[Editor's Note: This guest post is by a physician regular reader, Joshua Knudson, MD. We have no financial relationship.]
Focus has recently [actually back in February when this post was submitted-ed] been turned to places of which this blog may short shrift certain aspects of financial planning that are simply not a part of the primary author’s life. One area that was recently pointed out in An Invitation to Contribute was that regarding the 457(b). About the time that criticism was posted, I was in the process of evaluating a 457(b) available to me. Many self-employed or contractor physicians have all the tax advantaged saving space they need to save for retirement, but as more and more physicians become employees they will find themselves with limited retirement accounts. Additionally, their health insurance offerings may not permit a stealth IRA (HSA) further limiting their options.
As a single, employed physician with no dependents there are no 529s, spousal backdoor ROTH IRAs, SEP-IRAs or solo 401(k)s available to me. One option available to many physicians employed by a government or non-profit organization is a 457(b) plan. It has been briefly discussed in a previous Friday Q&A post but while that post touches on one main concern of the 457(b) more information is needed to determine if your employer’s plan is right for you.
How to Determine if your 457(b) Plan is Right for You
Similarities of the 457(b) To Your 403(b)
Many times these plans are described online or by the HR representatives as another 403(b) account only available to the high earning employees of the organization, like the physicians. In many regards the 457(b) is quite similar to your available 403(b):
- Both have annual maximum savings of 18K per year
- Both are contributed to with pre-tax dollars providing a nice tax break
- Both grow in a tax-deferred manner
- Both are taxed as ordinary income upon distribution
- Often times the same investment options will be available in both
- Both require withdrawals to start at age 70 ½ with required minimum distributions
In one important way, the 457(b) is even better than 403(b). It has no penalty for withdrawing money prior to age 59 ½. The lack of the 10% early withdrawal penalty makes it an excellent source of income for a physician planning an early retirement.
Governmental vs Non-Governmental 457(b)s
But in many ways, the 457(b) can be exceedingly complex and the decision to use one isn’t as easy as it often sounds. Part of the difficulty is that there are different types of 457(b) which act in very different ways. Online articles and posts in the Bogleheads forum can easily lead you to incorrect conclusions on your plan if you do not understand the differences in the types of 457(b). The primary distinction is whether your 457(b) offering is governmental or non-governmental. Many state university employed physicians may have access to a governmental 457(b) whereas those of us working for non-profit employers will have a non-governmental plan. A governmental 457(b) does meet the definition of “essentially another 403(b)”. If your 457(b) is governmental one could easily make an argument it is even better than your 403(b) (fees and investment options not withstanding) and you generally should be making maximum contributions to them both each year. If your offering is of the non-governmental variety more consideration should be given prior to enrolling.
Nothing like that first Christmas
The largest and most important distinction between the plans, and the one discussed in the prior post, is that governmental plans are required to be held in trust and non-governmental plans are not. This means your money in a governmental plan is not exposed to the creditors of your employer whereas in the non-governmental plan assets remain controlled by your employer and thus are exposed to their creditors if they were to go under. While I agree with WCI that this risk is quite small, I’m sure the employees of Enron felt similar prior to the collapse of their employer. The risk, albeit small, is not zero. If you are not comfortable with the potential loss of this portion of your nest egg due to employer bankruptcy then you should not be using a non-governmental plan. For many, this could be reason enough not to use the plan and appears to be the main reason these plans seem not be favored on the Bogleheads forum.
Poor Distribution Options
If you are comfortable with your money being exposed to your employer’s creditors, you next need to determine how your plan will distribute your money. All plans are different in this regard. You must read all the details from your plan documents to understand how your plan works. Pay attention not only to how it is distributed upon retirement, but also if rules apply to termination of employment, both voluntary and non-voluntary. (If you think that can’t happen to you I’d be happy to provide you the contact information for the five physicians fired by my employer in the last few months alone.)
If you leave your employer, some plans will not let you leave the money with them and may require a lump sum distribution. Others may require you to notify them in writing within a certain number of days of termination your desire to leave the money with them or you will receive a lump sum. You cannot roll over the money from a non-governmental 457(b) into an IRA, a 403(b) nor a 401(k). Your only rollover option is if your new employer also has a non-governmental 457(b) AND that new employer’s plan accepts rollovers. Your plan may require lump sum distribution at the time of retirement or you may be allowed to choose to receive the money over a certain number of years. For example, my plan recently changed for the better. Originally upon retirement you had to take a lump sum payout from the plan. Now you can choose between lump sum or divided payments over five years. Each plan will be different and can be rather inflexible with the distribution options. This can make tax planning much more difficult.
No Roth in Non-Governmental 457(b)s
And don’t think you’ll just make ROTH contributions to avoid the tax bill on a lump sum distribution. They aren’t allowed in a non-governmental plan like they are in a governmental plan. Imagine, if you were fired in your early sixties after making maximum contributions to a non-governmental plan for 30 years, earning a conservative 5% growth rate, I would hate to see the tax bill on that 1.25 million dollar lump sum distribution taxed at your marginal rate.
Fewer Investor Protections
Further, admittedly of much less concern, 457(b) plans are not what is called a qualified retirement plan. Thus, they are not required to detail all fees and expenses like other retirement accounts. You could be exposed to a higher drag on your returns than you are aware of.
Learn Your Plan
As you can see, no two non-governmental 457(b)s will be the same and there is no blog post or web site to tell you if you should be using yours or not. You need to know all the details of your 457(b) prior to deciding to use it or not. Most importantly is your plan governmental or not. (Why two plans with very different rules have the same name is beyond me.) If your offering is a governmental 457(b) I’d count my lucky stars and treat it as an extra 403(b). If not, you need to determine if you are comfortable with the risk, albeit small, of losing your money to your employer’s creditors. If you are, next evaluate the investment options and fees of the plan. Keep in mind all the fees are not required to be disclosed as this is not a qualified retirement plan. If you are comfortable with the options and fees, pay attention to the withdrawal phase language. What happens if you leave this job? If your plan doesn’t allow you to leave the money and you don’t have a non-governmental 457(b) to roll the money into at your new job, you need to plan for a lump sum distribution. What happens when you retire? Are you prepared to take your account in a lump sum? Over five years? Ten? If you work for a very stable employer and expect to be there until retirement maybe their 457(b) is for you. If you value flexibility with your money and fear the tax implications of a lump sum distribution, maybe you’re better off with taxable investing or other options detailed elsewhere on the site.
[Editor's Note: I've inserted this illustration to demonstrate the decision-making process with a 457 outlined by Dr. Knudson above.]
Not a No-Brainer
As I’ve tried to show, I don’t think the choice to invest in your non-governmental plan is as simple as “tax savings vs risk of loss” discussed in the prior blog post. All this is not to say it can’t be a valuable piece of the retirement puzzle for many employed physicians with limited access to tax deferred accounts. If using a 457(b) for retirement savings, it should be the first account tapped to provide income for retirement due to the risk of loss. You must understand how your distribution rules could impact your taxes. Be sure to have a plan in place in case you are fired or desire to leave employment. If required to take a lump sum at retirement, you may be able to time it so that your distribution can be used to fill your lower tax brackets rather than added onto a year of earned income and taxed at your marginal rate. Also, remember that just because you have to take a distribution doesn't mean you have to spend it. You can reinvest the money in a taxable account or use it to buy Single Premium Immediate Annuities (SPIAs) to provide a lifetime of income.
My Choice
For me, the tax break and lack of other tax-deferred account options make a non-governmental 457(b) plan too nice to completely ignore. Currently, about 10% of my retirement savings reside in one. I am comfortable with that amount of my nest egg being exposed to my employer’s creditors to get the tax benefits. However, the plan makes up 20% of my contributions to retirement savings this year and I do not think I am comfortable with that. At that rate, this account will grow to make up a larger portion of my nest egg over time and I’m not comfortable going beyond its current 10% level. As such, I am likely to pay down debt faster and/or increase my taxable investing with the money that would have gone to max out the account. That will allow me to sleep at night, all the while waiting for something to come along to cause a rewrite of my Investment Policy Statement (IPS) like a wife and kids or change in employer. What allows you to sleep sound at night may be quite different.
What do you think? Do you have access to a 457(b)? Do you use it? Why or why not?
Great post! I am just finishing up my first 6 months as a new employee. I searched all kinds of blogs for information about wether or not I should contribute to my 457b (non governmental). I actually decided to buy wished I wouldn’t have for the first year because my gross salary is still low since I was a resident half of this year and the tax savings wasn’t as great as it will be in the future. My plans downfall is that it requires you to take a lump sum at retirement with no option to spread out payments. I plan to contribute for at least 5-10 years then reevaluate to see if it is worth contributing more or if I should just invest in taxable. Thanks again for the post.
I hate those lump sum only 457s. I think you’re right that it was probably a mistake to contribute this year. Probably a better time for Roth contributions/conversions and paying off loans.
I found a major potential mistake in the information on this post. “As a single, employed physician with no dependents there are no 529s, spousal backdoor ROTH IRAs, SEP-IRAs or solo 401(k)s available to me. ” can actually be incorrect if you are hired as a 1099 employee as many doctors are.
As a single, employed physician that is a 1099 employee, one can set up a Super 401(k)s with contribution limits up to $500,000 depending on your income and age. The trick is you need an actuary to customize a plan for you. We actually do this for doctors all over the country.
[Attempt to solicit business on the first day on the website deleted.-ed]
Let’s be a little clear about what we’re talking about. This isn’t a 401(k) or a “super 401(k)”. You’re talking about a 401(h), and actually being quite salesy about it, leaving out the critical details, but leaving a taste and a link and your phone number.
The information posted is neither wrong, nor a mistake, except for possibly funding a 529 for yourself or a niece or nephew or something. You apparently missed the key word, “EMPLOYED.” If you are EMPLOYED you are not hired as a “1099 EMPLOYEE” because there is no such thing. Someone paid on a 1099 is self-employed, by definition. Not knowing that detail casts serious doubt on the remainder of the information you are providing. But let’s address that.
He mentions this is a 401(h) and that this is some type of trifecta of retirement plans. He states this is the only account that gets a tax-deduction at contribution, tax-protected growth, and tax-free withdrawals if spent on health care. Obviously that is incorrect since a Health Savings Account has those same features. So what is a 401(h)?
It’s a medical expense account benefit. More info here: http://flandk.com/wp-content/uploads/2016/03/Employee-QA-401h.pdf
Like many things in finance, the devil is in the details. Let’s look at the details:
It says contributions must be reasonable for health expenses. I’m not sure anyone at the IRS is going to buy a $1M per year contribution is reasonable for health expenses. It then says you can’t use it for anything BUT health expenses. So I assume the idea is that you are the employer to whom the money must be returned if not spent on health benefits. But even then, if you want to take it out of the business you’re going to pay some tax on it. It won’t be triple tax free.
It also notes that this is all part of a defined benefit plan. The older you are the less that has been put in, the more you can contribute to a defined benefit plan. It is not unusual for older physicians to be able to contribute $100-200K a year to a defined benefit/cash balance plan, which operates a great deal like “super 401(k)” since when the plan is terminated, you can roll it into any old IRA or 401(k). I suppose it might be possible to put a million a year into a DBP, but it would obviously be a rare doc that could do that. My DB/CB plan for my partnership only allows contributions of $30K per year for actuarial reasons.
At any rate, interesting stuff, but let’s try to avoid the salesy stuff and just stick with the facts. If people are interested they’ll still seek you out for more information and they’ll trust you more for being straightforward rather than so cagey. Why don’t you submit a guest post about it or something?
I have enjoyed contributing to a non-governmental 457. Have maxed it out the past two years. It had better investing options than the 401k plan even though they are linked. However, just found out that my employer is breaking ties with the hospital so will have to take the one-time lump sum distribution. Can you please explain exactly what this means for taxes?
If there is no option to roll it into an IRA, and I believe there is not with a non-governmental, I think you’re hosed tax-wise. Take the money, pay the taxes on it, and invest the rest in taxable. It’s not the end of the world, you got to put the taxes off for two years and hopefully aren’t in a higher bracket now than you were then.
Possibility of one time lump sum should not deter ANYONE from contributing into 457 B. Lets say you are active investor, you can buy / sell stocks with no taxes, write options and collect all that money with no taxes, invest in treasuries / bonds with no taxes, no taxes on leveraged funds pumping out high income (closed end funds), master limited partnerships, REITS , business development companies.
You can rebalance your portfolio, and you got it = NO TAX
Joseph, do the math yourself. By selling now, you pay tax and lose money. Then by not investing in 457B, you hand over 43% of $17500 to IRS every year. Buy the way, this will result in paying extra in AMT tax every year. Then with the left over money you will be forced to take additional risk buy investing in stocks. You could buy muni bonds, but it has its own issues.
Also, the advantage of 457 b is that you pay no penalty on early withdrawal. Life can through curve balls, and you cannot access funds from IRA’s / 401K without taxes and penalties. You could also take loan from 457 b.
Finally, buy yourself dividend paying whole life insurance (one of the best financial asset ever). Recently my 30 year term life insurance expired, I could keep it in force without physical, but annual premium would jump from $800 to $28,000 (no exaggeration). Thank god I picked up plenty of whole life while I was relatively young.
Your 457B allows you to write options? You buy MLPs, BDCs in your 457? Really?
You need to run the numbers on using a 457 for just a couple of years and taking it out as a lump sum. You might be surprised to find it is not as good as a simple taxable account tax-wise. The key is deferring the taxes for either a long time (so the tax-protected growth overcomes the fact that gains are eventually taxed at your full tax rate) or getting at least some of the money out at a lower marginal tax rate than you put it in at.
Yes, we have option to move 100% of funds in 401K and 457B from employer plan (mutual funds) to an attached brokerage account where we can, and I do all of the above.
Tax deerral is excellent vehicle. Save money now when you are in high tax brackets, allows you to invest in conservative assetts without annual tax bites, and if you are an active trader and know how to write calls, make out like a bandit.
Here is a tip. Lets say you have $20K, buy mnkd shares, then write options for jan 2018 at strike price of $2.50. With all the premium buy either silver or gld etf (I prefer silver at todays prices) and then write about 10% out of the money calls for jan 2017 or 2018. Do the analysis. You get huge downside protection, you can make 55% profit if you shares get called away, and do so much more with calls that I don’t want to get into them
Taxed accounts are fine for riskier, non income producing assets that you buy and hold. However, if you have enough dividend income then pay uncle sam even more due to OBAMA CARE TAX.
Pretty awesome 457! I’ve seen 401(k)s that have a brokerage window, but yours is the first 457 I’ve heard of with one.
I disagree with you that being an active investor and writing calls is going to help you make out like a bandit, but I do agree with you that if you’re going to do that sort of thing, it would be best to do it in a tax-protected account.
457b plans are not allowed to have brokerage options. Maybe poster is confusing it with another option.
I know for a fact that a certain 457 plan has a self directed brokerage option.
JT, that makes two of us
My group has a Deferred compensation plan, which It sounds similar to the 457. Our plan allows irrevocable annual deferral of up to 100% of the next year’s salary, elected each year. Payout could be lump sum, or paid out quarterly over 3,5, 10, or 15 years, but schedule had to be determined in advance and changes difficult and limited. I don’t take advantage of it. The big problem with this plan was the same as noted above: creditor risk, which was a real risk in the past for this group, although not recently. Also, there’s no flexibility in the amount deferred, and very limited emergency access to the money. Plus, the limits and restrictions on distributions make it difficult to use. It does offer some tax arbitrage benefits if the payout was scheduled for the post- retirement- pre social security years, ie 60 or 65 to 70 , but those years can be used instead for some Roth conversions and capital gains harvesting, so lots of risk for a small benefit. If the payout was deferred into the later years, I would have ended up in same marginal bracket anyway.
I’m not making fun of your first flow chart, but I think there is a mistake in it. Under “Worried about creditor risk of your employer?”, both paths lead to “yes”.
Oops! Obviously a mistake. Yes should go right and No should go down. I’ll try to go back and correct that.
Just a point I did not agree with in the article, Non gov 457b are frequently held in rabbi trusts. Essentially protecting your money from everything except bankruptcy. From what I Have read, some of the rabbi trusts are structured in such a way that you will be in a short line of unsecured creditors claiming your money in the worst case.
One more point. There is a big difference in a 457b administered by huge nationally known top hospital versus Podunk clinic. The former being much more secure. Hard to imagine MGH, Yale, U of C, etc. going bankrupt. Also look at their bond rating and summary from Moody’s or other rating agency to get the scoop on current financial status.
Additional point not mentioned is that for physicians, the money is protected from YOUR creditors which can be valuable for high risk fields.
While the rabbi trust may help, you’re still in line with other creditors. So as you mention, if you’re working for Podunk clinic, you may want to skip their 457. It’s hard to trust Moody’s and others after 2008, don’t you think? 🙂
The physician asset protection, of course, is valuable as I have mentioned in other posts written on 457s (although apparently not here.)
Any example of individuals losing 457 b funds to creditors?
No, but I’d love to hear about it if it happens.
While I don’t know about any specific cases, there are hospitals closing every year (see link in comments) and presumably some of them have 457b/ deferred comp programs. These are not nationally known university hospitals. Jim, do you or your staff have time to do some research on specific cases for a future article?
I don’t even know where to begin researching that. Would you like to look into it and submit a guest post? 🙂
I will look into it but I am not sure how far I will get. I’ll keep you updated.
Yes agree about Moody’s but there are hard facts in their reports about cash on hand, how long they can operate without another dollar coming in, debt, etc. This can change but it is reassuring.
There are secured and unsecured credit claims. I have read that rabbi trusts can be structured so that the physician or employee is in a short line of unsecured creditors ahead of secured. Don’t know how one could check on this as the HR people would have no idea about this kind of detail.
You can “rollover” the money to a taxable account. The employer will withhold 20% for you.
What a great rollover option! 🙂
could you please elaborate on this?
You can “rollover” the money to a taxable account. The employer will withhold 20% for you.
It’s a joke. He’s saying you can pull it out of the 457 and pay the tax on it.
I had no idea that there were so many types of 457bs. I’m a government worker, so I guess I won the lottery and I have 2 tax sheltered accounts that we max out. However, now I know to be a little cautious when I sing my praises of my 457 knowing that what I have available isn’t the same case for others. Thanks for getting this information out there and the flow chart really helped.
If I contribute to my 457(b) non-governmental plan that is located at a community hospital in Colorado but then retire to Florida when I get my distribution over 5 years, will I have to pay Colorado state taxes?
Shouldn’t.
About the credit risk: How many hospitals enter bankruptcy per year? Are these predictable?
This was studied. http://www.healthcarefinancenews.com/news/hospital-bankruptcies-result-trends-not-single-event
So, using estimates from this link, that’s about a 0.13% risk of bankruptcy per year? That’s actually higher than I expected. More than a 3% risk over the life of a retirement account, if I’m thinking correctly.
My non-governmental 457 is unfortunately a variable annuity product, which means my cheapest investment option has an effective ER of 1.35%. I am in the top tax bracket. Does this seem worth the tax savings over the long haul? (I’m about 15-20 years from retirement)
Ugh. What do the distribution rules look like?
Can’t take in-service distributions now that the balance is over 5k. I have maxed out two years already. Can take normal distributions after retirement or after I leave the job for any reason. No penalty in those situations. And despite the annuity, no surrender charges. So, really, I just dread paying 1.35% annually in an already tax-deferred product!
What I’m asking is can you spread the distributions out over many years or at least several years? If not and given the high ER, I’d skip it. If you can…it is probably still worth using but should be the first money you spend in retirement.
Yes, the distributions can be spread out, but the plan documents are extremely vague. Won’t know for sure until I can actually speak with a human. Thanks for your two cents, WCI.
WCI – Would you recommend investing in a non-gov 457(b) before contributing aftertax to a 401(k) beyond the 18k limit? Also, my employer offers a non-gov 457(b) but also a non-qualified deferred compensation plan which I know, as yet, very little about. Any comments on the later, in general?
After-tax contributions to a 401(k) aren’t necessarily better than a taxable account unless you have the means to convert them to Roth relatively soon.
Every non-qualified deferred comp plan is a little different. Can’t say much about it without the details.
i just had kind of a weird experience with 457b actually.
in the summer i left a job at Major University A and moved to Slightly More Major University B. I had a 457b at A that was worth about 40k (2 years of maxing).
went to do the paperwork to rollover and found out that B doesn’t allow incoming transfers to their 457b. so now my options are to take a distribution or to set it up now for future distribution 30 years from now. no 3rd option and i have to decide within a few months.
seems very odd to “lock” down such a relatively small amount of money until retirement but it’s either that or basically give up all the tax benefit i accrued.
I agree, it’s odd. The worst part is that you’d probably be better off in taxable (except asset protection-wise) than using a tax-deferred account just for a couple of years. Lower costs and lower taxes due to dividends/capital gains rates.
A good reason to read the distribution options BEFORE investing in them, whether governmental or not.
[Update: Read a few comments below- You usually still come out ahead with a tax-deferred account as long as you can take the money out at the same tax rate you put it in at or better.]
I’m not sure I understand the reason NOT to use a 457, unless you’re not maxing out other retirement accounts. I get that the investments/fees within the 457 might be lousy. But if I had put that money into, say a taxable account, I would pay taxes on that money regardless, so why not stick it in a tax-protected account first? Even if it ends up being distributed all at once when I change jobs, can I not just pay the taxes on it from the distribution, then put it in a taxable account then? It seems like just an extra step of paying the same amount of taxes a few years later. Or is there something I’m missing?
I ask because I’ll soon be a W-2 employee with an employer 401K and an option for a non-governmental 457. I think the first few years I’ll just focus on 401K, 2x backdoor Roth IRAs, and paying off loans, but a few years down the road (if I stay at this job) I might have to decide whether to use the 457.
Allixi, read my posts above. You have the right idea, and depending on your income do both 401 and 457 from day one. Depending on type of loans, try to refi and/or consider HELCO.
You’re turning gains that would be subject to dividend/capital gains rates and paying your full tax rate on them.
Tax deferred growth still wins out even if tax rate at contribution= tax rate at retirement
You know what, you’re right. I apologize for the error.
I was thinking about the situation where you have a non-deductible account where the growth is tax-deferred, such as a non-deductible IRA. In that situation, the taxable account could come out ahead if the investment is tax-efficient and the time period is short since gains would be taxed at the lower LTCG rate. But in a true tax-deferred account, you would still come out ahead.
For instance, consider a person with a 33% marginal tax rate and a 15% LTCG rate. He can invest $10,000 into a taxable account (super tax-efficient investment) or $15K into a tax-deferred account (same amount of money due to his marginal tax rate.) If the investment doubles in 5 years, the taxable account would have $18,500. But the tax-deferred guy would have $20K after-tax. He would still come out ahead.
But in a non-deductible IRA, it’s $10K vs $10K. The non-deductible IRA ends up with $16,666 where the taxable account ends up $18,500.
Just as a point of reference, I use my non-gov 457 b. I do not think my large hospital system will bankrupt (but who knows). I like the tax deferred contributions. This article convinced me to get a copy of the plan document to figure out the distribution phase. The summary they have available is too vague to figure out. I will probably limit how much I put in there over the years, decrease my exposure to bankruptcy and lack of rollover options.
I have both 403b and 457 (Non-Governmental) plans available to me, but never contributed to 457 for the following reason..
Currently our tax bracket is 28% and another 10-20K of income will push us into 33%. My employer does allow distributions over 5 yr period, but I’m concerned that while I try to save 28% fed tax now, I may end up with 33% tax on these distributions because of very little room available in my current tax bracket.
Is my concern valid?
I guess it’s possible that could occur. While a 5 year distribution period is better than a 1 year period, it’s still pretty lousy IMHO.
This is a great article. I’m an non government employee with access to an employer matched 403b which I max out (and get 15k matched funds from my employer which is nice). I do some independent contract work but don’t think I’ll be able to contribute much this year because I netted about 20k and it looks like I have to subtract the 18k I already contributed to my employee 403b. I maxed the 457 for the tax advantages and figure I will keep doing this. Fidelity manages our funds (both 457 and 403b) and told me there are plenty of options for distributions (delayed from time of leaving company, can be spaced over many years, etc). I certainly will review the plan summary sheet to double check this. Does make sense or should I max out the Roth? I’m trying to use the rest of my money to pay off loans (financed through DRB – thanks WCI!)
Sounds like you’re doing great. Personally, I’d probably max out a personal and spousal backdoor Roth before doing a 457, but you can certainly justify doing it the other way.
With the tax diversification and the much greater flexibility in withdrawal phase ROTH wins for me.
I work at a rural not-for-profit community hospital serving a large multi-county referral area. I find it very difficult to evaluate the likelihood of bankruptcy. I find it very unlikely the hospital will close, given lack of any competition but it seems yearly they are struggling to meet the budget. Bankruptcy or a buyout or something seems possible. Of course I am not privy to the hospital’s financial details.. any insights on actually evaluating the hospital you work at? For now have elected not to contribute to the non-gov 457b despite being in the highest tax bracket this year.
Excellent question. If your hospital is publicly traded, perhaps you can get the financials, but even so, I think your gut impression is probably best. If it seems sketchy, don’t use it. If it’s the biggest thing going in the state, you’re probably okay. Either way, the 457 should be the first thing spent in retirement.
Please help me figure out the best thing to do
This is an excellent article. It’s super relevant to me as my group just got bought up by Big Hospital with 401k and non-govt 457b plans. Big Hospital has AA bond rating from Fitch and Aa2 from Moody’s, so I’m not too worried about default. I will have a 401K plan with low cost funds but no after tax contribution option for mega backdoor Roth conversion. I am already maxing out my 401K, wife’s solo 401K, backdoor Roth x2.
The troublesome fact is that while the 457b has low cost funds, distribution is in a lump sum the year you stop working there (by your choice or theirs). So I’m not sure I want to contribute (over several years) to yield a balance more than my annual income now, otherwise when the lump sum is paid out, I might be pushed into a much higher tax bracket. Currently I’m at 28% marginal tax rate if it’s a good year and 25% if I don’t work as hard. We save quite a bit and will retire when I have enough to sustain an income which will be taxed at no more than 25%. I just don’t know if it’s better to completely forgo using the 457b and just invest in a tax efficient manner in taxable account. Even though I would lose the tax deferred growth, would I not be subject to 15% LTCG rate?
Thanks in advance!
I think your fear is realistic about having a huge lump sum to take out in a single year. But that doesn’t mean you couldn’t use it for 2-5 years. That lump sum wouldn’t be too big.
Thanks for the reply. I think I contribute enough to have it equal one year of income, then stop. In the meantime, I’ll try to lobby them to allow distributions to be spread out over a number of years.
This reply is exactly what I was dealing with and the impetus for this post. Like many financial issues there isn’t one right thing to do we each have to decide on our own. The main point to have a plan for the distribution and not be caught off guard by it. Personally the tax benefits are too great to completely ignore the 457, at least for me. I’d tax the tax lump for one year and use the lump sum to buy myself a pension (SPIA).
Thank you for the great article. There are not that many resources debating the pros & cons of it online. Like 401/403 k it is not a no brainier. Despite having great tax advantage it has some serious cons.
1. You can lose money– less likely but still possible.
2. When you leave your hospital group, you may have to take the lump sum and pay a big tax on it .
3. The money is tax deferred not TAX FREE. You will pay taxes on it some day. Now if you start taking distributions after age 70 on it along with your 401k, you may end up being in a higher tax bracket. For eg. A 35 year old physician maxes both his 401 and 457 every year ( say 18+18k) for 30 years. Say it grows tax free at 8% a year. When he takes redistribution after 30 years the money will grow to about 5 million. You will be forced to take 4% each year which makes you income of 200k / year in retirement putting you at a higher tax bracket.
4. Like WCI said above, 457b should be spent the first in retirement. If you decide to retire early and take the distribution , say in your late 50s or early 60s, you may get your tax advantage but you will not have left the money long for it to grow like you can in your brockrage account instead.
5. Lastly I think tax saving is not everything when it comes to saving and investing. You may not need that much money in retirement. It may sometimes be better to have more liquid assets ( tax friendly funds in brockrage accounts) for easy access in need and enjoy your money when you are younger.
Regarding point # 5, there is a lot of misunderstanding. There are lots of ways to get to retirement account money before age 59 1/2 as discussed here:
https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/
Regarding #4, if you don’t do a 457 and retire early, what money are you going to live on then? Likely your taxable (brokerage) account. So you’re not really letting that grow for a long time either. So #4 is a wash and NOT a good reason not to do a 457 (although there may be others).
You can also live on a 401(k) or Roth IRA in early retirement thanks to the SEPP rule.
True. But I was just responding to the criticism about why a 457 is not good because of lack of time in the account.
Incidentally, this article caused me to find the plan for my non-governmental 457 of a large and expanding health system in the Intermountain West. Disbursement is either a lump sum or divided evenly over as many years as you choose. Seems reasonable to me, as far as disbursement schedules go. Only have $30k in there now (amounts to about 1/10 of my portfolio thus far) and will likely reevaluate in a few years to see if taxable account would be better. But deferring income at my current 33% federal plus about 7% state tax rate seems reasonable. Doubtful I’ll be that high in retirement.
I have been contributing to a non-governmental 457b in the past few years and I have over 110k in it. I will be changing employer later this year and the new employer does not offer a non-governmental 457b. So I have to make a distribution decision with 60 days of separation from my old employer. I was told that there are four options available to me. The non-governmental 457b is with TIAA-CREF.
1. One-time lump sum distribution
2. Fixe-period pay out between 5-30 years
3. Life-time annuity pay out
4. Roll over to another non-governmental 457b which accepts incoming rollover (not applicable in my case)
I am in my late 30s. I do not need the money. I am not sure which option I should choose. Any thoughts? Much appreciated!
No good option there. You’re going to get whacked with taxes. I think spreading it out for 30 years may be the best bet, unless the expenses are high, then maybe spread it out over 5.
So I was looking at the distribution of my non-governmental 457 and my options are lump sum or lifetime fixed payout (annual, monthly or quarterly). If I leave my employer or retire early and choose to take a fixed annual payout, does the remaining money in the account allow for continued investment?
Not sure. Probably just annuitizes. The limited distribution options are a serious downside of 457s.
Who comes up with the distribution options for 457b’s? Why do they limit the distribution options or offer rather absurd options like lump sum distributions–what do they have to gain from such options? Who does one talk to discuss the possibility of other options? Any success stories of petitioning for friendlier, more reasonable distribution options? I would think if they had more reasonable distribution options, then more employees would utilize the accounts which would be a big win for the brokerages involved (more business), the employer (eg, more invested money means they could perhaps negotiate lower costs), and the employees (better retirement account).
Good question. I suspect in some cases it is for simplicity. The employer doesn’t want to be running a retirement program forever so you have to take it all out when you leave.
Hi, Thanks for the great post. There is no chance my hospital is going under. I am a resident and have been contributing to both my 457 and Roth IRA. Although no match is available for residents, I use it to lower my AGI. I do not have a 401k available to me. When I finish residency, I can just rollover my entire 457 amount (contribution + earnings) into whatever retirement vehicle my practice offers right? (lets say 401k or other approved rollover vehicle). Anything I should watch for or know?
As mentioned above you have to determine if your plan is governmental or not. If it is then yes you can roll it over. If it isn’t then you can only roll it over if your new employer has a non-governmental 457 AND their plan accepts rollovers.
If you don’t have access to 401k must have 403b access right? If they have access to 457 there’s got to be something else I would think.
Bottom line know if it’s governmental.
Know the distribution options when you finish residency because if the new employer has no accepting plan you could be left with a lump sum distribution.
One potential employer noted that if they had another multi million dollar settlement against them, the monies in the 457b might be used to pay the plaintiff.
In the past, I used a 457b at a prior clinic. When the leadership decided to sell to a HMO and I decided to go back for a fellowship, the monies from the 457b were a nice bridge during the year of fellowship pay down from attending pay.
Lastly, I do use my 457b. I only put a $100 in a month but in 3 years I have about $10k. I am willing to risk this small amount to the above risks and if I leave the current position I have a few extra bucks to make the transition without hitting my savings.
Seems like a reasonable approach.
I just looked into this as I have been maxing out a Fidelity (non-governmental) 457b for about 2 years, but my position is being “reorganized” and I will be moving to a different employer with essentially the same job at the same hospital.
Anyway, they said I can elect distribution either lump sum, or monthly, quarterly, or annually. Payments can be distributed over 20 years, as long as the last payment is before age 100. That seems pretty flexible!
So while I was worried about having contributed, after reading all these caveats here, especially since I am in a higher bracket now then I was when contributing, I am relieved.
I *might* be able to roll it all over into a 457b with the new employer — but I won’t consider that before knowing the rules regarding distribution with the new employer’s plan!
Sounds like a pretty good 457b to me!