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457b To Ira

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On Jan 2006 a person retired from her non-governmental employment at age 62 and decided to rollover her 457b into a traditional IRA. She then starts collecting Social Security benefits. At the end of 2006 she received a W-2 form from her employer where the rollover distribution is reflected as Earned Income under box 1 of the W-2. She files her income tax return and pays taxes on the amount of the rollover distribution. Box 11 of the W-2 did reflect the amount of the Nonqualified plan.

 

The Social Security Administration is now saying that she does not qualify for social security benefits because she had earned income in 2006, when in reality this money was rolled over to an IRA.

 

Should she had left the money in the 457b instead of rolling it over to an IRA? What can she do now to continue receiving social security benefits? Should the employer take the money back into the 457b plan and amend the W-2?

 

Thank you.

 

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On Jan 2006 a person retired from her non-governmental employment at age 62 and decided to rollover her 457b into a traditional IRA.

I am so sorry to tell you this.

 

Payments from a non-governmental 457(b) plan are not eligible for rollover to an IRA or to any qualified plan. These payments are considered wages, and as you know, your wages are not rollover eligible! Whoever gave her the advice to roll over that money was giving very bad advice indeed. Instead, this was technically an IRA contribution, which certainly exceeded the IRA contribution limits for that year. You have a much bigger problem on your hands due to that terrible advice.

 

 

Should she had left the money in the 457b instead of rolling it over to an IRA?
The money should not have gone to an IRA. Leaving the money in the 457(b) plan is an entirely different question. I may address that in a separate reply later.

 

 

What can she do now to continue receiving social security benefits?
If the social security administration counts 457(b) plan payments as earning income for eligibility purposes, then she will have to wait until she is eligible again. Check again with social security, I am not an expert in their rules regarding this.

 

 

Should the employer take the money back into the 457b plan and amend the W-2?
That is not an option and doing so would make matters even worse.

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Guest Sierra

Was the distribution check sent directly from the 457(b) Plan to the IRA Custodian or to the employee.

 

Joel

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Should she had left the money in the 457b instead of rolling it over to an IRA?
Leaving the money in the 457(b) plan is an entirely different question. I may address that in a separate reply later.

 

 

Okay, here goes: leaving the money in a 457(b) plan requires pre-planning if the 457(b) plan is sponsored by a non-government employer. It is not quite as simple as just leaving it in the 457(b) plan. But it can be done. The comments below are specifically directed toward a 457(b) plan sponsored by a tax-exempt company, not a government or government agency sponsored 457(b) plan.

 

First, the 457(b) plan's document should have some language in it that spells out when the amount becomes eligible for payment. If that date has already been reached, then the payable amount is taxable to the participant, even if no payment is made! That's the constructive receipt rule.

 

So, to avoid being required to have the amount taxable right away, most well-drafted 457(b) plan documents have a provision that requires a delay - to not allow immediate payments after the employee leaves. Instead, these documents have provisions that make the employee wait until an initial deadline, usually a couple months or so after leaving employment, before the amount becomes initially eligible for payment.

 

During those couple of months or so, before this initial deadline is reached, well-drafted 457(b) plan documents allow the participant to make an election to delay their payment eligibility date to an even later date. To do this, the participant would make a written election that specifies a new date in the future by when their 457(b) account will be eligible to be paid. The participant must make that election before the initial deadline date, and once their election is made and the initial deadline is reached, then they cannot change their mind and take the money earlier than the new deadline date as elected (they cannot accelerate the payment).

 

In addition (I'm sure this is already more than you wanted to know, but I can't stop myself), many 457(b) plans also allow one more election to delay (only one additional election is allowed). Just like their first election, this election to delay must be made before that new date gets reached. This election now establishes the final date by which their payments will become eligible for payment. Again, once this election is made and their first elected deadline is reached, then the participant cannot change their mind to take the money earlier (they cannot accelerate the payment).

 

Keep in mind, you cannot delay beyond age 70.5. Also, the assets of a 457(b) plan sponsored by a tax-exempt plan sponsor are considered employer assets and cannot be held in a protected trust (thus paid as W-2 not as 1099-R). That means those assets are subject to the claims of creditors. So, electing to delay the payment could have consequences if the sponsor has financial problems in the future sometime before the 457(b) payment is finally made.

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Guest Sierra

John,

 

Assume an account balance of $300,000. You use the word "payment". A single payment leads to a massive tax bill. Don't the Rules allow for a series of payments like over the life expectancy of the individual?

 

Thanks,

Joel

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Was the distribution check sent directly from the 457(b) Plan to the IRA Custodian or to the employee.

 

Joel

 

 

The distribution was sent to the IRA Custodian. The check was payable to the IRA Custodian. Check was endorsed by the IRA Custodian and was then given to the employee.

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If you mean: 5-year averaging type rules, the answer is no. These 457(b) payments are considered W-2 wages and you cannot average your wages for tax purposes (unless your income is from schedule F and you are a farmer).

 

If you mean: could the 457(b) plan have provided for other payment options, not just a lump sum option, then the answer is yes. So, did the plan offer these options? Did the participant elect one of those options? What do the plan provisions require as a default form of payment when no option is elected by the participant? All of these will require knowledge of the specific 457(b) plan's language and the decisions made by the participant. Let's see what the original poster responds with.

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Guest Sierra

John:

 

I said nothing about five years.

 

I asked you if a series of payments over life expectancy is allowed.

 

Thanks,

Joel

 

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Joel, I believe that was answered: "Could the 457(b) plan have provided for other payment options, not just a lump sum option, then the answer is yes. So, did the plan offer these options? Did the participant elect one of those options?"

 

So, yes, a series of payments can be listed as an optional form of distribution in the 457(b) plan document (and sometimes it is the default payment option). Again, this is regarding a 457(b) plan sponsored by a tax-exempt (nongovernmental) employer. Unfortunately, it does not look like the participant elected that option (or that plan did not have that option) and now that the payment date has occurred, so it's too late to change that.

 

Joel, MTZ has responded to your question about the distribution check, I'm curious what you'll recommend with that. I'm not sure what is meant by the last comment stating that the check was then handed over to the employee. Any ideas for correcting this?

 

I am guessing that the "correction" is to pay the taxes on the W-2 wages as would be expected, and to also do a correction regarding the excess IRA contribution (I am assuming the money went into an IRA, but that's not entirely clear to me now).

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Guest Sierra

 

Was the distribution check sent directly from the 457(b) Plan to the IRA Custodian or to the employee.

 

Joel

 

 

The distribution was sent to the IRA Custodian. The check was payable to the IRA Custodian. Check was endorsed by the IRA Custodian and was then given to the employee.

 

 

MTZ: Something is not right. If the check was payble to the IRA Custodian why was it not invested by the Custodian? Why did the Custodian endorse the check only to give it to the employee? What did the employee do with the check? In order for this account to be an IRA the check had to be endorsed by the Custodian and cashed and invested pursuant to the employee's instructions. Please clarify all of this for us.

 

Joel

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Guest Sierra

 

 

Was the distribution check sent directly from the 457(b) Plan to the IRA Custodian or to the employee.

 

Joel

 

 

The distribution was sent to the IRA Custodian. The check was payable to the IRA Custodian. Check was endorsed by the IRA Custodian and was then given to the employee.

 

 

MTZ: Something is not right. If the check was payble to the IRA Custodian why was it not invested by the Custodian? Why did the Custodian endorse the check only to give it to the employee? What did the employee do with the check? In order for this account to be an IRA the check had to be endorsed by the Custodian and cashed and invested pursuant to the employee's instructions. Please clarify all of this for us.

 

Joel

 

 

MTZ: Are we not entitled to a clarification?

 

Joel

 

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