Would you rather have a whole lot of money that will first be taxed (Federal and possibly state) when you withdraw it or a whole lot of money that will be tax-free when you withdraw it? Would you rather have a whole lot of money that is taxable to your heirs, upon your death, or a whole lot of money that is tax-free to your heirs?
Career civil service workers are the last major group of employees that still have a guaranteed Defined Benefit pension. Coupled with Social Security, your retirement income will roughly be 90-100 percent of your pre-retirement income. This guaranteed income, however, is also guaranteed to be eroded by inflation and longevity. One sure way to address inflation and longevity risk during retirement is to save a whole lot of money while still working.
Q.: Should you save on a pre-tax or after-tax basis? The Deferred Compensation 457(b)/401(k) Plans of the City of New York offers both savings methods: pre-tax and/or after-tax. Saving on a pre-tax basis means you pay no tax on the contributions when made but distributions (contributions plus earnings/profits) will be subject to ordinary income tax when withdrawn. Saving on an after-tax (Roth) basis means you pay tax when you make the contributions and the earnings/profits those contributions generate are tax-free when withdrawn.
Reminder: Your pre-tax account balance(s), (457(b) and 401(k), are subject to Required Minimum Distributions (RMDs), which are taxable. RMDs must start in the year you turn 70½. If your pension and Social Security equal roughly 90-100% of your pre-retirement income, it stands to reason that when RMDs kick in, you will have more than 90-100% of your pre-age 70.5 income—-substantially more.
While still working there is no way to pay tax on your future pension and Social Security income. Federal tax law, however, allows you to pay, while working, the tax on your future 457(b)/401(k) retirement income.
How? Contribute all you possibly can on an after-tax (Roth) basis to the Deferred Compensation 457(b)/401(k) Plans of the City of New York. Prior to age 70.5, your Deferred Comp Roth accounts should be rolled over to your NYCE Roth IRA, which is exempt from RMDs.
How so? The tax has previously been paid.
Q.: I am 51 and have about $500,000 in my pre-tax 457(b) account. I want to transfer it to the Roth 457(b) account so when I retire all of my savings will be in the tax-free Roth account. Can this be done? P.L.
A.: Yes, it can be done. You need to roll over/transfer an amount-certain from the pre-tax 457(b) account to the Roth 457(b) account. I suggest you embark on a multi-year rollover program to accomplish this.
Use $50,000 as the amount-certain. These annual transfer amounts are referred to as “in-plan rollovers” which cannot be reversed. Deferred Comp will furnish the required form. The tax due on the $50,000 may not be paid/deducted from the $50,000. The tax must be paid by increasing your withholding tax and/or filing estimated tax. Please consult with your tax adviser for help in deciding the best way to pay the tax.
For those of you that are investing pre-tax I suggest you do a rough calculation to see what your annual RMD will be each year from age 70 to age 113. Google: “IRA WITHDRAWAL CALCULATOR FOR FORECASTING FUTURE REQUIRED WITHDRAWALS.” This calculation will also show your taxable account balance should you die prior to age 113.
Have fun and please recognize the tax implications for you and your heirs. As always, reach out to me for assistance.
Mr. Frank is a fee-only Retirement Financial Planner and a retired city high school Teacher of Accounting. He can be reached by phone at (732) 536-9472, or via email at email@example.com.
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