457: Trad or Roth?

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Topic Author
Krawmp
Posts: 5
Joined: Thu Apr 19, 2018 1:47 am

457: Trad or Roth?

Post by Krawmp »

Hi everyone --

I've asked about this is a few other places and have gotten a few different answers (more than that, really) and I'm hoping that the Bogleheads can provide a little clarity.

I'll try to keep this simple but please let me know if I oversimplify. I'm happy to provide whatever info might be relevant. For now, here goes:

I teach for a state university, where I make about $103k/year at the moment. About $73k of that is my base salary (upon which my pension will be calculated) and the rest comes from evening and summer teaching, which I use to fuel my investments and travel budget. I contribute to a defined benefit pension plan through the state, max out my 403(b), 457, and Roth IRA every year, and invest 1k/month in a taxable account. My NW is in the $600k range, with the large majority of that ($550k+) in retirement accounts. In round numbers, about $350k of that is in Traditional (tax-deferred) accounts and $200k is in Roth accounts.

I *don't* contribute to Social Security and I *won't* collect Social Security.

I am 42 years old, I rent, and am engaged. My fiance makes a little more than me now but her salary will increase quickly in the coming years. Mine will not. I will get the annual 1-2% bumps that the union has squeezed out of the state and every 6 years, I'm eligible for a 6$ raise via post-tenure review (PTR)...but that process (like everything else) is subject to negotiation with the stats every few years when the current contract with the state expires. I should be a PTR bump this year, which is nice.

A few years ago, my employer began offering the Roth option on the 457 plan. I was raised to believe that Roth is always a good idea, so when I was given the option, I jumped. More recently, I've been reading up more on retirement investing and I've started to wonder whether the Roth is actually the no-brainer I used to believe. My doubt is pretty closely tied to my desire to retire on the early side. If I retire at 55, my pension will pay 37.5% of my base salary. By then, that will (conservatively) be $32k/year, which will cover most (if not all) of my current level of spending. Like many others, I'd like to continue (and hopefully intensify) my traveling in retirement. If I hold out until 62-63, my pension will pay 80% of my base salary (let's call that $80k/year from the pension, assuming it exists).

As far as I understand it, the main argument against the Roth is that taxes can be lowered by doing Roth conversions immediately after retirement using the lower tax brackets that are now emptied out by the lack of a regular paycheck. Because of my pension, I have doubts about whether this is really a viable strategy for me. I wonder whether my pension will fill in whatever the lower tax brackets might be in the future and whether my future marriage to a potentially high earner might do more than that.

I know these are all good problems to have, but I would appreciate your help in thinking them through a little more clearly than I have been. Please let me know if any additional info would be helpful. Recently, the accountants at my university and I have gotten to be on a first-name basis because I've changed my 457 contributions from Roth to Traditional to 50/50 to 67/33 and back again so many times. At this point, when I walk into the Benefits & Payroll office, I feel like Norm walking into Cheers.

Thank you in advance for any input, help, advice, insight, relaxation techniques,and/or pharmaceutical recommendations. :sharebeer
retiredjg
Posts: 42768
Joined: Thu Jan 10, 2008 12:56 pm

Re: 457: Trad or Roth?

Post by retiredjg »

Welcome to the forum!

I think you will continue to get multiple answers to your question. Here's my thinking.
Krawmp wrote: Sun May 20, 2018 3:02 am I contribute to a defined benefit pension plan through the state, max out my 403(b), 457, and Roth IRA every year, and invest 1k/month in a taxable account.
The presence of a pension makes the difference.

If you contribute huge amounts to tax-deferred accounts for many years, when you reach 70.5 your RMDs are also going to be huge. This can create a bit of a tax bomb in your 70's and can push you into higher brackets than when you were working.

Many people "fix" this by doing Roth conversions in early retirement and by using their tax-deferred money to live on.

Your pension means you will need less tax-deferred money to live on. You will also have less "room" in the lower tax brackets to do very large Roth conversions in your 60's. This is because your pension will be taking up space in those lower tax brackets. If you end up at 80% of base salary and only about 8 years for Roth conversions, I think you will definitely have a problem with RMDS because you may hardly need to spend your tax-deferred accounts at all.

My suggestion is NOT to fill both the 403b and 457 with tax deferred contributions. I think that is just asking for trouble later. I would use Roth 457 or at least half Roth. This will give you tax-deferred money in retirement, but maybe not enough to cause RMD problems.

After your marriage, I would not fill more than two tax-deferred accounts each year. I'd put the rest in Roth accounts.

Your plans are fluid. If you end up retiring at 80% of base at 62, you should probably use all Roth 457 because you will need little of your tax-deferred accounts to live and travel on. If you end up retiring much earlier at 37.5% of base salary, using more traditional 457b would be the better idea. This assumes your well paid wife also retires early. If she does not, that will make it difficult to do Roth conversions at lower tax rates than you are now.

https://thefinancebuff.com/most-tsp-par ... h-tsp.html

https://www.bogleheads.org/wiki/Traditional_versus_Roth
CnC
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Joined: Thu May 11, 2017 12:41 pm

Re: 457: Trad or Roth?

Post by CnC »

The only kicker to this is your 457 plan fees.


If the fees are higher it may not be worth as much doing Roth.


My opinion is to shoot for 50% of contributions in a Roth account and 50% in a pretax.
Topic Author
Krawmp
Posts: 5
Joined: Thu Apr 19, 2018 1:47 am

Re: 457: Trad or Roth?

Post by Krawmp »

Thank you both for the input :-)

It sounds like Payroll is going to be seeing me one more time, just to out things back how they were. But I think I do understand my situation better than I did a few months ago.

I'm sure there's still more to understand, since I (for example) never considered the admin fees on my 457 plan. I looked that up and it's .08% ($8 on 10k) annually. No idea if that's good, bad, or if it affects planning at all.

Thanks again for the help!
terran
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Re: 457: Trad or Roth?

Post by terran »

You seem to have a good understanding of the main concept in Traditional vs Roth: it's all about marginal tax rate now vs marginal tax rate in retirement.

To summarize your current situation:

Income: $103K
Age: 42 planning to retire at 55
Tax deferred: $350K + $18.5k/year 403(b)
Roth: $200k + $5.5k/year IRA + $18.5k/year 457(b)
Taxable: $50k + $12k/year
Pension: 37.5% of base salary (currently $73k) starting at 55. You don't pay into social security. What percentage do you currently contribute, as that will change your current tax picture?
Future pay: 1-2% raises already negotiated by union plus a possible additional $6k/year (is that what you meant?) raise every 6 years during your post tenure reviews.
Other considerations: Future spouse make $110k (?) and her income is expected to go up quickly (at what rate and to what?)

Using the Future Value function in excel (=FV), a 5% after inflation rate of return, a current $350k balance, $18.5K future contributions, and 55 - 42 = 13 years of contributions I get a balance at age 55 of $987,667.38 in your Traditional 403(b). Using the Payment function (=PMT), the same 5% rate of return, 100 - 55 = 45 years of withdrawals, the balance at 55, and a 0 balance at age 100 I get an annual withdrawal of $55,567.88.

If we ignore the annual raises (again, because we're trying to leave inflation adjustments out of the calculation), but say you get the full $6k raises every 6 years you'll be at a base salary of $73k +$6k at 48 + $6k at 54 = $85k at age 55, so you pension would be $31,875.

Together, that gives you a taxable income of $87,442.38. This is already higher than your current taxable income since you make $103k - $18.5K 403(b) = $84.5k, and that isn't yet counting the pension contribution, or other pre-tax benefits like health insurance. So if nothing were going to change for you in the future then it would seem reasonable to continue to the Roth 457.

Since you're planning to get married you should next be considering her income, savings, and expected future tax deferred balances. You should also look at your current single tax brackets (unless you're getting married this year) as compared to what your married tax bracket will be (based on current tax brackets) based on your pension and both your and your future wife's expected tax deferred balances.

Also consider what your current vs future state tax situation is likely to be, and what future tax rates are likely to do. I think assuming the pre 2018 tax brackets come back when the new tax bracket changes are set to expire seems reasonable, but don't get too pessimistic and assume tax rates will explode. If it weren't for the planned expiration of future brackets I would assume that future tax rates would stay the same.

Given that you're probably looking at having another $1.1 million between roth and taxable (same future value calculations), you might also consider whether you might be able to retire sooner than 55? What would happen to your pension? What do you expect your spending to be when you retire? Would you want to retire before 55?

Given the calculations above, and that you're marrying a higher earner my gut says you're probably better off prioritizing Roth until the year you get married. Given that you're thinking about early retirement my gut says that once you're married you should prioritize traditional unless you wife doesn't want to retire early, since that will push your retirement income much higher. Unless you still retire early even if she doesn't, then you'd have to do the calculations on current tax brackets vs tax brackets while she's working and you're converting to roth.

Remember that even though these calculations spit out numbers with accuracy out the penny, they're not at all accurate. They're just guesses because the assumptions that when into them (especially rate of return and after inflation raises) are just guesses. Also remember to try not to speculate too much about the future (like future tax rate changes) and just make the best decisions you can based on the information you have at the time.
retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: 457: Trad or Roth?

Post by retiredjg »

Since you are driving payroll nuts, it seems you are experiencing a fair amount of stress over this decision. As often happens, the choice between two good decisions is the hardest choice.

In the big scheme of things, this is not all that important - don't allow it to bother you much. In the big scheme of things, how much you save and having a stock to bond ratio you can live with in good times and bad times are probably the two most important factors in retirement planing. Much of the rest is "just details".

We spend a lot of time debating some of these details, but that does not mean they are critically important. The important thing is to save money, not so much where you save it.
DoTheMath
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Joined: Sat Jul 04, 2015 1:11 pm
Location: The Plains

Re: 457: Trad or Roth?

Post by DoTheMath »

Welcome! To reiterate what retiredjg said, you shouldn't stress about this too much.

In the universe of possible outcomes, I don't consider it a big deal if you end up paying more in taxes than you might have otherwise. All it really means is you did everything right, just maybe not as perfectly as you could have. Also, keep in mind you are talking about the difference between your marginal rate now and when you retire. If you are so lucky to have enough wealth that some of your retirement income gets pushed from the 22% to 24% bracket (or 24% to 32%, or whatever the relevant rates are in a few decades), the difference in taxes isn't huge.

It becomes more of an issue if you completely ignore the situation and RMDs eventually force you to take quite a bit more than you would otherwise withdraw. But this can be managed. For example, by adjusting Roth/non-Roth contributions as you go forward (e.g. as terran suggests), doing Roth conversions, etc. The main thing is keep an eye on things and adjusting as you go. If you kept blindly dumping everything into tax deferred and don't retire until 68, then you would be setting yourself up for a big tax bomb. But I wouldn't worry as you are clearly aware and already thinking ahead.

One thing I would double check on is how your 457b is handled when you retire/leave. Most university plans allow you to continue them, but I have seen BH's in the private sector discover that they are forced to take it as a lump sum when they retire. That's an atomic tax bomb!
“I am losing precious days. I am degenerating into a machine for making money. I am learning nothing in this trivial world of men. I must break away and get out into the mountains...” -- John Muir
Topic Author
Krawmp
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Joined: Thu Apr 19, 2018 1:47 am

Re: 457: Trad or Roth?

Post by Krawmp »

This is fantastic. Thank you all for such thoughtful replies.

Terran: Last year, I contributed $7.5k to the pension fund. That's a little more than 10% of my base salary. I believe the rule is 9% of gross and 11% of salary over $30k. I would be happy to retire earlier than 55, but the pension evaporates quickly. The earliest I could retire and collect a pension would be at age 50, but the pension would only be 20% of my base salary. At 55, it's 37.5%. At 58, it's 50.8%. It reaches 60% at 60, 70% at 62, and 80% at 64. This is why the university system chases people down the hallways with early retirement incentives.

Retiredjg (and DoTheMath): Thank you for the words of wisdom. I think it's fair to say that I've been going back and forth with myself on this lately. Your reassurance helps.

DoTheMath: I checked this evening and saw that I have the option to either keep my $$ in my 457 after retirement/separation or roll it over. I was happy to see that because the situation you described sounds like a tax disaster!

Thank you again for all of your input. This has been so helpful :sharebeer
CnC
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Joined: Thu May 11, 2017 12:41 pm

Re: 457: Trad or Roth?

Post by CnC »

Krawmp wrote: Sun May 20, 2018 10:21 am Thank you both for the input :-)

It sounds like Payroll is going to be seeing me one more time, just to out things back how they were. But I think I do understand my situation better than I did a few months ago.

I'm sure there's still more to understand, since I (for example) never considered the admin fees on my 457 plan. I looked that up and it's .08% ($8 on 10k) annually. No idea if that's good, bad, or if it affects planning at all.

Thanks again for the help!
That is a very good fee on a 457 plan.
bloom2708
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Location: Fargo, ND

Re: 457: Trad or Roth?

Post by bloom2708 »

If you can do $18,500 pre-tax or $18,500 Roth, then it probably doesn't matter too much. Your pension tips the scales toward Roth. I still don't like paying tax now that you many not have to later. What if your pension covers all your spending and you never touch your traditional or Roth dollars? You donate or pass them on to kids. You didn't need to pay the tax all those years.

Where it is more interesting is if you can do $18,500 pre-tax but say $14,000 Roth ($18,500 pre-tax income).

In that scenario, investing $4,500 more each year (pre-tax) and letting it grow for 30 years would be worth taking a flyer on. Yes, you could pay more tax in the future, but the amount could be size-ably more.

There is a whole thread on this that is 8 pages long. The problem is, all the future scenarios are guessing. Guessing on tax rates and returns and your income needs. Lots of guessing.

I still think "defer, defer, defer". Worst case is you are 70+ and have a huge pile and pay tax. That is a pretty good scenario in my mind.

Defer, defer, defer!
"We are here to provoke thoughtfulness, not agree with you." Unknown Boglehead
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Edie
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Re: 457: Trad or Roth?

Post by Edie »

Are you required to take your pension when you stop working?

Could you not stop working and use some of your tax-deferred money until a future date when you start your pension? This would be like funding gap years until social security for people in that realm, but you would be funding gap years until your desired pension amount?

I do recognize that your pension is probably based on years of service, but there is also probably a calculation to be done with the consideration of taking your pension at "normal" retirement age with fewer years of service.
Topic Author
Krawmp
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Joined: Thu Apr 19, 2018 1:47 am

Re: 457: Trad or Roth?

Post by Krawmp »

New ideas...I love it! (But it's also how I got into this jam in the first place lol :oops: )

Bloom: If you're asking whether I can split my 457 contribution into pre-tax and Roth buckets, with $4.5k going in pre-tax and $14.5k Roth, the answer is definitely yes. Is that what you were asking about? If so, what would bethe advantage of that set-up?

Edie: I contacted the State Board of Retirement and they told me that I can defer retirement. The pension itself doesn't increase by much each non-working year (and the year-over-year increase is greater with more years worked). For example, if I stopped working at 50 (with 20 years of service) and took the pension immediately, i would get 20%. If I waited until 51 to start, it would be 22%. Each year of deferred retirement (if I start at age 50/20years) is worth 2%. If I wait until 55, my pension would immediately be worth 37.5% (as opposed to 30% if I retired at 50 and deferred until 55) and each year of deferral would be worth 2.5%. I would imagine there's a graph with curved lines on it that Excel could draw for me. It would be interesting to look at...
CnC
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Re: 457: Trad or Roth?

Post by CnC »

Krawmp wrote: Mon May 21, 2018 12:26 pm New ideas...I love it! (But it's also how I got into this jam in the first place lol :oops: )

Bloom: If you're asking whether I can split my 457 contribution into pre-tax and Roth buckets, with $4.5k going in pre-tax and $14.5k Roth, the answer is definitely yes. Is that what you were asking about? If so, what would bethe advantage of that set-up?

Edie: I contacted the State Board of Retirement and they told me that I can defer retirement. The pension itself doesn't increase by much each non-working year (and the year-over-year increase is greater with more years worked). For example, if I stopped working at 50 (with 20 years of service) and took the pension immediately, i would get 20%. If I waited until 51 to start, it would be 22%. Each year of deferred retirement (if I start at age 50/20years) is worth 2%. If I wait until 55, my pension would immediately be worth 37.5% (as opposed to 30% if I retired at 50 and deferred until 55) and each year of deferral would be worth 2.5%. I would imagine there's a graph with curved lines on it that Excel could draw for me. It would be interesting to look at...
The goal of splitting them is tax effiency.

I'm a big fan of the Roth, but pretax has it's place also. You want enough pretax so that your pension + pretax withdrawal tops our at the bracket below your current one.

It's foolish to leave money on the table when it comes to traditional 401ks
retiredjg
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Re: 457: Trad or Roth?

Post by retiredjg »

I'm not sure that everyone reading this thread realizes that you are filling both a 403b ($18,500) and a 457 (another $18,500).

The question is not about the 403b - it is going to into tax-deferral. The question is what to do with the second account - should it be traditional, Roth or a combination?

And when you marry, what about the 3rd (and possibly 4th?) accounts?

I'm all for tax-deferral, but many people here have reported they ended up with too much in tax deferral. Their advice has been to try to avoid that.
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FiveK
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Re: 457: Trad or Roth?

Post by FiveK »

Krawmp wrote: Mon May 21, 2018 12:26 pm The pension itself doesn't increase by much each non-working year (and the year-over-year increase is greater with more years worked).
...
Each year of deferred retirement (if I start at age 50/20years) is worth 2%.
And that 2% is a 10% increase. The 10% is the pertinent number. How many years it would take for the higher annual pension to catch up with the lower but earlier pension depends on how much of the pension is invested and the return on those investments.

Given retiring in your 50s and life expectancy ~30 years from that, there is a good chance delaying the pension for some time would be beneficial in a stand-alone analysis, and even more beneficial when considering traditional->Roth conversions.
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