Is 457(b) contribution a bad idea right now?

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Is 457(b) contribution a bad idea right now?

Postby Hoodooguru » Sat Jul 27, 2013 3:11 am

Hello all.

I am reconsidering a decision I made a few years ago to stop contributing to an available 457 plan, and I would appreciate your input as to whether I'm thinking through this correctly. At the time I made the decision, I did it because I couldn't afford to make the contributions. Now I'm doing it for (perceived) tax advantages.

My wife and I are in our early 40's and we have two smallish kids - the youngest starts kindergarden in the fall. I work full-time and gross in the low 70's. My work provides me with a pension, a 457(b) plan (no match), and a HSA. My wife stepped back from working full time when our oldest child was born, but continues to work part-time, grossing around $10,000 to $15,000 per year. I anticipate that our income will increase $10,000-20,000 in the next couple of years.

Before we had kids, we maximized our contibutions to the 457(b) plan because we were both working full time and were in a higher tax bracket. After our first child, we aggressively put money away for college and have met our long-term goals in a guaranteed tuition plan. We have also religiously contributed the maximum amount to Roth IRAs each year and continue to do so. And we have an emergency account. And I'm about to put a bunch of money into my HSA because we have braces and a couple of expensive preventative medical procedures in our near future (we have a high-deductable plan).

My current concern is that we have over $100,000 invested in a taxable account (TSM), which we could effectively move to the 457(b) by making aggressive contributions from my salary and selling the funds (to live on).

For the past several years, all of our taxable income has fallen at or below the 15% rate, and we have been able to harvest all of our stock-gains from the taxable account at the 0% capital gains tax rate. I expect to do the same this year. If the market maintains or continues to increase next year, I expect to do the same next year as well.

As a brief aside, I recognize that it's impossible to predict the future and that many unforeseen events are likely to occur between now and 25 years from now. Even so, I plan...

If I stick it out with my current employer until I retire at around 67 (25 years from now), it is fairly safe to estimate that we could receive a pension of around $65,000 per year, plus both of our social security payments, plus required distributions from my 457 (and any regular IRA that we might have) after age 71. Given this (along with assumptions that we don't expect to have a worthwhile mortgage deduction and I anticipate that federal income taxes are likely to increase in the future), I am thinking that there is a significant possibility that we could be in a higher tax bracket during our retirement than we are now.

Am I crazy to think that, during this period of time when all of my taxable income is at or below the 15% income tax bracket and I'm able to harvest all of my stock-gains at the 0% rate, I am probably better off paying income tax now as opposed to contributing $17,500 per year to my 457(b) and paying income taxes later? To be clear, contibutions to the 457(b) would effectively come from the taxable account, thereby reducing my taxable investment exposure in the near-term.

The common mantra appears to be to maximize contributions to available tax shelters. But I'm currently paying very low taxes. And all of my capital gains are currently tax-free, whereas they would be taxed at the regular income tax rate under a 457 plan. So I'm having difficulty seeing the wisdom of deferring taxes with the 457 this year.

Am I missing something?
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Re: Is 457(b) contribution a bad idea right now?

Postby sometimesinvestor » Sat Jul 27, 2013 9:19 am

As you describe your situation it does not seem crazy to me but I do ask if there is a4 57(b) roth associated with where you work. THat might be worth considering.Clearly if you move intoa higher bracket in afew years (a promotion etc) the situation can be reexamined .
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Re: Is 457(b) contribution a bad idea right now?

Postby BL » Sat Jul 27, 2013 9:26 am

I would max the HSA and consider it a retirement fund (you can always use Medicare part B payments as medical expenses). Keep receipts of medical expenses paid out of pocket until then.
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Re: Is 457(b) contribution a bad idea right now?

Postby Garco » Sat Jul 27, 2013 10:31 am

I like your idea of paying yourself from your taxable TSM investment to put salary into a 457b. Although I'm quite a bit older than you, and my tax bracket is also much higher, when I vetted a similar idea to my CFP recently he smiled and said I should put as much of my income into such a tax advantaged account as I can. You can't know your future tax bracket with certainty. It sounds like you're expecting a raise and your bracket would increase.
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Re: Is 457(b) contribution a bad idea right now?

Postby Ged » Sat Jul 27, 2013 4:53 pm

Predicting future tax brackets is very hard. Since I started working income tax bracket changes have reduced my tax rates over what I expected was going to happen, making the choice of putting most of my savings in a 401K pretty good (I am retiring no more than 3 years from now).

Now though I am wondering if this will continue for those younger than I am. The change to CPI-U suggests a slower inflation adjustment to brackets than in the past.

You are starting to enter your peak earning years. With that it seems likely that your tax rates will likely be higher than after retirement.

Since you already have a significant amount of money in a taxable savings account you are in a position to delay social security after retirement and live off of the taxable money for a while. This will crater your tax rates and provide a great opportunity to convert an TIRA to a ROTH in retirement at very low tax rates. I think you might be making a mistake to convert this money to an 457b while working because you would miss out on the benefit of delaying taking SS.
Lack of planning on your part does not constitute an emergency on my part.
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Re: Is 457(b) contribution a bad idea right now?

Postby ruralavalon » Sat Jul 27, 2013 5:52 pm

Hoodooguru wrote: . . . . At the time I made the decision [to stop contributions], I did it because I couldn't afford to make the contributions. Now I'm doing it [restarting contributions] for (perceived) tax advantages.

. . . . . . My work provides me . . . a 457(b) plan (no match), . . . . . . . I anticipate that our income will increase $10,000-20,000 in the next couple of years.

Before we had kids, we maximized our contibutions to the 457(b) plan because we were both working full time and were in a higher tax bracket. . . . . . . We have also religiously contributed the maximum amount to Roth IRAs each year and continue to do so. . . . . .

My current concern is that we have over $100,000 invested in a taxable account (TSM), which we could effectively move to the 457(b) by making aggressive contributions from my salary and selling the funds (to live on).
. . . . .

Am I crazy to think that, during this period of time when all of my taxable income is at or below the 15% income tax bracket and I'm able to harvest all of my stock-gains at the 0% rate, I am probably better off paying income tax now as opposed to contributing $17,500 per year to my 457(b) and paying income taxes later? To be clear, contibutions to the 457(b) would effectively come from the taxable account, thereby reducing my taxable investment exposure in the near-term.
.

Continue to max out the Roth IRA as a priority over everthing else on the investing front.

Could you in the next few years with the increased income of $10-20k/yr max out the 457b, without drawing down from the taxable account? I would suggest maxing out the 457b if and when you can from current income, and leaving taxable alone when and if thats possible.

Otherwise, I do think its a good idea to draw down from taxable (while you can do so tax free), if that is what it takes to enable you to max out the 457b in a given year.
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Re: Is 457(b) contribution a bad idea right now?

Postby letsgobobby » Sat Jul 27, 2013 6:10 pm

Is your employer a governmental agency?
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Re: Is 457(b) contribution a bad idea right now?

Postby bobcat2 » Sat Jul 27, 2013 6:32 pm

Is your pension in nominal or real dollars? It's a lot today, but if it is nominal it might not be much in real terms 40 years from now. :(

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Re: Is 457(b) contribution a bad idea right now?

Postby Hoodooguru » Sun Jul 28, 2013 4:45 pm

Thanks to each of you for responding and for being so thoughtful.

In response to your questions and comments:

sometimesinvestor: I do not have a Roth 457(b) available. But I'm thinking that I should lobby to have one made available.

letsgobobby: Yes. I work for a government agency.

bobcat2: I should clarify my pension expectation - the amount is based on my highest five years of earnings and the number of years of service, and includes an annual COLA. If I remain a member of this pension plan until I am 67, I will receive about 65% of my top salary. I am a professional and a manager and have been subject to a salary freeze for several years (which appears ready to lift). Given this, I believe there is significant potential for my earnings to be significantly higher in the future.

BL: I am in complete agreement that I should maximize my HSA contributions - especially since covered expenses from the HSA will never be taxed.

Garco and Ged [earthsea?]: I appreciate your reminder that I am not likely to successfully predict our future tax bracket in 25, 35, or even 45 years (assuming we survive that long). As I pondered your comment and challenged my underlying assumptions, I found myself considering an infinite branching of future possibilities. This led me to conclude that I should probably just accept the simple answer, fund the 457(b), and be done with it. If it's the "wrong" choice, no big deal - at least we've saved money for the future.

In terms of Ged's comment about the potential for delaying SS, I will have to think about this. My initial thought is that we are likely to have significant taxable assets at retirement even if I maximize my 457(b) contributions (due to increase earnings and inheritance). Plus we will have my pension, which should be more than enough to live off of (especially once the mortgage is payed off). We live pretty simply, and I don't see that changing too much as we get (even) older. I recognize that things like unforeseen medical issues among other things might complicate that picture, however.

Also, I don't think a contribution this year and/or next year will have a tremendous impact on our taxable assets. Once both kids are in school full time (public school), our day-care costs will decrease significantly and my wife will be able to significantly increase her work hours (and income). Plus I am likely to be earning more as well. If this is correct, our increased earnings will go to the 457(b) and we'll leave the taxable accounts alone (more or less).

ruralavalon: I fully agree that fully funding our Roth IRAs is our first priority. And I intend to maximize my 457(b) contributions with future earnings increases. And I now think I'm agreeing that I should draw down our taxable to fully fund my 457(b).

Cheers! :beer
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Re: Is 457(b) contribution a bad idea right now?

Postby ruralavalon » Sun Jul 28, 2013 5:10 pm

Hoodooguru wrote: . . . . . My initial thought is that we are likely to have significant taxable assets at retirement even if I maximize my 457(b) contributions (due to increase earnings and inheritance). Plus we will have my pension, which should be more than enough to live off of (especially once the mortgage is payed off). We live pretty simply, and I don't see that changing too much as we get (even) older. I recognize that things like unforeseen medical issues among other things might complicate that picture, however.

Also, I don't think a contribution this year and/or next year will have a tremendous impact on our taxable assets. Once both kids are in school full time (public school), our day-care costs will decrease significantly and my wife will be able to significantly increase her work hours (and income). Plus I am likely to be earning more as well. If this is correct, our increased earnings will go to the 457(b) and we'll leave the taxable accounts alone (more or less).

ruralavalon: I fully agree that fully funding our Roth IRAs is our first priority. And I intend to maximize my 457(b) contributions with future earnings increases. And I now think I'm agreeing that I should draw down our taxable to fully fund my 457(b).

Excellent plan, I believe.
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Re: Is 457(b) contribution a bad idea right now?

Postby pingo » Sun Jul 28, 2013 8:45 pm

Hoodooguru wrote:If I stick it out with my current employer until I retire at around 67 (25 years from now), it is fairly safe to estimate that we could receive a pension of around $65,000 per year, plus both of our social security payments [...]


Is this right? I have no idea how it all works, but my employer retirement pension documents say that there's some kind of "windfall provision" or something that will prevent recipients from receiving at least part (or all? or a large portion?) of social security. Other posters will know for sure, or perhaps you could look into it...?
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Re: Is 457(b) contribution a bad idea right now?

Postby grabiner » Sun Jul 28, 2013 8:49 pm

pingo wrote:
Hoodooguru wrote:If I stick it out with my current employer until I retire at around 67 (25 years from now), it is fairly safe to estimate that we could receive a pension of around $65,000 per year, plus both of our social security payments [...]


Is this right? I have no idea how it all works, but my employer retirement pension documents say that there's some kind of "windfall provision" or something that will prevent recipients from receiving at least part (or all? or a large portion?) of social security. Other posters will know for sure, or perhaps you could look into it...?


The windfall provision applies if you receive a pension from employment not covered by Social Security, as well as Social Security. A similar government pension offset applies if your spouse receives a pension from employment not covered by Social Security as well as a spousal benefit. The OP didn't mention this, so I assume he has paid into Social Security through his career.
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Re: Is 457(b) contribution a bad idea right now?

Postby Ged » Sun Jul 28, 2013 8:54 pm

Here is an explanation of the windfall provision.

http://www.ssa.gov/pubs/EN-05-10045.pdf
Lack of planning on your part does not constitute an emergency on my part.
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Re: Is 457(b) contribution a bad idea right now?

Postby pingo » Thu Aug 01, 2013 5:54 pm

Thanks for the clarification on the Windfall Elimination. I don't know if it was the way my pension expressed it, or my own mis-understanding of it, but I had understood something different than what it is. I think I get it now!

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