Ok, fellow readers, I’ve got a question for you. I think that Roth IRAs are the bomb, and my wife and I have had one ever since I learned about how cool they are. There is one problem with the Roth IRA though; that pesky $5,000 per year deposit limit.
Employer Options
At my work, however, we have a new option. I have a 457b plan (much like a 401k, but you can begin withdrawals when you stop working, rather than waiting until the magical age of 59 1/2). I chose this over the 401k because of the ability to withdraw, without tax penalty, your balance if you ever leave service. You don’t have to wait until the full 401k age. And, you have the same contribution limits as the 401k, much higher than the Roth IRA.
My employer has offered a Roth version of the 401k, but again, I didn’t want the age limitation. Now they have the Roth option for 457b accounts. I’m certainly taking advantage of that by putting future contributions into a Roth 457b plan instead of the traditional 457b plan.
Should I Convert My Account into a Roth?
Here’s the weary query I put to you; should I convert my current 457b balance into a new Roth 457b account? Just like converting a traditional IRA to a Roth IRA, you have to pay taxes on the entire balance. On the plus side, there is no penalty to be paid.
So what do you think? Here are my options.
Option 1: Leave the account as is.
I could leave the money I have in my 457b, and just put future contributions into the new Roth 457b. The pro is that I don’t have to worry about paying a tax on a rollover; on the other hand, the money in the old 457b account will be taxable when I withdraw the funds in the future.
Option 2: Make the rollover, and pay the piper his due.
This is the option I’m leaning towards, but it’s definitely going to cost me. With a total of about $20,000 in the account, my employer will withhold about $7,500 for taxes (about 35%). After I do my taxes next year, the actual taxable amount will be closer to $3,000. Still, that’s a huge chunk of change. On the other hand, when I retire I won’t have any taxes to pay on withdrawals.
What would you do?
So I leave this question for you, readers: Which option would you choose? This is definitely an open question, with many variables missing, so I will give you a little more info. I’m 30-35 years old, and will be able to retire from my government job at 2/3 of my salary at the age of 55-60. I do not plan on working after retirement, and I plan on travelling a lot afterwards. I shouldn’t have any debt at retirement, except for a possible car payment. Any other government workers out there with this option?
More Retirement Planning Options
I definitely would not convert with the numbers you have laid out. The employer withholding 35% means that money is gone from the account (even though you get part of it back when you do taxes at the end of the year).
Just leave the $20K in the 457 and if you wish to contribute to the Roth 457 in the future, do so. The $20K is not enough to affect your tax bracket much in retirement.
DaveGreat comments guys, thanks! I am such a fan for everything “Roth” it can blind me from all the other options. Using your numbers (well, I guess they’re really my numbers!) I see it’s better to keep the money there. Future contributions to the Roth 457, that sounds like the best way to go. Thanks Rebecca and Dave!
NickDo what you feel comfortable with. I have converted my 401k to a Roth before and it was painful to have to pay the taxes but I’m glad it’s done now. If you change your mind, you can always convert later.
LindaThat is tough but given we just paid about $5K in taxes a few years ago, I would lean towards option 1. Leave the money where it is at and open up a 457 Roth. I can not imagine having to fork over more money in taxes.
Amy RamosYeah, I’m not particularly a fan of paying taxes if I don’t need to (and really, are any of us?). Linda, always good advice. Research can get you so far, but in the end, you have to do what you feel best about. Thanks!
NickA financial adviser once gave me this piece of advice:
Divide your money 3 ways:
30% of your money should be taxable now (CDs, Money Market, other taxable investments)
40% of your money should be taxable in the future (401k, IRA, etc.)
30% of your money should never be taxed again (Roths of all types)
This is like diversifying your tax-ability and makes sense to me.
MITBetaThat’s one I hadn’t heard before; learn something new everyday! In the long run, I can see that my future taxable 457 can be part of that equation. I’ve still got a few decades to go!
NickCrazy, the owner of our company just sent out a memo asking if we would be interested in a roth 401k! Hello!?! Yes! I am going to share this article with coworkers – converting depends on if you have the money to pay the taxes WITHOUT touching your principle
Katie ChristiansonShare, share away! I was excited too when I found about our Roth option.
NickI would convert it. When you retire, you’ll be making 2/3 your salary. Assuming that 2/3’s is the portion just before you retire, most likely it will be more than you are making now. Also, while we can’t predict tax rates, I would assume taxes will be higher because of our government not being able to control spending.
However, with that said, $7,500 compounded for 25 years at 6% return (being conservative) is about $32K. Are you comfortable enough in “giving up” $32K to not have to pay taxes in the future? While $32K seems like a lot, if you really save a lot your account and don’t convert, will you pay more than $32K in taxes?
Don @ MoneySmartGuidesI’m not sure 6% is conservative (or perhaps I’m too conservative!) but even at that rate, the final amount of interest I would have earned is about $24,500, not the full $32K balance. That said, I think I will end up saving enough in the future such that the taxes on my 457 will be more than that. The tax rate being such a huge unknown variable, I prefer the idea of putting as much money away now that will not be taxed in the future.
NickFirst, would you otherwise invest the $3,000 you would have to pay in taxes or just spend it on something else. If you have the same tax rate in retirement that you have now, it doesn’t matter if you pay the taxes now or in retirement. Even though the money compounds into nominally more money in retirement, you also have to look at the opportunity cost of investing the $3,000 you pay in taxes now. That said, what do you think your tax rate will be in retirement? It sounds like it’s around 15% now. Do you expect it to be lower or about the same in retirement? If so, don’t convert. But if you expect a higher tax rate in retirement, conversion makes sense (and with a defined benefit pension, you may well be in a higher tax bracket).
BrittProvided congress makes no changes (what are the chances of that?) I think I will still be in the 15% tax bracket at retirement. I think it makes the most sense now to just leave the current 457 alone, and just put future contributions to a Roth 457.
NickOne option might be to convert when you leave the employer (assuming it’s well before retirement). That way you could convert to an IRA, then convert that to a Roth and pay the taxes with cash rather than have the amount withheld.
JillI’m far too conservative with my money and job to do that! Especially right now, the agency I work for is not hiring, with state cutbacks. If I left my job, I couldn’t get another state job, and I’m not interested in working for the private sector.
Nick