Too much pre-tax?

[coldestcat]

At my job I am eligible for a 457b and a 403b plan. I have both opened but am no where near maxing these accounts, I also have an HSA for us that I contribute to. My wife has a 457b and can eventually open a 401k. In these early years of our careers should we be putting every raise into upping the contributions to these accounts until they are maxed or should some of our money be going into post tax investing (I am heavily leaning toward index funds for our investment strategy)?

It seems like we cant go wrong with doing the most pre-tax savings we can manage, but a lot of strategies talk about getting into the market early and often and we dont want to be missing anything.

[Boofinator]

In my opinion, you can only do too much tax-deferred savings if you drop into the 0% tax bracket*. In which case you max Roth (if available). Then, you start filling up taxable.

The Mad Fientist breaks out the options and results in this post**:

https://www.madfientist.com/how-to-access-retirement-funds-early/

*Some argument could be made that the 12% tax bracket might be worth going Roth, but my counterargument would be that this does not apply to potential early retirees.

**He neglects to account for tax-loss harvesting in a taxable account, which results in a one-time (rather than compounding) savings of a few percent on contributions, but it wouldn't make up for the compounding in a tax-advantaged account.

[hadabeardonce]

You can collect from a 457 immediately after severing from your employer, so I wouldn't worry about the pre-tax issue. It's a great early retirement account.

[coldestcat]

So from the Mad Fientist article and @hadabeardonce I am getting that I can convert an account to a traditional IRA once I retire but for the 457 I would not even need to do that.

@Boofinator ,when you say the only way to do too much tax-deferred savings is in the 0% bracket. Which would ostensibly only be once we've retired, and at that point I would not be contributing to the accounts any longer. Am I understanding that right? There are probably corner cases of exceptions but for my case, I think that is correct.

In this case my $$ goal is to be able to max both the 457, 403, and the HSA. Itll take a while to get there for me. My wife will get there quicker since she has higher wage and cannot contribute to the HSA.

Thanks!

[Boofinator]

@Boofinator ,when you say the only way to do too much tax-deferred savings is in the 0% bracket. Which would ostensibly only be once we've retired, and at that point I would not be contributing to the accounts any longer. Am I understanding that right? There are probably corner cases of exceptions but for my case, I think that is correct.

If you earn below the standard deduction ($24k for married), you would fall into the effective 0% tax bracket. Also, there are some rare employment positions that are not taxed, for example military serving in a combat zone. Very few people working fulltime would meet these criteria.

[Psychstache]

At my job I am eligible for a 457b and a 403b plan. I have both opened but am no where near maxing these accounts, I also have an HSA for us that I contribute to. My wife has a 457b and can eventually open a 401k. In these early years of our careers should we be putting every raise into upping the contributions to these accounts until they are maxed or should some of our money be going into post tax investing (I am heavily leaning toward index funds for our investment strategy)?

It seems like we cant go wrong with doing the most pre-tax savings we can manage, but a lot of strategies talk about getting into the market early and often and we dont want to be missing anything.

We're in the same boat. 2 403bs + 2 457s + 2 HSAs + 2 IRAs = 95k in tax advantaged space available. We spend the year dumping as much as we can into the 403bs and 457s. At the end of the year/before completing taxes, we figure out how much we can contribute to HSAs and TIRAs to maximize tax benefits. If we still have space in the IRAs, then we put some in Roths, but we have trouble filling up all the space there that we haven't bothered with a taxable brokerage account.

As someone else mentioned, the 457s are immediately accessible once you terminate employment, so I wouldn't worry about access in ER.

[coldestcat]

thanks @Psychstache, for the similar reference. I thought a couple could only have 1 HSA between the two of them.

Also I am putting some of my funding into the HSA monthly since I thought it was supposed to be the best account for retirement (https://www.madfientist.com/ultimate-retirement-account/) rather than waiting until the end of year. Is there a reason why you do it that way?

[hadabeardonce]

So from the Mad Fientist article and @hadabeardonce I am getting that I can convert an account to a traditional IRA once I retire but for the 457 I would not even need to do that.

Yeah, you wouldn't want to convert because then your money would fall under the rules of a IRA.


This is decent document for comparing plans: https://www.irs.gov/pub/irs-pdf/p4484.pdf

457(b) Governmental,
Withdrawals, Loans,  and Distributions,

• withdrawals permitted after severance from employment,
• must start receiving distributions by April 1 following the later of year of retirement  or attainment of age 70½,
• plan may permit loans and distribution for unforeseen emergency or small inactive  accounts

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

Nonqualified 457(b) plans: Governmental 457(b) distributions are not subject to the 10% additional tax except for distributions attributable to rollovers from another type of plan or IRA.

[MDM]

It seems like we cant go wrong with doing the most pre-tax savings we can manage, but a lot of strategies talk about getting into the market early and often and we dont want to be missing anything.

The word "but" in that sentence raises a flag.  Do you perceive a difference between "pre-tax savings" vs. "getting into the market"?  If so, what difference?

[coldestcat]

@MDM This is kind of the root of my question. Do pre-tax accounts "count" as investing? Because index funds or real estate is so widely discussed as the investment vehicles, I feel I might be left out since I won't be able to do either of those things for a while since I am trying to max the pre-tax accounts first.

In other words, am I doing ok by just having my money in the 457,403, and HSA, or do should I also be investing in other things before I max the accounts?

[MDM]

@MDM This is kind of the root of my question. Do pre-tax accounts "count" as investing? Because index funds or real estate is so widely discussed as the investment vehicles, I feel I might be left out since I won't be able to do either of those things for a while since I am trying to max the pre-tax accounts first.

In other words, am I doing ok by just having my money in the 457,403, and HSA, or do should I also be investing in other things before I max the accounts?

Depends on what you are doing with the money in the 457, 403, and HSA: have you left it as cash or have you invested it in index funds?

See the first eight rows of the 'Basic Terms' tab in the case study spreadsheet.

[theolympians]

@MDM This is kind of the root of my question. Do pre-tax accounts "count" as investing? Because index funds or real estate is so widely discussed as the investment vehicles, I feel I might be left out since I won't be able to do either of those things for a while since I am trying to max the pre-tax accounts first.

In other words, am I doing ok by just having my money in the 457,403, and HSA, or do should I also be investing in other things before I max the accounts?

Some confusion there. Putting money in 457, 401's, IRA's IS investing. Typically, those plans offer mutual funds. Also typically, they offer index funds, small cap, large cap. Myself, I would not invest anything post tax until my pre-tax plans, and the roth, are funded.

[diapasoun]

It seems like we cant go wrong with doing the most pre-tax savings we can manage, but a lot of strategies talk about getting into the market early and often and we dont want to be missing anything.

The word "but" in that sentence raises a flag.  Do you perceive a difference between "pre-tax savings" vs. "getting into the market"?  If so, what difference?

I was also wondering about that. If you have your 401k invested in index funds (as you're pondering, OP), then you are in the market. You will be getting sweet sweet growth AND sweet sweet tax advantages.

OP, my personal philosophy is that I'm maxing my tax-advantaged spaces until one of the two following things happens:

1. I have enough money in my tax-advantaged spaces that it is projected to grow to be enough to cover my expenses from age 65 on
2. I am able to max those spaces with money to spare

I'm close to 2. I'm not close to 1.

[seattlecyclone]

In my opinion, you can only do too much tax-deferred savings if you drop into the 0% tax bracket*. In which case you max Roth (if available). Then, you start filling up taxable.

That was basically my opinion for quite some time, but I changed my mind after I FIREd and looked more carefully into how ACA subsidy phase-outs affect your overall marginal rate in retirement. If you look at the graphs in that post, someone living off the Roth pipeline has precious little income that's really taxed at less than 12% overall. Basically anywhere above the Medicaid cutoff (at 138% of poverty level for those in expanded Medicaid states) and below the ACA cutoff (at 400% of the poverty level), Roth conversion income will be taxed at 22% and up. For this reason I think that under current laws, Roth looks mighty attractive in the 22% bracket and below, it's something of a tossup in the 24% bracket, and pre-tax only starts to look like a clear winner in the 32% and higher brackets.

Of course there's always the strong possibility that the ACA will be reformed over the years. Even if it isn't, those who wish to avoid Medicaid for whatever reason (or who don't live in an expanded Medicaid state) will probably want to have some source of savings that can throw off an annual MAGI high enough to get into the ACA subsidy range in the first place. Whether this points toward having a pre-tax retirement account balance that you can do Roth conversions from, or a taxable account that you can claim the dividends and capital gains on, will depend on individual circumstances. Some sort of tax diversification is probably a good idea regardless.

[Boofinator]

In my opinion, you can only do too much tax-deferred savings if you drop into the 0% tax bracket*. In which case you max Roth (if available). Then, you start filling up taxable.

That was basically my opinion for quite some time, but I changed my mind after I FIREd and looked more carefully into how ACA subsidy phase-outs affect your overall marginal rate in retirement. If you look at the graphs in that post, someone living off the Roth pipeline has precious little income that's really taxed at less than 12% overall. Basically anywhere above the Medicaid cutoff (at 138% of poverty level for those in expanded Medicaid states) and below the ACA cutoff (at 400% of the poverty level), Roth conversion income will be taxed at 22% and up. For this reason I think that under current laws, Roth looks mighty attractive in the 22% bracket and below, it's something of a tossup in the 24% bracket, and pre-tax only starts to look like a clear winner in the 32% and higher brackets.

Of course there's always the strong possibility that the ACA will be reformed over the years. Even if it isn't, those who wish to avoid Medicaid for whatever reason (or who don't live in an expanded Medicaid state) will probably want to have some source of savings that can throw off an annual MAGI high enough to get into the ACA subsidy range in the first place. Whether this points toward having a pre-tax retirement account balance that you can do Roth conversions from, or a taxable account that you can claim the dividends and capital gains on, will depend on individual circumstances. Some sort of tax diversification is probably a good idea regardless.

I admit and plead ignorance on the affect of the ACA for early retirement. I've tried to read a few bloggers' posts on the topic, but the non-immediacy of the topic to my situation always loses my attention. But I've reread, and I see and concede your point regarding the math.

Actually, to go back to my original post, I was probably a little more black-and-white than my actual beliefs dictate. I haven't been in the 12% bracket-equivalent for many years, but if I was I would probably think long and hard about diversifying taxes in the temporal realm by choosing Roth until the 12% bucket was filled. However, even though the math says it is optimal under the current laws, I personally wouldn't recommend going Roth at 22%, because my decision tree shows the ACA to have much less than a 100% probability of continuing to exist as it is when I retire.

[MoneyQuirk]

As much as possible should be going into the pre-tax savings.

Worst case scenario you can pull it back through a 5-year ladder, loan against it, or (absolute worst case scenario) a withdrawal.

But realistically, you probably won't have any need to draw on it.

[DadJokes]

We're a bit torn as well. People argue that 12% is an extremely low (historically speaking) marginal tax rate, and that we should lock in that tax rate by prioritizing Roth over traditional. However, looking back, outside of WWII, tax rates have always gone down, not up. I just don't see a politician being willing to raise taxes on the middle class (even if we are undertaxed).

However, I split the difference. We still fund a Roth IRA every year, which doubles as a backup emergency fund. Other than that, the rest of our investing goes into traditional accounts.

Also, @coldestcat @Psychstache you can only one one HSA between yourself and your spouse. Or rather, you can only contribute $7,000 ($7,100 in 2020) to HSAs between the two of you.

[coldestcat]

Yep, I have the one HSA for both of us, but the HSA, 457, and 403 give me a lot of room to put my money pre-taxed and I just wanted to make sure that is fine.
Thank you @MoneyQuirk that answer makes sense and is also what I am trying to do now. It will just take me a while before I am making enough to max all of those accounts. Thats my goal though.

[JSMustachian]

I would max all the pretax accounts until you are close to the 10% bracket and then go Roth.

Be careful with the 457B withdraws once you are closer to retirement if you plan to use the ACA. The combination of 457B withdraws and roth conversions to fund your early retirement could reduce or eliminate subsidies. For this reason I plan to have a few years of expenses in a taxable account.