Taxable Brokerage or 457 Roth?

[PhrugalPhan]

Hi, I am a local government worker with about 8 years left until I can get off the golden handcuffs (that is - retire with full pension benefits). For background: In the past few years (about 7) I have been maxing out my 457 plan defined contributions at the rate of 50% pre-tax and 50% post tax (AKA - Roth). I also max out my Roth IRA (balance is currently close to 100K). Combined they are in the range of 15 years of current expenses.

I'm not FI, but I do have very low expenses, currently saving in the area of 75% across all savings vehicles. Since paying off the house in 2012 I have started a brokerage account to invest the excess that previously went to the mortgage (It has a balance that is a year of my current expenses). My savings balances (savings / checking / CDs) are well over 1 year of expenses as well.


With that all said, here's my question. I have read on other sites (as well as on here) where people expound the virtues of investing in a brokerage accounts (versus defined contribution plans). Benefits mentioned are usually: No/Low dividend taxes, immediate access to the funds in case of need, and low cost fund availability. I was considering cutting back on my 457 deposits this coming year to invest more in my brokerage account, but then I started to consider if this made any sense for me. And here is what I came up with.

• With either (Roth v. Brokerage) I have to pay taxes up front, so there is no tax benefit today with both, but a definite tax benefit in the future for the Roth over the brokerage.
• Defined contribution plans have much better legal protection from lawsuits, etc... than a brokerage account has.
• There is no limit on the Roth amounts I can save (I can do 100% Roth in the 457 plan if I want).
• This is a very large employer, and some of the funds have extremely low expense ratios, so I am happy with my current choices.
• As long as I am employed I don't need to access the 457 funds (my house and car is totally paid off and I have no known major expenses coming up), and as soon as I leave employment I can access the 457 funds with no penalties if needed (a great benefit of 457 plans).
• If I want to play with individual stocks, the 457 plan has a brokerage window.
• Given my expected pension and SS benefits, I doubt I will ever be able to have dividends taxed at 0% in my brokerage account (though if I leave this job earlier than my full pension date that could change).

There is something satisfying with saying I have a large brokerage account balance (I currently don't, but would like to get there), but I would rather make the more logical choice. Is there any reason I am missing for cutting back on the 457 contributions (especially the Roth kind) and putting more in my brokerage instead? Thanks.

 

[aja8888]

Sean, why not introduce yourself in the "Hi, I am..." forum for new members?

 

[Animorph]

Strictly from a tax perspective, you get tax-free growth within a Roth but not in a taxable account. You pay the same initial taxes for either one. So if you can live with the Roth restrictions, I'd favor the Roth over a taxable account.




And really, a normal pre-tax retirement account does pretty much the same thing, except that contribution limits mean that you can't contribute as much after-tax value to a pre-tax account as you can to a Roth. Some of your contribution will end up in the IRS's hands eventually. Another plus for the Roth.


Where the pre-tax retirement accounts shine is if your taxable income will significantly decrease after you retire. So maybe you would pay 25% in taxes now, but 15% or even 0% after you retire. The pre-tax account lets you take advantage of that. You might be in that situation if you retire a few years before you start taking Social Security or pensions. During that time you can also Roth convert, so if a Roth didn't make sense before, and you have a taxable account, you can Roth convert after retirement when your taxes are lower.




Plenty of stuff to think about. I'd keep maxing out your retirement accounts, but think about what your taxes will look like in the future.

 

[PhrugalPhan]

Thanks for the feedback. Here is feedback to a few points brought up.

Given my current income, and the future pension and SS payments (plus a pre-SS benefit that comes with my pension plan as soon as I retire), I doubt there will ever be a time my marginal tax rate will be lower than it is today (unless tax rates go down ) so I don't think that I will ever have the chance to take out money at lower tax brackets than today (though moving to a tax free state after retirement may make a slight dent in that statement).

My 457 plan automatically cuts off deductions once I hit the limit for the year, so that is not a concern for me.

There is a LTC plan I can get at work each sign up period. No exam is required. I examined the payout limits (per period / overall / length of time) and the amount I would need to pay. Add in the fact I have a desk job, I workout every day and in the best shape in 20 years, and no family history of early health problems, and I don't think LTC insurance makes sense for me. Instead I invest the amount I save not doing that and basically self-insure. I know its a risk, but I think it is a good risk.

And for the 457 plan costs, the employer is very good about it, even having employees on the board that negotiates fees with the administrator. And the past two years we have gotten rebates into our accounts from actual fees being less than expected (this year was a $600 bump for me).

So it sounds like I should stick with the plan I have, getting some tax benefit now, while upping my Roth balances to keep taxes low in retirement. Thanks again for the replies.