Hello:
Which way to go deciding on either 457b Pre-Tax or 457b Roth?
What is your marginal tax bracket, how old are you, how much tax-deferred retirement money do you have now?
You want to pay taxes at the lowest marginal rate. If your current rate is higher than expected in retirement, best to do pre-tax contributions and if your marginal rate is lower than expected in retirement, best to do Roth contributions. If you expect your tax rate to be similar in retirement, then consider contributions to both the Roth 457 and pre-tax 457. Of course, there is no certainty as to what future marginal rates will be.
Some individuals have a older age opportunity to do Roth IRA or 401k contributions if they retire early, work part time in the private sector, delay Social Security and do not have a large pension.
Note also that unlike other tax-advantaged retirement plans, there’s no penalty for early withdrawals from pre-tax 457 plans, so individuals who retire early or resign can withdraw funds without incurring a 10% penalty.
That assertion might not be the case, if the individual or couple already has a large tax-deferred bucket and they are close to retirement. If these are true, then they have to worry about bracket creep after RMD age, IRMAA penalties, and the “Widow’s Tax”. So the health of the couple matters, too. This is complex CFP level question. In this case, the aim is to minimize taxes paid over one’s LIFETIME not just the current tax year.
There are untold thousands of Boomers who have a crumbling wall of tax deferred money problem because:
- While working, they were told to minimize current taxes, kick the can down the road essentially, because “your taxes will be lower later”
- They were also told to spend tax taxable money first, then tax-deferred, then Roth / HSA at the end
- And if say they are well-off… then they find, surprise, their taxes in retirement are NOT going to be lower! (that would be me)
- Then they get to meet the evil twin sisters, MAGI & IRMAA
- Widow’s Tax - maybe they have this giant wall of tax-deferred money, then suddenly one partner is widowed and can no longer file Married Filing Jointly, the MAGI and IRMAA DOUBLE in size
- We have not even mentioned that a future Congress will have its hands full wrassling with the Federal debt, and taxes may go UP. I think we are paying the lowest tax rates in our lifetime now.
I guess my point is, one size does not fit all, it depends, it’s complicated for some families. For all of the reasons cited. A fiduciary fee-based CFP can help.
But the no-brainer is this - if your marginal tax rate is low now, like 12% or not very far into 22%, then ROTH ALL THEY WAY.
This just popped into my email inbox from Fidelity
RMDs from an IRA give you a lot of flexibility to use at tax time. As a retiree I find the ability to do end-of-year QCDs and FIT withholding very handy.
That’s what I was told when I was younger. Turns out – I’m in the same federal tax bracket retired as when I was working. (I was a regular middle-class person, not a high-earner).
So just be careful when thinking what your “expected” tax bracket will be. All the advice given to me was not the best for my situation now. Not at all. It was for high-earners in high tax brackets. Not people like me.
Now I’m doing Roth conversions on all of those pre-tax accounts, and paying the tax on the withdrawals/conversions at the same rate now as when I was working! I would rather have paid it back then, and not now, but Roths didn’t always exist back then.
If I were to advise my former self, I’d say do the max Roth that you can, and then if needed/wanted, contribute to the pre-tax account!! The opposite of what most advice tells people.
Of course, if you are a high-earner, you’d probably want the tax break.
Also-- I learned this doing Roth Conversions from my 403b and IRA – my pre-tax contributions were pre-tax federal only, but not state (your state may vary, especially those states that have no income tax).
So when making Roth conversions or regular withdrawals now, the taxable amount for my state is less than federal, since my contributions had already been taxed!
It’s not a terrible calculation, but you do run into this when you eventually withdraw from your pre-tax account (IRA, 401k, 403b if contributions were state-taxed).
My advice – check if your contribution is state-taxed or not. If so, save any statement that shows how much you contributed each year and some verification that it was taxed.
Even better, keep a spreadsheet of your yearly contributions, so when you finally do withdraw the money from your pre-tax account, you have your contributions for state-tax purposes, if needed.
This will vary with your state – I can only speak from my experience in my state!
If you don’t do this, you may pay tax again on your contributions that were already taxed!!