Should I put more money in tax deferred or Roth IRA?

[bukopop]

Hi,

I am 36 yrs old and have 457 tax deferred plan (GreatWest retirement plan) and I was wondering whether to put more money in Greatwest or Roth IRA. I'm in the 25% bracket right now. I just learned that upon retirement, 457 plans tax you up front 20% withholding tax of your distribution. Then it will be determined what bracket you are in at the end of the year then tax you based on that (so you may end up with a refund, or maybe not or you may pay upon when tax is due) but the whole idea is that they withhold 20% tax for you upfront when you withdraw upon retirement.

On the other hand, with ROTH IRA, you don't need to think about this tax calculations later. I maybe taxed at 25% bracket right now but I just get my money later, period. I know that there are limitations with IRA contributions, etc. but for now, I don't know whether to fund ROTH first and Greatwest later or vice versa. I am not maxing my Greatwest plan because it is hefty (max allowed contribution is a little over $17K/year) but I contribute at least half of the maximum allowed *in addition to my pension/Calpers).

Any thoughts/advise? Thanks!

 

[RetireAge50]

I'm leaning toward the tax deferred but maybe put at least some in both. Depends on what marginal tax bracket you will be in later.

That said I am also in 25% bracket now and have maxed out the Roth each year except one. But at the same time we also max out all available tax deferred accounts.

 

[heeyy_joe]

Roth.

 

[fosterscik]

I am in a very similar situation. My system and I fund a 403b plan automatically (9% of my salary with an additional 13% match from the state) and can fund a 457 and/or Roth in addition. In my case I fund both the Roth and the 457 at the maximums allowed - I'm lucky my kids have all graduated form college! If I could not afford to do so I would fund the Roth first and then any additional would go to the 457. Why? My state 403b plan is tax deferred (like the 457) and I like the idea of having substantial tax-free Roth funds in addition to tax deferred. It will give the ability to keep in the 15% tax bracket when retired while (hopefully) funding a travel rich retirement.

 

[bukopop]

Thanks for all your replies. Hope to see more

 

[RetireAge50]

Another way to look at this question is if you were retired today would you rather have $1,000,000 tax deferred or $750,000 Tax Free (Roth).

If you withdraw over 10 years (excluding gains) the Roth you will get $75,000/year. The tax deferred you will get $100,000 - taxes. The tax rate will be zero for some (standard deduction and personal exemptions) 10% for some, 15% for some and maybe 25% for a small part.

So tax deferred is better as of now. But who know how the laws will change ...

 

[karluk]

I just learned that upon retirement, 457 plans tax you up front 20% withholding tax of your distribution. Then it will be determined what bracket you are in at the end of the year then tax you based on that (so you may end up with a refund, or maybe not or you may pay upon when tax is due) but the whole idea is that they withhold 20% tax for you upfront when you withdraw upon retirement.

My experience is that the 20% federal withholding is dependent on how the distribution is taken. In December I took a large one time distribution that was, indeed, subject to 20% withholding. But then starting in January I scheduled a regular ongoing monthly distribution. For tax withholding purposes, these monthly distributions are treated the same as a regular paycheck. The amount withheld depends on the amount of the distribution plus the number of exemptions you are claiming.

So I suggest you disregard concerns about a hypothetical 20% mandatory withholding on distributions from consideration when deciding between the 457 plan and a Roth IRA. I personally have both. My 457 contributions allowed me to stay out of the 25% tax bracket while I was working, and now the distributions are not materially different than a paycheck.

 

[Mulligan]

Will you have a pension when you retire, I assume? For me, my pension kept me in my same tax bracket in retirement so I didn't really see a value in tax deferred. I had my head in my financial rear for too many years. I should have been maxing out the Roths from the get go and until retirement.


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[bukopop]

Thanks Karluk. So are you saying that when you withdraw money from 457, you can withdraw to whatever amount you want every month? There's no minimum require distribution?

 

[bukopop]

Hi Mulligan,

Yes I do have a pension with Calpers. Question.. What made you say that "you should have been maxing out the Roth's from the get go and until retirement?" Do you mean, you would have benefited more by doing that than solely investing in 457 plan?

Because my dilemma is that if I have few extra bucks... I'm not sure whether to focus on maxing out my Roth or Greatwest... like which one to do first. I can't fund and max both at this time.

 

[karluk]

Thanks Karluk. So are you saying that when you withdraw money from 457, you can withdraw to whatever amount you want every month? There's no minimum require distribution?

Yes, that's what I'm saying. I am currently withdrawing $4,000 per month. According to my calculations that amount plus our other sources of income will put us right at the top of the 15% tax bracket. So the amount you choose is at your discretion. Withdraw what you need to pay your bills, or whatever is needed to reach some tax target. It's at your discretion. The administrator of the 457 plan doesn't care, as long as all of your paperwork is in order.

 

[Mulligan]

Hi Mulligan,

Yes I do have a pension with Calpers. Question.. What made you say that "you should have been maxing out the Roth's from the get go and until retirement?" Do you mean, you would have benefited more by doing that than solely investing in 457 plan?

Because my dilemma is that if I have few extra bucks... I'm not sure whether to focus on maxing out my Roth or Greatwest... like which one to do first. I can't fund and max both at this time.

Bukopop, the best I can do is give you my personal experience and then you can decide if it would be similar to you. For many years I was in the 15% bracket and as I moved up the chain, I moved up to the next tax bracket, but so did my pension. Looking back it made little sense to get a 15% tax break only withdraw into the 25% bracket and now very close to 28% tax bracket. Better off to have paid the 15% tax and then established a low cost Roth like I did the final few years I worked. 403bs that I were familiar with had horrible expense fees that were hidden which compounds the problem. I do not know about your 457 situation. People who receive ( and I know there are not many) generous pensions need to think a little differently as you have limited ways of controlling income for tax purposes once you are retired. If you are retiring into the same tax bracket, having taxed money put into low cost mutual funds is better tax wise than tax differed as you will pay lower capital gains rate than income pulled from these accounts that will be taxed in your tax bracket. At least this was the hard lesson I learned!


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[Delawaredave5]

Much comes down to future tax bracket vs. today. If your future bracket is same as today, 25%, then they are both equal financially. You're in a middle bracket now - so probably not a big deal either way.

There are other "back end" reasons to do the Roth. Roth has no Required Minimum Distribution at 70 - if you have large retirement assets that you don't need, Roth allows you to leave in and pass to heirs. There's other "heir benefits" to Roth over traditional.

 

[pb4uski]

If I was in the 25% bracket today I would probably lean to deferral assuming that my tax bracket in retirement will be less than 25%. But if you really think that your tax bracket in retirement will be similar then I would go with the Roth.

Generally, you are in a lower tax bracket in retirement, especially if you retire early.

 

[samclem]

If there is a 20% tax withholding, it won't matter at all when you are retired, it's the ultimate tax rate that is important. If they withhold 20% as it is withdrawn and you only really owed 12%, then you'll get 8% back from the gummint. The same thing will happen every year, so it's just a little bump, and the only time you are effectively "missing" that 8% is the first year.

Take a look at the expenses in that 457 plan, if they are high then that might factor int your decision (maybe only contribute the amount needed to get the max employer match, then go with a Roth.

There's a lot to be said for having a mix of account types (Roth, tax deferred, conventional after tax) when we are in retirement. None of us knows exactly how tax laws will change and few can know what our investment results will be. Having a few different tools in the bag can allow some smart tax tricks to reduce the bite.

But, as others have said, if you expect your tax rate in retirement to be lower than your present rate, it is best to lean toward tax deferred accounts. To get a good estimate of your tax rate in retirement, be sure to include SS (it gets treated differently depending on income level), your anticipated RMDs from the anticipated earnings on your conventional IRAs, etc. It's not as simple as it might appear at first.

 

[jayc]

Fund the 457 to the max 17k if you can. I always thought it was great that you could put 100% of your hard earned $ in off the top.

Open your Roth as a personal account at vanguard or schwab. Fund it to 5.5k.
Try to do this every year to the max.