The intention during your working years was to save a lot in taxes now and pay less in retirement – not the same or more, but the path to tax zombie land is paved with good intentions. To help you avoid the 457 plan tax zombies, there are a few solutions to this potential problem, one of which I’ll explain.
The Roth IRA is a type of retirement account that allows you to save after-tax contributions for future expenses, including retirement. Why is this type of account such a huge benefit for public sector employees? Because during your working years, you can use tax deductions to lower your overall tax rate, then make after-tax contributions to the Roth IRA. For example, imagine a married couple; the husband is age fifty and his wife is forty-five. The husband is a police chief and will retire at the age of sixty. His wife works in the private sector and will also retire at age sixty. Currently, the couple earns $150,000, have three dependent children, and carry a mortgage. Given these facts, it is possible for the couple to bring their effective tax rate under 10%. Now, fast forward ten years when the mortgage has been paid off, the kids are no longer dependents, and the husband is retired. With the former police chief now drawing a pension and his wife still working, it is possible that the couple has a lower income, yet are paying taxes at a higher overall rate! Worse yet, suppose the couple want to put a down payment on a second home or pay for their kids’ weddings. The husband might withdraw money from his 457 plan, which will be taxed at their current, possibly higher income tax rate.
Our fictional couple could have avoided an attack by the tax zombies by taking the tax hit at a lower rate and funding a Roth IRA during their working years. By doing so, they would have paid only, for example, 10% of their income to the IRS. Then, when it came time to put the down payment on the second home or pay for their kids’ weddings, the distributions from the Roth IRA would have been totally tax free (assuming the couple followed the Roth IRA qualified distribution rules). An even better approach from a tax standpoint, provided the municipality allowed it, would have been for the husband to make contributions to his 457 deferred compensation plan with a designated Roth account (DRAC). While the Roth IRA allows $5,500 of contributions, a 457 plan with a DRAC allows contributions of $17,500 (2014 figures are are subject to change).
According to Public Retirement Planners, LLC contributions to a Roth IRA or DRAC during your working years can be one of the most tax-efficient ways of saving for retirement. Of course, making pre-tax contributions to a 457 plan can also be tax-efficient; it just depends upon your personal circumstances, so I encourage you to review your income tax situation to determine if it’s better for you to make pre-tax or post-tax contributions to your retirement plans.
Even though the example that I provided is fairly straightforward, in reality, there are tons of moving parts involved with tax and retirement strategies, so it would serve your best interests to seek the advice of a competent, experienced financial planner and accountant before deciding on making pre-tax or post-tax contributions to your retirement accounts.
Securities and advisory services offered through Ausdal Financial Partners, Inc. Member FINRA/SIPC 5187 Utica Ridge Road Davenport, IA 52807 563-326-2064 www.ausdal.com. Public Retirement Planners, LLC and Ausdal Financial Partners, Inc. are separately owned and operated.