Featured Post: Making Lemonade Out Of Lemons

As I mentioned in a previous post, my wife and I use our 457 account with AIG Valic. While AIG Valic is not the worst-case scenario, its fee structure is still very high. Due to the insurance component of the plan, there is an additional 1% to 1.25% fee expense added to the underlying mutual fund investment.

For example, if we want to invest in a Vanguard fund (and we always do!), we have to add an additional 1.25% to the cost of the fund. This means that solid, cost-effective Vanguard funds suddenly have costs of 1.5% or higher. I do not care what people say; 1.5% is very expensive–especially when you feel that you receive ZERO value-added for the additional insurance fees. (Yeah, yeah, I know that if I die while my portfolio value is less than my total contributions that my beneficiaries will receive a payment equal to my total contributions. OH JOY! I have to die during a prolonged market slump. Thanks but no thanks, I’ll take my chances on the U.S. economy.)

This leads to an obvious question:

If we dislike AIG Valic and variable annuities so much, why do we fund our 457b accounts?

Here are our reasons:

1. We kinda, sorta view our 457b account as our emergency fund. Sure, we cannot get to it unless we leave our current jobs, but in that event we would have access to about $50,000. At that point, any withdrawals would be considered regular income; there would be no 10% penalty for early withdrawal.
2. We use the 457b plan to aggressively reduce our taxable income. By salting away $20,000 to $30,000 in the 457b, we are able to get our taxable income to the 10% tax bracket on our federal income taxes. This also helps to reduce our state income tax liability.
3. We use or 457b accounts to buy back service purchase years in our teacher’s retirement pensions. I bought back 2 years of previous service and 2 years of graduate study time with my 457b accounts. I do this because the 457b account allows me to buy back these years of service with PRE-tax dollars. For example, I rolled $4,000 from my 457b plan to the teacher’s retirement system to buy back 2 years of previous service. Since I was in the 15% tax bracket, I saved my self $600 dollars in federal income taxes! Not to shabby!
4. When it is all said and done, we will eventually roll our 457b money to our Vanguard IRA accounts. This will allow us to access better fund offerings than the current fixed income accounts that we are in now. So in one sense, our 457b accounts allows to boost our IRA contributions by $15,500 for each of us. The only problem is that we cannot get our money into a good investment until we leave our current jobs.

What do you think? Am I crazy?

Don’t be foolish and naive like I was. I went years without shopping around my insurance rates, and one day it dawned on me.. All I had to do was take 5 minutes and get some free quotes and boy, did I ever save some major $$