Roth 457 vs traditional 457 + brokerage account

[rollergrrl]

Why I think the traditional 457 is a better option. Please let me know what you think? Am I looking at this right.

Let’s say you are going to max out your 457 and are currently in 22% tax bracket. Right now the maximum contribution amount is $19500

Option 1 : Roth 457
Max out would cost: $23,790 to invest $19500

Option 2 Traditional 457
Max out would cost: $19500 to invest $19500
BUT: you also invest $4290 (the cost of the Roth in option 1) into a brokerage account

After 20 years of investing both 457 accounts would equal the same. Let’s say we averaged a 10% return. Your total would be $1,233,974

Brokerage Account 10% return = $271,094

You start withdrawing 6%

Option 1 Roth: $74,038.44

Option 2 Traditional: $57,750 after taxes
Brokerage: $13,826 after taxes
Total: $71,576


Option 1 is $2462 more but it adds more risk and not worth it. Also the more years you invest the traditional + brokerage actually ends up providing more income.

the traditional 457 accounts allows withdrawals before 59 1/2 without Penalty when you leave your job.

The Roth 457 you have to be 59 1/2 to withdraw funds otherwise you have a Penalty


Do you agree Traditional 457 is better?

 

[armor99]

Just something else to consider. Not sure if the Roth 457 works the same way as a Roth 401k, but if it does, whenever you retire, you can roll the 457 into a ROTH IRA.
Provided you had that ROTH IRA for more than five years in the past, you can instantly withdraw all of your personal contributions from the 457 that you just put into it. And that event will have no taxes or penalties whatsoever… and you can do this at any age, not just at 59.5
This is the main strategy I will be using to get to my retirement funds early.

 

[SevenUp]

After 20 years of investing both 457 accounts would equal the same. Let’s say we averaged a 10% return. Your total would be $1,233,974

Brokerage Account 10% return = $271,094

Due to annual taxes on the brokerage account, it would not have grown as much as the tax-advantaged accounts.

 

[RunningBum]

Option 1 is $2462 more but it adds more risk and not worth it.

How does it add more risk?

Also the more years you invest the traditional + brokerage actually ends up providing more income.

You're going to have to show the math to get me to believe that.

the traditional 457 accounts allows withdrawals before 59 1/2 without Penalty when you leave your job.

The Roth 457 you have to be 59 1/2 to withdraw funds otherwise you have a Penalty


Do you agree Traditional 457 is better?

Nope. Maybe for some special situations before 59 1/2, unless you can roll the Roth 457 into a Roth IRA and remove contributions tax and penalty free.

 

[EastWest Gal]

If it is a government Roth 457, I understand there is no penalty for early withdrawal and you only pay tax on earnings if you withdraw before 59-1/2. So if you need to withdraw, withdraw less than you put in. Non-governmental plans may vary. Am I incorrect?

 

[rollergrrl]

If it is a government Roth 457, I understand there is no penalty for early withdrawal and you only pay tax on earnings if you withdraw before 59-1/2. So if you need to withdraw, withdraw less than you put in. Non-governmental plans may vary. Am I incorrect?

The before 59 1/2 is only for traditional 457 accounts you lose this benefit if the 457 is a Roth.

 

[rollergrrl]

How does it add more risk? [/QUOTE
The risk is that you can’t touch the money before 59 1/2 when it’s in a Roth 457. If it was in a traditional 457 you can touch without penalty, if you leave job.

You're going to have to show the math to get me to believe that.

If you run the same numbers but for 30 years.

 

[SnowballCamper]

Which is better depends on the difference between your income tax rate when contributing vs. when withdrawing. A big change that happened after I started contributing was the reduction in capital gains taxes for income under 80k a year. This made the regular brokerage account much more appealing (in retrospect).

Our tax bracket is generally higher in earning years. As a result, it is easier to pay the tax once (when you have the excess disposable income) and enjoy the gains knowing there are no more taxes. On the other hand, we generally live on less money in retirement than when we were working, and as a result are likely in a lower tax bracket when we withdraw the funds.

Without knowing the future, there isn't a definitive better option. As a result, this is a common topic. Good luck with your choice!

 

[SnowballCamper]

Since I'm hiding from the heat, and got bored, I'll elaborate on how I get some different numbers.

Option 1 : Roth 457
Max out would cost: $23,790 to invest $19500

I think the math is that you need $25,000 to pay 22% in taxes (0.22*25,000=$5,500) and have 78% (0.78*25,000=$19,500) left over to max your contribution

Option 2 Traditional 457
Max out would cost: $19500 to invest $19500
BUT: you also invest $4290 (the cost of the Roth in option 1) into a brokerage account

I think you got the concept here correct, but that it should be $5,500 into the brokerage.

After 20 years of investing both 457 accounts would equal the same. Let’s say we averaged a 10% return. Your total would be $1,233,974

Brokerage Account 10% return = $271,094

You start withdrawing 6%

Option 1 Roth: $74,038.44

Option 2 Traditional: $57,750 after taxes
Brokerage: $13,826 after taxes
Total: $71,576

I model the contribution going all in at the beginning of the year and get $1,228,548.74 at the end of the 20 years. The $5,500 annually to the brokerage grows to $346,513.75. A withdrawal of 6% from the Roth is $73,712.92. Option two is $73,712.92+(.06*346,513.75)=$94,503.75, but taxed partially as regular income when withdrawn (73k of it) and the remainder taxed as a mix of dividends and capital gains. If for simplicity we assume a cumulative tax of 22% on the whole thing you get $73,712.92=0.78 * 94,503.75. The decision is just a trade off of withdrawal rules for a possibly lower tax rate in the future.

 

[SevenUp]

I think the math is that you need $25,000 to pay 22% in taxes (0.22*25,000=$5,500) and have 78% (0.78*25,000=$19,500) left over to max your contribution

Yes.

I think you got the concept here correct, but that it should be $5,500 into the brokerage.

Need to pay 22% tax on that $5500 so $4290 invested is correct.

The $5,500 annually to the brokerage grows to $346,513.75.

Whatever the annual contribution amount, annual tax drag will likely reduce the final balance.