or distributions from a 457 plan you left with a former government employer. However, there are two major exceptions: 1) you can't rollover distributions you've already started receiving as equal periodic payments over ten years or more, or started receiving as annuity payments over your lifetime, and 2) you can't roll over required minimum distributions you've started receiving because you are age 70 1/2.

Q: What are the advantages of the rollover rules?
A: The portability provisions allow you to consolidate your retirement accounts. Consolidating your savings streamlines your paperwork, makes it easier to develop and maintain your investment plan, and simplifies your required minimum distribution calculations when you reach age 70 1/2.

Depending on the features of your governmental 457 plan, having the option to roll over your savings to a different types of retirement plans may offer you a broader selection of investment options. In particular, IRAs allow you to invest in most types of savings and investment stocks and bonds.

Traditional IRAs may offer you and your beneficiaries more flexible and tax-favored distribution options at your retirement or death. If you are still working, you can continue to contribute to a traditional IRA until age 70 1/2.

Furthermore, if you're eligible, rolling over your governmental 457 plan to a traditional IRA gives you the option of converting your savings to a Roth IRA. You can convert your traditional IRA to a Roth IRA if your modified adjusted gross income in the year you convert is less than $100,000. Unlike traditional IRAs, Roth IRAs allow tax-free withdrawals for qualified distributions, and you are not required to take required minimum distributions at age 70 1/2. Note: You will owe taxes at your regular income tax rate on the amount you convert.

Q: What should I consider before rolling over my retirement savings?
A: Before moving your savings to any new plan, compare the costs, services, investment choices, and distribution options. Also check if you're subject to surrender fees or contingent deferred sales charges.

In addition, get the details about each plan's restrictions since your savings will be governed by the rules of your receiving plan. For instance, if you roll over your traditional IRA to a 457 governmental plan, you generally cannot make withdrawals unless you leave your job or retire, reach age 70 1/2, or meet the strict definition of an unforeseeable emergency. In contrast, you are free to make withdrawals anytime from your IRA, even though you have to pay the federal income taxes owed and any 10% early withdrawal tax. However, rolling over your traditional IRA or employer retirement plan to your governmental plan doesn't mean these assets are no longer subject to the 10% early withdrawal tax. Governmental 457 plans, which don't impose the early withdrawal tax, are required to record these rollover assets separately so they will continue to be subject to the 10% tax. Furthermore, if you roll over your governmental 457 plan to a traditional IRA, 401(k), or 403(b) plan, your 457 savings becomes subject to those plans. Consequently, you'll incur the 10% early withdrawal tax if you make withdrawals before age 59 1/2, unless an exception applies.

For 401(k) and 403(b) plans, the exceptions to the 10% early withdrawal tax include withdrawals you make when you separate from service during the year of your 55th birthday or later, or distributions you take as part of an IRS-defined series of substantially equal periodic payments. Exceptions also include withdrawals you make if you become permanently disabled, or for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income.

For IRAs, exceptions to the 10% early withdrawal tax include distributions you take as part of a series of substantially equal periodic payments, or withdrawals you make in the event of your permanent disability. Exceptions also include withdrawals for qualified higher education expenses, qualified first-time homebuyer expenses, unreimbursed medical expenses that exceed 7.5% of your adjusted gross income, or medical insurance premiums when you have received unemployment compensation for 12 or more weeks.

Q: What's the best way to roll over my governmental 457 savings?
A: You are able to make a direct trustee-to-trustee rollover from your governmental 457 plan to a traditional IRA or eligible retirement plan. With this direct rollover option, the distribution check is made payable to your IRA custodian or new employer plan trustee, so you'll avoid triggering current income taxes.

If you don't go the direct route, you'll receive a check payable to you and you'll have 60 days to reinvest your money in a traditional IRA or eligible retirement plan. Your check, however, will be reduced by 20% because federal tax law requires your former employer to withhold that amount as prepayment for federal income taxes. That's because the IRS assumes you're planning to cash out your governmental 457 plan, even if you aren't. So unless you come up with that 20% out-of-pocket and add it to your IRA or eligible retirement plan within 60 days, the 20% will be considered a withdrawal and you'll owe income taxes on the distribution. If you add back the 20%, the IRS will refund that amount, but only after you file your tax return for the year and show you're due a refund. 

You have many choices concerning your retirement plans and may have questions on what is right for you. The Investment & Retirement Services, located at CDC FCU, can help. For more information, contact Howard Brown, the CDC FCU Investment & Retirement Services Representative at 678-553-5328 or email to set up an appointment. 

This article is intended only to provide general information and is not intended to provide legal or tax advice. Please contact your tax advisor for complete information and assistance. 

Representatives are registered, securities are sold, and investment advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor, 2000 Heritage Way, Waverly, Iowa 50677, toll-free (866) 512-6109. Nondeposit investment and insurance products are not federally insured, involve risk, may lose value and are not obligations of or guaranteed by the financial institution. CBSI is under contract with the financial institution, through the financial services program, to make securities available to members. 

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