457 Mandatory w/holding costing too much

[Theseus]

This could of, and almost did go to the pet peeve thread. DW and I ERd mid 2014 at age 58 and 8 months and 57 and two months, respectively. We have been using DWs 457 plan pre-59-1/2 exemption to supplement our pensions, which cover about 1/3 of expenses. This is all working out to plan, but the wrinkle I did not account for (purely due to my ignorance of it in the planning stage) was the mandatory 20% withholding rate on her 457 plan distributions. Normally I managed my payroll withholding to keep our taxes withheld very close to the taxes due, but intentionally let it run high last year while still working to compensate for the then future distributions. Net result was ~ $4k over withholding for 2014. That was my peeve, entirely my own mistake but paying taxes on those extra distributions in our last high income year just wasn't smart. Hopefully someone else might learn from my mistake.

So, DW will be 59-1/2 next month. Right now I am planning on rolling her 457 balance over to an IRA that will allow either 10% withholding as the default, or 0% if I select that and make quarterly payments. YTD withholding is already very close to our calculated net 2015 tax bill after trimming the gross distributions down to reflect not overpaying. I anticipate having more precise control of distributions from an IRA, and leaving amounts budgeted but not currently required, i.e. major home maintenance, vehicle replacement in the IRA where returns would presumably be better than in personal savings accounts.

Added bonus, providing it isn't scuttled by a SCOTUS decision, would be that reducing distributions would increase our ACA Premium Tax Credit at year end. Running the numbers, I find a potential for thousands in savings between federal and state taxes just for 2015, not counting PTC increase. I've already rolled my 401 to an IRA at TD Ameritrade, so I've got the mechanics of that down. DWs 457, and possibly her 403 as well could both be rolled over. A question I have for those who followed my convoluted explanation, are there any pitfalls to watch for when rolling over a 457?

[papadad111]

Is the 457 is a government one?

"Non-governmental 457 plans have a number of restrictions that governmental ones do not.

Money deferred into non-governmental 457 plans may not be rolled into any other type of tax-deferred retirement plan (IRA 401k etc). It may be rolled only into another non-governmental 457 plan. ".

[steelyman]

I'm glad you didn't post to the other thread, as your title makes clear what it's about (and easy to find).

It prompted me to check the rule for my 457 (a state plan), and it seems to have the same mandatory 20% withholding rule. I haven't run into that as I haven't asked for distributions.

I have been required to take distributions from an (inherited) IRA, and for that it was possible to set the withholding percentage, even at 0%. I told them to withdraw my effective tax rate, because I'd like to avoid filing quarterly estimated tax.

My 457 plan allows direct (trustee-to-trustee) rollovers to IRA accounts with no tax withheld - important, since an indirect rollover (as in, "they cut you a check") is subject to withholding.

[Theseus]

Quote:

Originally Posted by papadad111 Is the 457 is a government one?

Government, and plan materials do reference option of rollover.

[Theseus]

My intent will be to do trustee-to-trustee rollover. While the plan has a good website when it comes to managing the funds, reviewing history, transactions, etc. it is utterly frustrating when it comes to managing distributions. When we initiated distributions we had to do a phone call, and the apparently knowledgeable rep was so very agonizingly slow in explaining the details DW and I were in utter disbelief. And nowhere to be found on the website is any way to change distributions, or initiate a rollover, so we will need to call - not looking forward to that experience again. It was borderline being talked down to, although to give the benefit of the doubt probably just being overly conscientious about making sure we understood.

[skipro33]

Here is the 'trick' I used when I retired so the first year didn't get hit with the taxes drawn from my 457 account, where my last year's income included a cash payout for unused vacation.

I took a loan on my 457 just days prior to retirement. A loan draw did not trigger the 20% tax withholding as it's expected to be paid back in post-tax dollars. However, a loan on your 457, like a loan on a 401K, is considered due in full when you default on the loan by not having a payroll deduction in a few months. You don't actually have to pay it back, you borrowed it from yourself after all, but it is considered a draw at that time and you have to include the remaining loan amount as income. There is 'interest' that has accrued, but again; this is paid back to your own account. Also, a default on your own 457 due to retirement is not a detrimental thing. I talked to Fidelity, where the account is held, and they said to just let the process of a default work through and I'd receive the statement that the loan is now considered a draw in a few months.

There is a aviat though; if you need to draw from your 457 to pay the taxes now due on your last year's 457 loan that is now considered a withdraw and not a loan anymore, that draw will have the 20% withholding added.

Small price to pay IF you need to get the tax money that way.

In my case; I borrowed $20,000 from my 457 just prior to retiring in December of 2012. Upon my retirement, I was sent a 1099 I think that indicated the balance of the loan was now a draw. I filed this form with my taxes and paid taxes on this amount the next tax year.

One thing to consider; do not retire so close to the end of the year that any final compensation paid is received in the NEXT tax year. For example; you retire on Dec 27th 2012 and receive your final pay in January 2013. That final pay is taxed in 2014. If you did that AND had the loan taxed in 2014 as well, you would be right back in the same boat; paying too much income tax. Retire early enough in the year that your first full year of retirement is solely on your retirement income and your 457 loan taxes won't be any worse than a draw would be on any future year.

Hope that all makes sense!!

[Theseus]

Quote:

Originally Posted by skipro33 A loan draw did not trigger the 20% tax withholding as it's expected to be paid back in post-tax dollars. However, a loan on your 457, like a loan on a 401K, is considered due in full when you default on the loan by not having a payroll deduction in a few months. You don't actually have to pay it back, you borrowed it from yourself after all, but it is considered a draw at that time and you have to include the remaining loan amount as income.

Clever strategy! I think it did cross my mind to do that with my 401, but dismissed because it would have triggered a pre 59-1/2 penalty whereas as you point out defaulting on a 457 loan takes the bite out of that bark.

[karluk]

OP appears to have two fundamental problems with the 457 plan - poor customer service and mandatory 20% withholding. I certainly think that bad customer service is a very good reason to roll the 457 money into an IRA, but I know from personal experience that it's possible to avoid mandatory 20% withholding from 457 plan withdrawals by structuring the distributions properly. I've taken distributions from my 457 plan in three different ways and each method has different tax withholding rules. For me, a one time distribution had 20% withholding, my regularly scheduled monthly distributions have withholding controlled by the W-4 form info I filed with the plan administrator, and the rollover I made to a Roth IRA had no withholding.

So the rules on tax withholding are quite a bit more complicated than just saying all 457 plan distributions are subject to 20% withholding. There are enough exceptions to make it worthwhile to investigate one's options before rolling over the 457 into an IRA. I wouldn't give up my own 457 plan because I would lose the option to invest in the stable value fund the plan offers, so I feel quite fortunate to have found a way around the 20% withholding rule.

[Theseus]

Quote:

Originally Posted by karluk So the rules on tax withholding are quite a bit more complicated than just saying all 457 plan distributions are subject to 20% withholding. There are enough exceptions to make it worthwhile to investigate one's options before rolling over the 457 into an IRA. I wouldn't give up my own 457 plan because I would lose the option to invest in the stable value fund the plan offers, so I feel quite fortunate to have found a way around the 20% withholding rule.

The distribution options described in the plan imply rollover eligible funds might just as well be rolled in our case; "A mandatory 20% federal withholding tax applies directly to distributions taken that could be eligible for rollover." Step one completed today, verified with intended IRA trustee that no-withholding distributions were possible with them. Paperwork in the mail.

Stable Value option in the 457 has been providing a fair return and is tough to abandon, although I had 75% of the 457 funds in VIIIX which has provided a better albeit risky return. Easy enough to duplicate the institutional fund, but not so easy to get a decent return on investments being periodically cashed in for distribution. We initially set up monthly periodic payments of a period certain from the 457, but now that I'm seeing how our retirement budget has been playing out in real life quarterly distributions seem perfectly reasonable.

[karluk]

Quote:

Originally Posted by Theseus The distribution options described in the plan imply rollover eligible funds might just as well be rolled in our case; "A mandatory 20% federal withholding tax applies directly to distributions taken that could be eligible for rollover." Step one completed today, verified with intended IRA trustee that no-withholding distributions were possible with them. Paperwork in the mail. Stable Value option in the 457 has been providing a fair return and is tough to abandon, although I had 75% of the 457 funds in VIIIX which has provided a better albeit risky return. Easy enough to duplicate the institutional fund, but not so easy to get a decent return on investments being periodically cashed in for distribution. We initially set up monthly periodic payments of a period certain from the 457, but now that I'm seeing how our retirement budget has been playing out in real life quarterly distributions seem perfectly reasonable.

I am unable to tell from your post whether your 457 plan has any distribution options that bypass the mandatory 20% withholding. Perhaps the customer rep that you talked to simply was unaware of the tax withholding rules for various types of distributions.

For future reference, the language in your plan docs is simply echoing the IRS's own rules. In order to avoid 20% withholding, you need to follow the IRS's guidelines and pick a distribution option that makes the payments ineligible for rollover. Quoting from the following IRS link:

Quote:

Periodic payments include substantially equal payments made at least once a year over the life of the employee and/or beneficiaries or for 10 years or more. For wage withholding purposes, these payments are treated as if they are wages . You can figure withholding by using the recipient's Form W-4P

Pensions and Annuity Withholding

[Theseus]

Quote:

Originally Posted by karluk I am unable to tell from your post whether your 457 plan has any distribution options that bypass the mandatory 20% withholding. Perhaps the customer rep that you talked to simply was unaware of the tax withholding rules for various types of distributions. For future reference, the language in your plan docs is simply echoing the IRS's own rules. In order to avoid 20% withholding, you need to follow the IRS's guidelines and pick a distribution option that make the payments ineligible for rollover.

I do recall there was some discussion regarding how payments going beyond 10 years could be exempt, but since this account was primarily intended as a pre 59-1/2 distribution vehicle it only represents about 8% of our retirement funds so stretching it out that far doesn't provide enough current income. My 401 account is funded for the heavy lifting, and I've got about 18 month to go before 59-1/2. I had also checked the 403 plan, and it also calls for a 20% withholding so rolling DW's 457 over to an IRA seems to be the best option at this point. Will probably leave the 403 sit for now as it has a very good return on Prudential Guaranteed Investment for short term safety.