Lineweaver Financial Group
Traditional vs. Roth 457b Deferred Compensation Plans
A public employee’s deferred compensation plan has always been a very important part of their retirement planning. However, with the recent changes in the public pension plans, and likely more coming in the near to immediate future, planning for one’s retirement has never been more important. One of the best ways you can combat any negative changes to your pension is by paying yourself first; and a great way to do that is through your deferred compensation plan.
Hopefully, every Police Officer has at least started contributing to a deferred compensation plan available in their city. That is the first step. However, now most cities offer multiple plans to choose from, so it’s important to know what your options are and choose the plan that best matches your needs. Also, even more recently, some cities now offer both a “traditional” deferred compensation plan and a Roth option as well. Depending on your situation, one or the other may suit you best, or even a combination of the two.
The traditional deferred compensation plan is what most Police Officers have been contributing to for years. Your contributions go in pre-tax, which reduces your taxable income now and lowers the amount of taxes you pay today. Throughout your career, all the gains in the account grow tax deferred. You then pay taxes when you retire or when you separate from your employer and want to start withdrawing those funds to supplement your pension in retirement. So you reduce your taxes today, defer taxation on all gains in the account throughout your career, but eventually pay taxes on the whole account as you draw it out over time. The goal is that hopefully you take the money out at a manageable level so that you pay a lower tax rate than you otherwise would have in the past. However, it’s important to note if you decide to liquidate your account all at once, it would all get added to your taxable income for that year and you could jump up several tax brackets. This could cause you to end up losing a lot more of your account to taxes if you withdraw your funds frivolously and without proper planning.
The Roth deferred compensation plan works pretty much the exact opposite. Your contributions go in AFTER tax, so you don’t receive any tax break today, and your taxable income doesn’t get reduced either. However, all subsequent gains in the account grow tax deferred. When you retire or separate from employment, your ENTIRE deferred compensation account can be withdrawn TAX FREE as long as it is considered a qualified distribution. In order to be deemed a “qualified distribution,” the Roth account must have been established for at least five years, and you must be at least 59 ½. As long as these conditions are met, any and all of the Roth account can be withdrawn at any time tax free!
However, it’s important to note the traditional deferred compensation plan has no age requirement on distributions--you just need to be retired or separated from service. As you can see from the above, in order to take advantage of the full benefits of a Roth deferred-compensation plan, you would want to wait to take withdrawals after age 59 ½. This is an important thing to consider if you are planning on retiring prior to that.
So which plan is right for you? There is no short and easy answer. A lot of things come into play: your current and future tax brackets, the age you plan on retiring, how much you think you will need per year in retirement, and much more. For some, the best way to diversify their tax strategy could be by contributing to both of these plans. That way, in retirement, you will have some pre-tax assets to draw from and also after-tax Roth assets. Deferred compensation plans offer high-dollar limits that you can contribute to each year, so they are a great tool to use to try to effectively maximize your retirement. If you’d like more guidance on which plan makes the most sense for you, feel free to give us a call.
Lineweaver Financial Group
Securities offered through Triad Advisors, member FINRA/SIPC. Advisory services offered through Lineweaver Wealth Advisors, LLC. Lineweaver Wealth Advisors is not affiliated with Triad Advisors.