*Disclaimer #2: I am not a professional, and MyMoneyWizard.com is an opinion-based blog. Nothing on this website should be considered financial advice.
Welcome back to the first reader mailbag in a while!
This series has proven even more popular than I expected. Allow me to illustrate with a visual representation of me opening the Reader Mailbag inbox:
I kid, I kid! Huge thanks to everyone who’s sending in all the great questions.
So it’s about time that I finally get to answering those questions!
1. What the heck is a 457(b)?
Hey Wiz! Love your blog. I graduated a year ago and found your site while looking to take advantage of my retirement benefits at work. We have a 457(b). From what I’ve read, this type of plan is similar to the 401(k) you always recommend.
Do you have any specific thoughts on 457s?
Yes, yes, and yes!
When it comes to investing for financial freedom, if 401(k)s are the gold standard, 457s might be the palladium standard.
(Fun trivia: Palladium is a precious metal about 30 times as rare as gold…)
That’s because, according to Investopedia.com, “457 plans are non-qualified, tax-advantaged, deferred compensation retirement plants.”
Uhh… English please.
What this means is that 457 plans function similar to Traditional 401(k)s. Meaning, they bring three key attributes:
- They’re a benefit provided by employers (many of whom offer some sort of matching to the program)
- You fund them with pre-tax dollars (which is huge because it means you can reduce how much you pay in taxes today, and then your investments grow without being taxed)
- You withdraw your investments in retirement.
But number 3 is where things get really interesting for 457s…
Unlike 401(k)s, which charge you 10% if you withdraw your investments before age 59.5, most 457 plans have no early withdrawal penalties.
For someone interested in reaching early financial freedom, this is huge. Imagine hitting your financial independence number at age 45 and immediately being able to start living off your investments, no fancy loopholes needed.
Unfortunately for us mortals, 457s are usually only available to state and local government employees. (And some nonprofits…)
There’s also a few quirks to keep in mind.
- Any employer matching counts towards the annual contribution limit. ($19,500 as of 2021)
- Some strange 457 plans (usually non-government ones) are technically owned by the employer. This means your retirement account could be at risk if your employer kicks the bucket and declares bankruptcy.
- 457(f) plans are about 100x more complicated than 457(b), so definitely make sure you read the fine print.
Long story short, you can bet that if I had a normal 457(b) plan, I’d definitely be jumping for joy. And as soon as I landed, I’d start maxing that thing out ASAP.
2. Two book recommendations
I’ve followed you for a year or so and I stumbled across 2 books that I think you would really like.
1. The Soul of Money, by Lynne Twist It discusses tribes in the Amazon that haven’t ever used money to powerful CEOs. It is written by a professional fund raiser for The Hunger Project.
I say that if you spend about $20 on a book and you learn at least 1 thing in it that changes your life, it is a great purchase.
2. Simple Wealth, Inevitable Wealth, by Nick Murray. This classic is a one stop shop on investing and my favorite recommendation to anyone who invests on their own. I have my MBA, but this book is really all you need, in my humble opinion.
Sweet! I’m definitely adding both to my ever-growing “Want to Read” list.
Has anyone read these?
3. Taking advantage of the H.S.A. in the U.S.A.
Money Wizard, very much enjoy reading your blog as we seem to be at similar spots financially when you started though I’m a few years older (currently 37).
Do you have any thoughts on maxing out your HSA and using it as another retirement investment account that’s more explicitly set up for medical? That’s my plan since my employer gave us a high deductible option this year.”
Health Savings Accounts are awesome. Madfientist calls them the Ultimate Retirement Account. Why?
- They’re tax free on both contributions AND withdrawal
- If you never get around to using your HSA contributions, the HSA just turns into a traditional IRA at age 65.
- With some clever planning, you can live off your HSA in early retirement.
Personally, I put maxing your HSA at #5 (right above maxing your IRA) on my super-official-unofficial Correct Order of Investing guide.
I looked into it myself, but my employer’s high deductible insurance options weren’t great, so I don’t currently have an HSA. But I’m very jealous of those who do!
4. It’s all about the leverage, baby! (Or is it??)
What is your opinion on leveraged ETFs? I want to invest in an ETF which follows an index and I narrowed it down to some products on S&P 500 and NASDAQ-100. I’ve found leveraged ETFs which double or triple the daily results of the underlying index.
What attracts me about these products is that you have the benefit of having leverage without having to put up the difference if the price goes down. The value of your investment just decreases until it increases back up. If you buy and hold long term, I assume you would get at least the return you would get on an unleveraged ETF. Considering the information they offer the returns have been at least 10X over the last 10 years.
Please let me know your thoughts on these types of products. Maybe there are some extra risks compared to the unleveraged that I have not understood? Thanks!
I actually get this question a lot, because the logic is totally sound. Leveraged ETFs sound like a great idea. But surprise! They’re a total trap…
Stay far, far way, IMO. The problem with leveraged ETFs is because of how the funds have to structure the leverage, their value is guaranteed to be eroded over time. Counterintuitively, this means leveraged ETFs are rigged against long term investors.
To explain exactly why requires a pretty math-heavy explanation. Here’s one of those. And another. And a third. (And yes, I included three different articles just to show that this opinion is pretty much an agreed upon fact in the financial community.)
But the simplest way to explain it is this: if you have a stock and it goes down 50%, then goes up 50%, you’re all good right? Wrong!
Run the math:
- $100 drops by 50% = $50
- $50 gains 50% = $75
In simplified terms, leveraged ETFs amplify your losses faster than your gains. Bad news!!!
It may have just been my employer, but though I could withdraw prior to age 59.5 without a 10% penalty, it had to be all of the account which would have pushed me into a high tax bracket. When rolling it over to an IRA I could do a partial withdrawal. So I took as much as I could to stay in the 22% bracket, and rolled the rest into my IRA.
The Money Wizard says
Interesting. One thing I’ve learned when researching 457s is that they definitely seem to differ based on employer, state government, etc. So this is one instance where it’s worth reading the fine print, as painful as that usually is.
Thanks for sharing!
Thanks for hitting on the 457b! It does appear to vary a lot by employer. I’m at a non-profit and the withdrawal options are 1 lump-sum or 2 equal distributions. While I love the idea of the 457b and do invest in it, I’m a little worried about the tax situation on withdrawal. Say I end up saving $200,000 in it and then have to withdraw it all in one year when I leave the company 🤷♂️ I don’t think rollover is an option either unless it’s into another qualified 457b. Thanks again!
Yes. I had thought I could spread it out over several years but my only options were a total distribution, or to roll into an IRA and take a partial distribution at the same time.
But then the remaining balance is subject to the penalty.
Again, every employer might have different rules?
No More Weekdays says
I’m fortunate that my employer offers a great HDHP. Based on the premium, the deductible, and the out of pocket max, there is no scenario where our low deductible plans beat the hdhp. I know that might not be true for every employer’s plans but generally if you’re not cash-poor, the hdhp plans + HSA can be a great option.
The Money Wizard says
That is awesome! Thanks for sharing.
David @ Filled With Money says
The thing about one leveraged ETF that puzzled me is that I know that they’re designed to decay in value over time. However, there’s one leveraged ETF that I saw (I forgot the ticker) that’s supposed to be 3x the S&P 500 that didn’t have ANY time decay associated with it.
Even more than that, they actually had slightly higher than 3x returns of the S&P 500 (prob has to do with dividends).
I was absolutely puzzled and floored.
The Money Wizard says
Hmm, that is strange. Maybe it’s a ponzi scheme? Haha…
What about using a margin loan as leverage on an index funds? Let’s say a leverage of 1,5 with interest rate of 2%?
This is a leveraged ETF (but you leverage it yourself). The rules you explained dont apply to this situation right?