Q.: Over lunch the other day, a co-worker mentioned that he was converting money from his pre-tax 457(b) account to his Roth 457(b) account. This is all new to me. Can you clarify? S.C.

A.: Your colleague is referring to an In-Plan Roth Conversion from your pre-tax 457(b)/401(k)Plan account. Regardless of age or employment status, if you have a pre-tax account you may convert all or a portion of it to the after-tax Roth feature. These conversions are taxable events. Check with your tax adviser as to how you should pay the tax. In-Plan Roth Conversions are done inside the plan and may be just what the doctor ordered for you to have tax-free income during retirement.

The following disclosure comes from the Deferred Compensation Plan of the State of New York:

An In-Plan Roth Conversion from your pre-tax plan account involves complex income-tax issues. The following lists some, but not all, of the issues you must consider before submitting the In-Plan Roth Conversion Form.

  • Amounts held in a Roth 457 contribution account or an outstanding loan account are not eligible.
  • Only a plan participant, a surviving spouse of a plan participant or a spousal alternate payee of a plan participant is eligible.
  • Distributions may be partial lump sums, subject to plan limits.
  • The amount of the In-Plan Roth Conversion will be reported as taxable income in the year of the conversion and you will be responsible for paying income taxes on this amount. The plan can only withhold for taxes if you are eligible to receive distributions and if so instructed.
  • You should consult with your tax professional to understand the impact this transaction would have on estimated federal and state tax payments, overall change in tax liability, availability of funds to pay the taxes and any other related issues. The increase in your reportable taxable income may have other financial impacts that you should consider.
  • The In-Plan Roth Conversion will be separately shown on your plan records. However, the balance will be subject to Required Minimum Distribution rules.
  • Certain amounts may be subject to a federal Special Recapture Tax of 10% if withdrawn prior to the fifth anniversary of the In-Plan Roth Conversion. This rule is separate from the five-year rule to determine if a distribution is considered qualified for other tax purposes. Please consult your tax advisor to determine whether this tax would be applicable.
  • Once an In-Plan Roth Conversion has been processed, it cannot be reversed. The plan can make no exceptions to this rule. By comparison, conversion of an IRA account is not subject to this rule. By executing this form, you are acknowledging your understanding of the tax implications of the transaction and have consulted with appropriate advisers. The plan does not provide legal or tax advice.

Mr. Frank is a fee-only Retirement Financial Planner and a retired city high school Teacher of Accounting. He can be reached by phone at (732) 536-9472, or via email at rollover@optonline.net.

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