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  • 457b with poor distribution options

    I am an employed MD at a relatively large, financially stable hospital system. I have access to 403b and 457b accounts that I have maxed over the last 4 years. The fund options in the 457b are good (index, low fees, I use a 3 fund portfolio). The distribution options stink, though. If I separate before age 60, it's a lump sum. If separation after age 60, can elect to spread over 5 years. I definitely don't anticipate staying past age 60 and staying on an extra 2 or 3 or 5 years just to get the better distribution sounds, well, terrible.

    My current balance is 105.5K in the 457b. Total retirement account balance is ~600K. No taxable account yet but will start that this year as I will have paid off my mortgage in its entirety (this was a behavioral finance choice as I am aware it was arithmetically incorrect).

    I am weighing contributing to the 457b for 2022 vs moving to taxable for all investments beyond 403b/HSA/2x backdoor Roth (all maxed yearly). I considered the numbers thusly:

    No further contribution: 105.5K at 8% gross for 12 years (approximate retirement horizon) = 274K which would be distributed as a lump sum
    Contribute for 2022: 127K at 8% gross for 12 years = 330K distributed as lump sum

    I am in 35% federal tax bracket for 2022. I will be in 32% federal tax bracket for 2023 and beyond due to backing off clinical volume.

    Basically I cannot decide if saving the 35% federal (6% state) tax bite on the 21.5K I could put in the 457b is worth the back end risk of reverse arbitrage. With the obvious uncertainty surrounding annual returns over the next 12 or so years or what future tax policy will look like.

    Any thoughts?

  • #2
    Realistically any further 457 contributions are going to come out later in a very high tax bracket. Without trying to predict future rules or returns, I would rather save in your taxable account since most of the returns will be taxed as CG plus it gives you spending flexibility down the road when you consider retirement.

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    • #3
      Under your scenario I'd stop using the 457

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      • #4
        I’m a fan of 457 plans and usually recommend them for most, but in your situation I’m not so sure. It’s tough to tell from your post how old you are, or if you anticipate staying at this place until retirement (realizing that decisions like this can change in a heartbeat). If I were in your shoes, I’d probably stop contributing to the 457 and let it ride, and then if you end up being there for the duration until retirement, start contributing again in the last few years before retirement/separation.

        My plan has better distribution options than yours, but my plan is to get the 457 value such that I can withdraw it over 5-7 years after (hopefully slightly) early retirement at age 58 or so and subsist primarily or entirely on the 457 plus some saved cash in order to try and get in some Roth conversions.

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        • #5
          Poor distribution option is a good reason not to partake in the 457b. Stop now to avoid a growing tax bomb. Continue investing in a taxable brokerage instead.

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          • #6
            Originally posted by MaxPower View Post
            It’s tough to tell from your post how old you are, or if you anticipate staying at this place until retirement (realizing that decisions like this can change in a heartbeat).
            I am 39. Have been at current job (2nd out of fellowship) for five years. Anticipate staying though as you say, hard to know that for sure. Retirement age also not definite but am shooting for age 50-55 or so. Youngest child is in kindergarten so hard to envision stopping prior to her finishing high school (or even college depending how that goes).

            I ran the projections for the earliest reasonable retirement date as it seems like the longer I stay, up until age 59, the worse off the 457 option becomes. I really don't think I would work until 60, and if that were to change, I think retirement would have kind of sorted itself out.

            The comment about the marginal tax rate of any additional money going in being so high really made sense to me. Appreciate everyone.

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            • #7
              Originally posted by BruinBones View Post
              Poor distribution option is a good reason not to partake in the 457b. Stop now to avoid a growing tax bomb. Continue investing in a taxable brokerage instead.
              I am maxing out on my 457(b) as they have a very good distribution option. I can keep the account and withdraw as much or as less as I want. I have to withdraw a minimum of $250 a year to keep it going.

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              • #8
                given you're 39, I'd think about it this way. If it's aggressively invested, it will probably double in value in 7-10 years. If you plan to retire before age 54/55 (I'll get to why below) about 3 years before you plan to retire, I'd make the total balance in the 457 all bonds or a stable value fund. You'll lose on the return but you'll have a very good idea how much money will be coming to you in 2-3 years time. You'll also limit future growth so it's not an unknown tax bomb anymore. Knowing that you can plan taxwise.

                You can also choose to retire the year you turn 55 (personally this is my plan). So you can retire when you're 54 as long as you turn 55 that calendar year. Read your summary plan document of your 401k/403b. Likely, there's a rule that if you retire the year your turn 54/55 then you can use your 401k/403b money for anything as you well please with no penalty. In other words, no 59.5 year penalty. Then you could use your 457 money first and start doing roth conversions and even use some of the 403b/401k money for expenses before you turn 59.5 years old. I'm just going to assume you have a large balance in the 401k/403b

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                • #9
                  Originally posted by JBME View Post
                  given you're 39, I'd think about it this way. If it's aggressively invested, it will probably double in value in 7-10 years. If you plan to retire before age 54/55 (I'll get to why below) about 3 years before you plan to retire, I'd make the total balance in the 457 all bonds or a stable value fund. You'll lose on the return but you'll have a very good idea how much money will be coming to you in 2-3 years time. You'll also limit future growth so it's not an unknown tax bomb anymore. Knowing that you can plan taxwise.

                  You can also choose to retire the year you turn 55 (personally this is my plan). So you can retire when you're 54 as long as you turn 55 that calendar year. Read your summary plan document of your 401k/403b. Likely, there's a rule that if you retire the year your turn 54/55 then you can use your 401k/403b money for anything as you well please with no penalty. In other words, no 59.5 year penalty. Then you could use your 457 money first and start doing roth conversions and even use some of the 403b/401k money for expenses before you turn 59.5 years old. I'm just going to assume you have a large balance in the 401k/403b
                  So that's really interesting; I hadn't thought about the asset location part. My AA is basically 80/20 S/B (with plan to move 5% from S->B every 5 years or so until 50/50) and given that I haven't started my taxable yet, I haven't had to worry much about asset location as long as my overall %s stayed reasonably within range.

                  I wonder if it would make sense to try to have as much of the 457 in bonds as possible, with more equity in the 403b and even in taxable at some point. That way, as you say, the growth of the 457 and thus the eventual tax hit would be less. As I approach retirement I could adjust AA in taxable as needed.

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                  • #10
                    I think that's a good idea. The general rule is first preference for bonds is in tax-deferred accounts, whether it's a 457 or a 401k/403b. In your situation though you have this "problem" 457 where you know you'll get a lump sum so have your 20% bonds in there right now. As you take the money out from that, you'll increase the bond percentage in your 401k/403b to maintain your AA at the time

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                    • #11
                      Well yeah those distribution options suck. Agree with above.
                      And be sure to retire on Jan 1

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                      • #12
                        Why would a 39-yo investing to live potentially 50-60 yrs after retirement (assuming joint life expectancy) want to go into bonds now? What is the purpose? Wouldn’t it be better to grow your net worth and pay taxes accordingly than to grow less simply to pay lower taxes? This is like saying you need to work less in order to pay less taxes or buy an expensive business asset you don’t need for same reason.
                        Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                        • #13
                          Originally posted by jfoxcpacfp View Post
                          Why would a 39-yo investing to live potentially 50-60 yrs after retirement (assuming joint life expectancy) want to go into bonds now? What is the purpose? Wouldn’t it be better to grow your net worth and pay taxes accordingly than to grow less simply to pay lower taxes? This is like saying you need to work less in order to pay less taxes or buy an expensive business asset you don’t need for same reason.
                          That has just always been my investment plan / asset allocation. I'm not considering moving "more" into bonds in this instance; just considering preferentially putting the bonds that make up the 20% of my total AA into this 457 account so as to limit tax implications. So (not exactly the case but for simplicity of the example) 100% equity in the 403b and Roths that make up 80% of my total portfolio and 100% bond in the 457 that makes up 20% of total portfolio. As opposed to having an 80/20 distribution in the 457 and in the 403b and in the Roths, etc. The Roths and 403b will be more aggressively invested and thus expected to grow more, with the 457 the opposite.

                          Because I will be forced to take all of the 457 distribution at once whereas I can more gradually draw down other accounts. Am I thinking about this wrong?

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                          • #14
                            Originally posted by NeuroMD View Post
                            Because I will be forced to take all of the 457 distribution at once whereas I can more gradually draw down other accounts. Am I thinking about this wrong?
                            This is one of the benefits of this forum, you can consider alternatives to your plans, keep what works, modify or discard what doesn’t. If you evolve your plan where your 457 is all bonds as part of your current 80:20 AA, then it does make sense to continue to contribute as long as you define a goal or endpoint. Since you expect to be in the 32% tax bracket in the future, perhaps seeking to have your 457 end up in the upper portion of the next lower bracket (24% currently) is a reasonable goal. Properly timing your discharge date to early in the tax year so that you have minimal employment earnings as suggested by childay will give you a bolus of cash with less tax burden than your employment. Depending on your family expenses, this could last a while.

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                            • #15
                              Originally posted by NeuroMD View Post


                              I wonder if it would make sense to try to have as much of the 457 in bonds as possible, with more equity in the 403b and even in taxable at some point. That way, as you say, the growth of the 457 and thus the eventual tax hit would be less. As I approach retirement I could adjust AA in taxable as needed.
                              If you do allocate bonds to the 457b, check to see if they have a Stable Value Fund (also known as “pooled” or “guaranteed income” funds). These low risk funds preserve the value of your principle and provide a nearly-guaranteed decent rate of return. A good choice for your bond allocation if offered by your plan.

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