In 1789, Benjamin Franklin wrote a letter to a French physicist regarding the permanency of the newly minted U.S. Constitution but lamented that only two things in life are certain – death and taxes. That statement rings as true today as it did in 1789, perhaps even more so. The U.S. Government now collects taxes on an enormous scale and touches upon nearly every aspect of our lives, and even our nation’s finest have to cough up their fair share. However, the IRS is kind enough to give us certain tools that, if used correctly, can reduce our lifetime tax burden. Enter the Roth versus Traditional 457(b) Retirement Plan.
Roth Vs. Traditional Contributions
When you contribute to your Traditional 457(b) retirement, you don’t pay taxes on your contribution. Instead, you defer the taxes you owe on that portion of your salary until retirement. In exchange, your taxable salary is lower for that year by the amount you contribute, leaving you with more cash in your pocket than you otherwise would have.
As a rudimentary example, if your salary is $50,000 and you contribute $2,000, you now only owe taxes on $48,000, all other things being equal. In retirement, you’ll pay your taxes on that $2,000 plus taxes on its growth upon withdrawal. Your taxable income will increase by the amount you withdraw, and once you reach a certain age, you’ll be forced to begin making withdrawals (Required Minimum Distributions, aka RMDs).
Roth contributions are the exact opposite: you contribute post-tax funds. In exchange, you get tax-free growth and tax-free withdrawals, and withdrawals won’t increase your taxable income for the year. As of 2024, Roth 457(b) plans no longer have RMD requirements, meaning you can allow your funds to continue growing until you need them.
When to Make Traditional Contributions
So, Roth contributions are the clear winner here, right? Well, not exactly. We shouldn’t discount the tax deferral you get in the year of your contribution and the tax bracket you expect to be in when you retire. The amount you save from your tax deductions could be more than the taxes you pay in retirement when you begin making withdrawals.
For example, if you earn $70,000 a year and contribute $7,000 to a Traditional 457(b), your taxable income drops to $63,000. If you’re in the 22% tax bracket, this saves you $1,540 in taxes for that year ($7,000 x 22%).
However, in retirement, if your income is lower and you’re in the 12% tax bracket, you’d pay $840 in taxes when withdrawing that $7,000 ($7,000 x 12%). In this case, the initial tax deferral provides a benefit, as the $1,540 you saved upfront is greater than the $840 you pay later. This would be especially helpful if you could use those savings to help pay down debt, beef up your emergency fund, or invest further. If you invest those tax savings of $1,540 each year into an account that grows at an average rate of 10% per year, in ten years, the account could increase to approximately $26,998 ($15,400 invested, resulting in $11,598 of growth).
This is a highly simplified example, but it fairly illustrates the potential benefits of deferring your taxes until retirement. Your situation will differ, and it’s highly advisable to consult with a tax professional before making any changes to your financial strategy.
When to Make Roth Contributions
The example above makes great sense, but it rests upon one assumption – that taxes will be lower in retirement. Surprisingly, we’re actually experiencing some of the lowest tax rates in our nation’s modern history. Let’s take a look at the highest marginal tax rates and the 22% tax bracket changes over the years (or the bracket nearest to 22% at the time).
| Year | Top Tax Rate | Income Threshold (Married Filing Jointly) |
|---|---|---|
| 1985 | 50.0% | $169,020+ |
| 2002 | 38.6% | $307,050+ |
| 2013 | 39.6% | $450,000+ |
| 2021 | 37.0% | $628,301+ |
| 2024 | 37.0% | $731,200+ |
| Year | 22% Tax Rate | Income Threshold (Married Filing Jointly) |
|---|---|---|
| 1985 | 22.0% | $21,020 – $25,600 |
| 2002 | 27.0% | $46,700 – $112,850 |
| 2013 | 25.0% | $72,500 – $146,400 |
| 2021 | 22.0% | $81,050 – $172,750 |
| 2024 | 22.0% | $94,300 – $201,050 |
Source: https://taxfoundation.org/data/all/federal/historical-income-tax-rates-brackets/
As you can see, the income thresholds for both the highest tax rates and the 22% tax bracket have significantly increased over the years. Not only do you have to earn much more to fall into the top tax bracket, but the top tax bracket percentage is also lower than it used to be. Looking at more middle-class tax brackets, it’s now also more difficult to fall into the 22% tax bracket (or its nearest ‘equivalent’), translating to a reduced tax burden for the middle class as well.
Choosing to make Roth contributions can be a matter of principle: pay taxes now while rates are historically low rather than assuming they’ll be lower in the future. It may be emotionally easier to pay taxes now at a known rate than to defer them and risk facing higher rates down the road and kicking yourself for not paying them at a lower rate when you had had the chance.
There are other compelling reasons to choose Roth over Traditional contributions, such as a lack of RMDs, meaning you can let your funds continue growing until you reach later stages of life when your other savings may be running dry. Also, your Roth account could be left behind to a beneficiary as a tax-free gift.
You can also strategically convert your Traditional funds into Roth funds. It often makes the most sense to convert in a low-tax year, a low-market year or a combination thereof. However, you won’t be able to touch those funds for five years, even if you’re already retired, without risking penalties and additional taxes.
The Benefits of Tax Diversification
Nobody is saying you should only make Roth or Traditional contributions. A savvy strategy is to contribute to your Traditional account in years when you could benefit from a tax deferral and, in other years, contribute to your Roth account for tax-free income down the road. This diversification of your tax burden can give you greater flexibility in managing your tax brackets during retirement.
For example, let’s say you want to withdraw $30,000 from your retirement savings, but doing so would bump you into a higher tax bracket. Instead, you could withdraw as much as possible from your Traditional account without increasing your tax bracket and then withdraw the rest from your Roth account, which won’t affect your taxable income.
In Conclusion
By understanding how each option impacts your taxes now and in the future, you can make informed decisions that fit your financial goals as a firefighter. It’s not about choosing one over the other—it’s about using both strategically to minimize your tax burden and maximize your retirement savings. In a world where both death and taxes are certain, a smart tax strategy can make all the difference.
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