Roth vs. 457

[Frenchy1011]

I posed this question to my advisor, and was wondering if any of you had strong feelings one way or another. I am currently maxing out my employee 403(b) and my Roth IRA and Spousal IRA. I asked if I should be maxing out my tax-deferred 457 plan prior to maxing out my Roth's, or it is ok to max out the Roth's first.

 

He stated that if I am maxing out my 403(b), then it is a good idea to max out the Roth's first before the 457. He stated that the reasons for this are multiple. One, that there would be a mix of tax-deferred money as well as money that I've already payed taxes on when I retire. He said there is no required distribution to the Roth's, which is an advantage. When I asked him if it wouldn't be better to put money into a tax-deferred account like the 457 now because I am a high income earning professional and in a high tax bracket now, and will be in a lower tax bracket when that 457 money needs to be taxed in retirement? He said that no, in fact I am in the lowest tax bracket now than I will be for the rest of my life, even in retirement. He said that because of inflation, the taxes and brackets will be bound to go up (which makes sense). The part that doesn't quite make enough sense is that he stated that the 12K-ish that I am making currently on my income and the 6K (for example) that I would be using in retirement would still be taxed at the same tax bracket level (such as the 25% bracket). I find this hard to believe, but didn't know enough about that to respond adequately. Any thoughts or help? 457? Or Roth?

 

Thanks!

 

Stephen T.

[conniebird]

I would do Roth before 457, but ideally you'd do all 3...not one or the other. I max out a 403b, 457b, and a Roth IRA.

 

If it's a private 457b you'll need to make sure the distribution options upon separation are favorable...if not (i.e. lump sum only) then I would really pause before contributing to it.

[GXA]

Agree.  If you are already maxing out your Roth IRA, as you mention in your statement, I am a little confused about what Roth space you are considering.  Once you have maxed out your 403(b) and Roth IRA, your next tax deferred option would be your 457.

[Frenchy1011]

Thanks for the replies. I do think my 457 options are reasonable and it is not a lump sum payment.

And GXA, because I do not currently have enough to max out all three accounts, I was wondering if it was better to max out the 457 instead of the Roth or the Roth first and hold off on the 457 until I have some more ability to put money into that account. If that makes any sense haha.

[conniebird]

I vote Roth before 457b

[chansen]

A significant piece of this answer would be determined by your current tax bracket. You are correct, mathematically the largest determining factor between a Roth IRA and a tax deferred IRA (or 457) is current tax bracket versus future tax bracket. If I am in a 39.6% tax bracket today and plan on being in a 15 to 25% tax bracket in retirement, the 457 is the best answer.

If I were to make a SWAG at your current tax bracket, I would guess that you are in the 25% tax bracket. You mentioned a Spousal Roth , so you are married. Since your referred to it as a spousal IRA, I am assuming she is not working. You mentioned $12kish current income. If this is gross, you are earning $144,000 a year. This would put you in a 25% tax bracket. If that is the case, it is pretty much a wash.

Having a mix of taxable and tax free assets in retirement is great. It is one of the best ways to manage your post retirement taxes. But, if you truly believe you will be in a $6k retirement world, I would lean toward the 457. Keep the taxes in my pocket as long as possible. You’ll be in the 15% tax bracket in retirement. Yes the taxes will creep up but so will the brackets.

Another thing you always want to think through is how is your advisor being compensated. Anytime you are given advice, you should understand the possible motives of the advice. That is not to say that compensation always drives the advice, it is just good to understand. In your case, you are dealing with a commissioned salesperson. If you contribute to your 457 instead of your Roth IRAs, he doesn’t get paid. From your other posts, I would be very concerned that this is part of his reasoning.

[jfoxcpacfp]

First of all, it doesn't matter as much as you think what tax bracket you "plan on" being in when you retire. You will have some control over your income, but no control over the government definition of what is taxable and what isn't and at what rates. If you are a high earner, your marginal rate is 39.6% + state taxes unless you are living in one of the few no-tax states. (Of course, you're paying Medicare on top of that, but you'll pay that regardless.) That's a lot to give up. otoh, if you are in that rarified bracket, you should be able to easily fill out all tax beneficial space, so I'm not sure why you are experiencing such a dilemma.

Frenchy1011 wrote:

The part that doesn’t quite make enough sense is that he stated that the 12K-ish that I am making currently on my income and the 6K (for example) that I would be using in retirement would still be taxed at the same tax bracket level (such as the 25% bracket). I find this hard to believe, but didn’t know enough about that to respond adequately. Any thoughts or help?

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I confess to not knowing what you are talking about here. What 12k-is are you making currently on your income?

[Frenchy1011]

chansen wrote:

A significant piece of this answer would be determined by your current tax bracket. You are correct, mathematically the largest determining factor between a Roth IRA and a tax deferred IRA (or 457) is current tax bracket versus future tax bracket. If I am in a 39.6% tax bracket today and plan on being in a 15 to 25% tax bracket in retirement, the 457 is the best answer.

If I were to make a SWAG at your current tax bracket, I would guess that you are in the 25% tax bracket. You mentioned a Spousal Roth , so you are married. Since your referred to it as a spousal IRA, I am assuming she is not working. You mentioned $12kish current income. If this is gross, you are earning $144,000 a year. This would put you in a 25% tax bracket. If that is the case, it is pretty much a wash.

X

by TurboMac

Having a mix of taxable and tax free assets in retirement is great. It is one of the best ways to manage your post retirement taxes. But, if you truly believe you will be in a $6k retirement world, I would lean toward the 457. Keep the taxes in my pocket as long as possible. You’ll be in the 15% tax bracket in retirement. Yes the taxes will creep up but so will the brackets.

Another thing you always want to think through is how is your advisor being compensated. Anytime you are given advice, you should understand the possible motives of the advice. That is not to say that compensation always drives the advice, it is just good to understand. In your case, you are dealing with a commissioned salesperson. If you contribute to your 457 instead of your Roth IRAs, he doesn’t get paid. From your other posts, I would be very concerned that this is part of his reasoning.

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Thank you for this information. This is really informative. I am currently salaried at $175,000 yearly, so it comes to approximately $14,000 monthly after pre-tax deductions (403b and health/dental/vision and taxes). If I take an approximate 50% of that into retirement, that would be about $7,000. I am currently mostly in the 25% tax bracket with just a little of my income into the 28%. Thus the way I understand it that I will still most likely be in the 25% tax bracket in retirement.

 

Seems that I obviously should do both if I can afford it. Also, if it is a wash, then possibly fill my 403(b), and then try to fill my 457(b) and one of the Roth IRAs, instead of nothing in the 457 and maxing both Roths?

 

This is all great information and I greatly appreciate everybody's responses.

[artemis]

One thing that hasn't been mentioned yet is that there's a degree of risk in using a 457 plan; the money is technically not yours but belongs to your employer, and if your employer went bankrupt you could lose that money.  The risk is probably small, but it's real.  For that reason alone I'd be inclined to max out the Roths first.

[Frenchy1011]

artemis wrote:

One thing that hasn’t been mentioned yet is that there’s a degree of risk in using a 457 plan; the money is technically not yours but belongs to your employer, and if your employer went bankrupt you could lose that money. The risk is probably small, but it’s real. For that reason alone I’d be inclined to max out the Roths first.

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I have read that as well. Thanks for pointing that out. My employer is a very large hospital based Physicians Clinic with 21 clinics in the Nebraska/Iowa area, and don't anticipate it going bankrupt, but definitely something to keep in mind.

[chansen]

If it was me, I would max out the 457 and then the Roth IRAs. If you are in a 25-28% tax bracket now and expect to be in a 25% retirement than I would rather take the tax deduction today. Hang on to as much money as possible and look for ways to reduce taxes when you get to retirement. As you progress in your career, your income will go up. By the time you can afford to contribute to the Roth IRAs you probably will no longer be eligible. That's when you can contribute to an ordinary IRA, then after some time elapses decide if you want to convert it to a Roth IRA. At that point you are not giving up any current tax savings in hopes of future tax savings. That's when you start building your tax free assets.

Again, pretty much a tax wash between the two options. I just hate paying taxes today to avoid future taxes if there is not a large differential.

[Frenchy1011]

chansen wrote:

If it was me, I would max out the 457 and then the Roth IRAs. If you are in a 25-28% tax bracket now and expect to be in a 25% retirement than I would rather take the tax deduction today. Hang on to as much money as possible and look for ways to reduce taxes when you get to retirement. As you progress in your career, your income will go up. By the time you can afford to contribute to the Roth IRAs you probably will no longer be eligible. That’s when you can contribute to an ordinary IRA, then after some time elapses decide if you want to convert it to a Roth IRA. At that point you are not giving up any current tax savings in hopes of future tax savings. That’s when you start building your tax free assets. Again, pretty much a tax wash between the two options. I just hate paying taxes today to avoid future taxes if there is not a large differential.

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Thank you for this analysis. I agree completely, I see myself basically staying in the same tax bracket, and as a FM physician, I will most likely never reach a 39.6% tax bracket during working years and fall down to the 15-25% bracket in retirement. I will most likely be staying relatively in the same bracket. I actually think that the best option for me at this point would be to fill my matched 403b, max my personal Roth, stop contributing to my spousal Roth, and see how much I can put into the 457. At the very least I can put $18K to the 403b, $5500 to my Roth, and $5500 to the 457, all without putting any more money than I am already putting in. This way I will still have a relative mix of pre- and post-tax retirement savings.

 

And once I increase my salary or can figure out how to save more, max out the 457 followed by the Spousal Roth. And obviously employ the Backdoor Roth if my salary gets too high for the Roth.

[conniebird]

chansen wrote:

If it was me, I would max out the 457 and then the Roth IRAs. If you are in a 25-28% tax bracket now and expect to be in a 25% retirement than I would rather take the tax deduction today. Hang on to as much money as possible and look for ways to reduce taxes when you get to retirement. As you progress in your career, your income will go up. By the time you can afford to contribute to the Roth IRAs you probably will no longer be eligible. That’s when you can contribute to an ordinary IRA, then after some time elapses decide if you want to convert it to a Roth IRA. At that point you are not giving up any current tax savings in hopes of future tax savings. That’s when you start building your tax free assets.

Again, pretty much a tax wash between the two options. I just hate paying taxes today to avoid future taxes if there is not a large differential.

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I disagree, Roth IRA space is valuable. No RMDs, and sure tax laws can change, but you can't do defensive investing.

Private 457bs are not bullet proof and with the way healthcare is going, unless you're working for a large rock solid institution with favorable distribution options upon separation, it's not a no-brainer. I do max out my work's 457b (and 403b, Roth IRA), but if I was not able to financially would fund Roth first personally.

[Frenchy1011]

conniebird wrote:

Private 457bs are not bullet proof and with the way healthcare is going, unless you’re working for a large rock solid institution with favorable distribution options upon separation, it’s not a no-brainer. I do max out my work’s 457b (and 403b, Roth IRA), but if I was not able to financially would fund Roth first personally.

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Definitely interesting. I think the good answer is to just fund all three haha.

[Bott1637]

One more vote here on the funding of the ROTHs prior to a 457(b).  Your 457 distributions are "reasonable" but what are they?  Are they the same if you retire, versus if you leave the job, versus if you are fired?  They often are not.  What are the investment options available in the 457 and what is the extra fee they assess for the plan?  It's hard to find out as they legally don't even have to tell you.

I agree with the financial advisor above, if you run the numbers might you come out ahead by doing a 457 rather than a ROTH.  I doubt the difference will very large and certainly won't justify how much more flexibility you will have over YOUR money if you have it in a ROTH rather than a 457(b).  A 457 is deferred compensation, you can lose it if your organization tanks as mentioned above.  But what about if your clinic sells out to a hospital system, from what I understand there would be nothing from stopping them from disbursing this account as a lump sum if the new company decides not to continue the plan.  Given the inability to role a non-governmental 457(b) into an IRA you'd have a lump sum.

I think they should be the last thing to contribute to (before a taxable account) and the first money spent in the withdrawal phase. I don't know if you are currently in the lowest tax bracket of your life as your advisor claims but regarding where to put your money I think he's spot on.