Roth IRA and 457b Question from a New Attending

[subnauticamed]

Hi all,

I'm a new attending and I've got a few questions about Roth IRAs and 457bs that I wanted to pose to the group. For reference - I'm about 6 months into my first job as an employed physician of large, non-profit healthcare system. The system appears to be financially sound. Sorry if this question has been asked already - did a quick search and didn't find the specific answer to my questions.

1. Roth IRA - I've been maxing this out since residency. This is the first year where my gross income will exceed $198,000 (6 months of fellowship+5 months as an attending), which I understand is the limit for typical Roth IRA contributions. I have an automatic contribution of $500/month into the Roth, so I have about $5500 or so in there currently. Can I go ahead and just max this out at $6000, or will this become an issue when it becomes time to file taxes, as my gross income will exceed $198k?

2. Non-governmental 457b - I've been maxing out both my employer's 401k and 457b. The 457b has low fees and the ability to invest in Vanguard funds which is great. It's unclear to me how long I'll be sticking with this job, however. If I tentatively plan to change jobs in the next 1.5-3 years, is contributing to this account a good use of money or would it be simpler to place these contributions in a regular brokerage account? On reading the fine print of the plan, I should be able to get a lump sump payment on a date I elect or roll-over the contributions into another non-governmental 457b.

Thanks very much - would appreciate any and all thoughts.

[JBME]

1) Are you over the income limit for 2021? You will need to recharacterize all of those contributions and then convert them to Roth if you end up over the income limit for this year. In the future, assuming the backdoor Roth is allowed for 2022 and beyond, you should do the contribution for the year all at once. So save up $6k in cash and then deposit $6k into an IRA and then convert it to Roth. Should be easy to save up $6k quickly if you're an attending.

2) What are the distribution options? What if you move on to another employer that doesn't have a 457b, or has one that doesn't allow rollovers? You don't want a lump sum payout of this money when you're an attending and therefore in high tax brackets. You might want to do taxable instead from now on based on what you said.

[subnauticamed]

Thanks for the reply.

1. I just crunched the numbers and I would be slightly over the income limit for 2021. If I have those contributions already in a Roth IRA, what specifically would I need to do to fix this? Create an IRA at Vanguard, move the 2021 contributions from my roth into a regular IRA, and then do a Roth conversion? (e.g. look up how to do a typical backdoor Roth IRA contribution)?

2. Looks like specific distribution options would be:
- Can defer payment until age 70 1/2
- Lump sum payment on a date elected by me
- Installment payments over 5 years
- Rollover to a new employer's non-governmental 457b with a letter of aceptance

So based on what you're telling me, it probably makes the most sense to stop contributing to this. Should I then leave the current contributions in here, and either withdraw it or see if I can transfer it over if I change employers?

Thanks again.

[JBME]

Where is your Roth IRA? You need to fix this by the end of the year. Look up how to do the typical backdoor Roth. Also look up how to fix the problem where you directly contribute to a Roth IRA and then find out you're over the income limit. If your Roth IRA is at vanguard this likely involves a phone call where you ask for the contributions you've made so far to be recharacterized.

As for the 457, you could defer payment until age 70.5 or a later date but then you're going to have to hope and pray that the organization doesn't go bankrupt. I think in your case I'd do taxable. You cannot do anything about what is currently in the 457 plan until you actually separate from service. But I'd stop contributing. If it's not a lot of money I'd consider leaving it in there or transferring it if you happen to go somewhere else were a non-gov 457 plan is an option and rolling it over.

[artemis]

If it's not a lot of money I'd consider leaving it in there or transferring it if you happen to go somewhere else were a non-gov 457 plan is an option and rolling it over.

If it's not a lot of money and if you end up at a place that doesn't have a non-governmental 457b plan that allows transfers, another reasonable option would be to select the 5-year payout option. Taking a small amount of money out over a period of 5 years wouldn't raise your taxes too much, and you could re-invest the money in your taxable account.

In general, non-governmental 457b plans have enough wrinkles in them that they are probably best avoided until late in your career (when they can become a valuable place to stuff the cash you'll need to bridge the gap between when you plan to retire and when you plan to start SS). They just aren't as safe a governmental 457b plans are, and I wish they'd rename them to end the confusion between the two plan types.

[MaxPower]

In general, non-governmental 457b plans have enough wrinkles in them that they are probably best avoided until late in your career (when they can become a valuable place to stuff the cash you'll need to bridge the gap between when you plan to retire and when you plan to start SS).

Counterpoint—I’ve contributed to my 457 since starting at my non-governmental place of work ~7 years ago. I now have a reasonably healthy, low/mid 6-figure sum on which I was able to defer 40%+ taxes. From a financial standpoint I could not work for 2 years and be just fine without really any change to my current lifestyle. I realize that if you didn’t put that money into a 457 you could put it into a taxable account, but there would immediately be 40% less of it (for me—your tax drag may vary).

I would guess that the odds of needing money to tide you over during a job change (forced or unforced), or having a medical issue or disability crop up that puts you out of work is on orders of magnitude more common than losing your 457 to bankruptcy. That’s not to say there aren’t drawbacks because there clearly are, but in lots of cases I think the benefits outweigh the risks.

[FIREshrink]

Nongovernmental 457b has been discussed many times, probably mostly safe but I prefer not to use mine. I have a hard time deferring my compensation for many years without a clear path to recovering it, unless the benefits are assured and substantial.

[JBME]

Counterpoint—I’ve contributed to my 457 since starting at my non-governmental place of work ~7 years ago. I now have a reasonably healthy, low/mid 6-figure sum on which I was able to defer 40%+ taxes. From a financial standpoint I could not work for 2 years and be just fine without really any change to my current lifestyle. I realize that if you didn’t put that money into a 457 you could put it into a taxable account, but there would immediately be 40% less of it (for me—your tax drag may vary).

I would guess that the odds of needing money to tide you over during a job change (forced or unforced), or having a medical issue or disability crop up that puts you out of work is on orders of magnitude more common than losing your 457 to bankruptcy. That’s not to say there aren’t drawbacks because there clearly are, but in lots of cases I think the benefits outweigh the risks.

fair points. It may be that you get to defer 40%+ from taxes but eventually you will take it out and the tax won't be 0%....most likely this OP would end up in the 22-24% bracket when there's a job change. I also assumed it was the OP's preference/plan to take another job in 1-3 years after his current job, and the change would be immediate. If the OP had said the plan was to work there for 1-3 more years and then take a year off, or even maybe 6 months, then I would change my recommendation because we can clearly see a need coming for this money.

[MaxPower]

fair points. It may be that you get to defer 40%+ from taxes but eventually you will take it out and the tax won't be 0%....most likely this OP would end up in the 22-24% bracket when there's a job change. I also assumed it was the OP's preference/plan to take another job in 1-3 years after his current job, and the change would be immediate. If the OP had said the plan was to work there for 1-3 more years and then take a year off, or even maybe 6 months, then I would change my recommendation because we can clearly see a need coming for this money.

I agree if you’re definitely only planning to stay for 1-3 years that it probably doesn’t make a ton of sense since the odds of taking it out at the same or higher tax bracket is pretty good. I guess I was more or less discussing your assertion that it only makes sense to contribute to a 457 late in your career. At that stage, there’s very little time for compounding or growth, but you definitely do minimize the risk of your hospital going belly up, or being forced to take an unfavorable withdrawal when you don’t want or need it. As with most things personal finance related, the answer depends…

[JBME]

I agree if you’re definitely only planning to stay for 1-3 years that it probably doesn’t make a ton of sense since the odds of taking it out at the same or higher tax bracket is pretty good. I guess I was more or less discussing your assertion that it only makes sense to contribute to a 457 late in your career. At that stage, there’s very little time for compounding or growth, but you definitely do minimize the risk of your hospital going belly up, or being forced to take an unfavorable withdrawal when you don’t want or need it. As with most things personal finance related, the answer depends…

ah, well I didn't assert that someone else. I think all of the points you and artemis are saying are fair points and things for the OP to consider. This is not a 100% clear yes/no question

[Ekanive23]

I’m going for PLSF so the 457 cuts down on another 2 grand a year of payments as I can shelter about 20k. If I ever leave my job, it’ll be a ************************ of a down payment fund too for a house.

[Tim]

I’m going for PLSF so the 457 cuts down on another 2 grand a year of payments as I can shelter about 20k. If I ever leave my job, it’ll be a ************************ of a down payment fund too for a house.

I hear you. Income tax rates on a lump sum house payment typically are more than the interest rates. Cash flow yes, but.... curious about the numbers. Just saying it is a math problem.

[Ekanive23]

I hear you. Income tax rates on a lump sum house payment typically are more than the interest rates. Cash flow yes, but.... curious about the numbers. Just saying it is a math problem.

As of now I have an immediate ten percent return because I shelter the income from public service loan forgiveness loans. Once I have my 10 years up, I might be better taxable and paying long term capital gains on the gains instead of full income tax.

they just gave us raises as hospitalists and I think I’ll earn 500 k or so because of it so the tax bill would be high on a withdrawal while I’m grinding like I am . However, I’m obligated currently just because of the shelter of money from student loan calculations.

[Tim]

As of now I have an immediate ten percent return because I shelter the income from public service loan forgiveness loans. Once I have my 10 years up, I might be better taxable and paying long term capital gains on the gains instead of full income tax.

they just gave us raises as hospitalists and I think I’ll earn 500 k or so because of it so the tax bill would be high on a withdrawal while I’m grinding like I am . However, I’m obligated currently just because of the shelter of money from student loan calculations.

Understand. The lump sum house downpayment will be taxed at even higher rates on top of the earnings from the job. The point is you have a tax bomb coming with the strategy, at the tail end. Not a criticism, just pointing out the 457 will have a high tax cost later.