Taxable Brokerage Need?
Recently started a 457b at work after not having one available. This will be my primary work investment as my 403b does not offer a high match. I will be getting the small math in my 403b though. With the flexibility of a 457b, is there a big need to invest in a taxable brokerage account for early retirement?
My thoughts was to use it for the financial goals that are more the 5 years out such as buying another property or something else.
I also have a Roth IRA that I max and pension eventually. The 457b will be used as a bridge from early retirement (53-54ish).
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If you're likely to be in a lower tax bracket when you take distributions from the 457b, pre-tax contributions now let you pay less tax on those dollars later. As Roberto mentions though, income from a pre-tax 457b is ordinary income so taxed at less favorable rates than LTCG from a taxable account.
You might consider saving for specific 5+ year spending goals in a taxable account to pay less tax on those gains while income is high because you're working but directing longer term savings to the pre-tax 457b to benefit now from that tax break.
You might look at the book, Tax Planning To and Through Early Retirement by Cody Garrett, CFP®and Sean Mullaney. I have a copy and it's a great resource.
I have a similar situation… I have a 457b and a 401k through work. I also have an HSA through work. My order of investment is max out the 457b, 401k and HSA first all pre-tax to get the tax savings and supercharge my progress. I then do the max on my Roth $7,500 for this year.
After that is when I then invest in my brokerage.
I don't have any matches from employer but I see the advantage of maxing out my pre tax accounts before I go to brokerage.
I'm also considering switching over to Roth 401k and Roth 457b which would slow my progress and increase tax burden but I could see the benefit of that Roth money later in life.
For me, I think the only way I invest in taxable brokerage is if I have maxed out my 401k and 457b and HSA first. That's just me though.
I also have a HSA that I max but didn't mention in my original post. Before switching to a 457b Roth, I would look more into that. I thought I heard at one time there is some weird rules or provisions with withdrawing before 59 ½. Not positive so I would double check before switching.
A traditional 457b should work fine as a bridge to retirement. As others said, the withdrawals are taxed as ordinary income. This isn't a problem as long as you end up in an equal or lower tax bracket.
Taxable brokerage has the potential to be tax free if you're able to stay in the LTCG 0% bracket. The funds you contribute to your brokerage is taxable, so the "tax free" potential isn't a clear winner.
A Roth 457b has different early withdrawal rules and is subject to an early withdrawal penalty, just as a 403b and 401k may be.
I am unsure about the order of withdrawals, but a 457b Roth may also require prorated withdrawals that are proportional to your contribution vs earnings balances. If this applies, that makes it hard to withdraw the contributions early, unless you rollover to an IRA first.
You didn't specify which type of 457b account you plan to use.
The 457b is NOT “subject to an early withdrawal penalty, just as a 403b and 401k may be.” That is the very beauty of the 457b, and also the basis of the original question. Excellent discussion folks!
Many of the tax documents on the IRS.gov website around designated Roth funds do not include a carve out for 457(b) plans. And many financial providers mention that Roth 457(b) plans are subject to an early withdrawal penalty.
Even if those sources are wrong or misleading, it is not accurate to say without caveat that 457(b) plans are NOT subject to early withdrawal penalties.
Funds that were rolled over from non-457(b) plans, for example, are still subject early withdrawal penalties even if they are currently in a 457(b) account.
I think it's important to keep the nuances here.
457b plans vary greatly, so we need to know more details to say what to do.
First of all, non-gov 457b plans are not required to be fully funded and are not protected against employer bankruptcy. Do not use these plans for ANYTHING unless you have already maxed all other tax-advantaged options (403b, Roth IRA, HSA).
Second, most 457b plans have terrible investment options. Check this first.
Third, some 457b plans start mandatory distributions upon separation, which is bad for taxable income if you are changing jobs instead of retiring, and some distribute the entire balance in one payment, which is absolutely terrible.
Thanks for your reply. My 457b is through the state of Minnesota and is a governmental 457b. Overall the investment and expense ratios are very good.
According to their website "You are eligible to withdraw savings from your MNDCP account at any age upon retirement, termination of employment, or disability." So I am not subject to mandatory distributions.
Appreciate your thoughtful response and recommendations of things to consider.
Sounds like you have one of the (few) good ones; congrats, and definitely max this first!
Thanks for a great discussion! I would definitely max out the 457b before a taxable brokerage account. I would double check your account, but it sounds like both types have no early withdrawal penalty, and both types involve paying income tax (the taxable brokerage account uses post tax dollars). If that’s the case, the difference is a small amount of additional tax on the taxable brokerage account.
There was an episode from the very early days of ChooseFI titled "The Unfair (FI) Advantage of Teachers" with the Millionaire Educator. My recollection (as I don't have a 457b myself), is that with a 457b you can do many of the same things as with a taxable brokerage.
The only caveat would be that money withdrawn from a 457b counts as ordinary income, while money from a taxable brokerage would be considered capital gain or loss (as long as you held the position for more than a year). So, as long as you aren't planning to have especially low income years for a while to execute Roth conversions (i.e., the Roth conversion ladder bridged with a taxable brokerage), then there is probably not a meaningful difference.
Episode:
Ep 013 | The Unfair \(FI\) Advantage Of Teachers | 457b
Yes, I have listened to that episode a couple of times before I got the 457b and need to go back and listen to it again.
Thanks!