Episode 24 – A Roth option for DCP
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Jenny
Welcome back to Fund Your Future with DRS. Today we’re excited to talk about a new savings option that will become available to DCP customers this fall. Starting October 1st, the DCP or Deferred Compensation Program will have a Roth option, and we have Catherine here today, who works at DRS as an Education and Outreach representative. So, Catherine, we’re excited to have you to talk about this Roth option.
Catherine
Thank you. I am excited to talk about Roth. I train public employees both in the field and online, and I have received a lot of positive responses. Yesterday, I was in Lewis County giving individual appointments and many people of different ages were asking about Roth, even about opening a Deferred Comp account just to invest in Roth.
Jenny
Oh, awesome. So, tell us a little bit about what is Roth? Why are people so excited about this?
Catherine
Well, I think it’s very exciting because it gives a second way to save. It’s an option within Deferred Comp. Up until October, the only way we have been saving will be saving up until October through Deferred Comp is pretax. That means the money that is automatically taken out of our income reduces our adjustable gross income. So, we are not paying as much tax on it.
And that’s a wonderful thing. I mean, tax time comes out and it’s like, “wow, that’s great.” This is different insofar as the money will come out automatically from your pay, but it will not reduce your adjustable gross income. In other words, you will be paying tax for that year that you contributed the money.
Jenny
Yeah, I like to kind of think of it in a way as like how I put money into my savings account now. I’m getting my paycheck from my place of work, which I’ve already, you know, paid taxes on, and then I’m going depositing this elsewhere. But now it’s all rolled in.
Catherine
Yes. And not only that, it’s not going to be put like putting money in the bank or credit union, because most likely you’re going to make a lot more money on it and the amount of money that you can put in… But I… we can talk about that later. I’m just excited about it.
Did you know that the 457(b), which actually came about in November of 1978, didn’t have the option to offer a Roth until January of 2011. And members, pension members through DRS, have been very excited about the Roth.
And so, we’ve wanted to add it for a while. And finally, it was approved by the legislature and so we’re able to offer it. So, we’re very excited.
Seth
I know one of the things that people have gotten a little bit confused about when we’ve started to talk about this option is that some folks are very familiar with Roth IRAs. Yes. And so they think, “oh, the state’s going to offer a Roth IRA” and this is not. IRA stands for individual retirement account, which means it’s something you’re doing on your own, something kind of through a private investment option.
And as you said, Catherine, this is part of the 457 program, the Deferred Compensation Program. This is a different way to save within that program. So, you want to talk a little bit about the difference between a Roth IRA and DCP.
Catherine
There’s one huge difference, and that is how much you can save. If you are in a Roth IRA, I believe the annual limit this year is like $6,500. If you’re 49 years of age and under. I believe $7000, maybe it’s a little bit more $7,500 – I haven’t checked for this year – for a Roth IRA if you’re 50 or older. And that’s nice. But with a 457(b), if you are 49 and under, you can put in up to $22,500 this year.
Yeah. And if you are 50 or older, $30,000 now this money has to come from your compensation. I know I get asked this all the time. “Hey, I just have this extra money. Can I put it in?” No, you can live on that extra money and defer more of your paycheck to your DCP. But I mean, the amount that you can save is significantly higher.
Seth
I think the other good thing for people to keep in mind, if they’re thinking about the Roth IRA or the Deferred Compensation. For IRAs, there are certain income limits, like if you make over a certain amount of money, you can’t actually participate in a Roth IRA. So maybe somebody had previously looked into starting a Roth IRA and said, oh, I can’t do that.
But for the Deferred Compensation Roth option, as long as you can participate in DCP, you can participate in the Roth option so that it’s a good thing to maybe revisit if you’re interested in saving in those after-tax Roth dollars.
Jenny
Yeah. So, we talked a little bit about the taxes. I always like to think about it with the winning the lottery example. I really like these Roth options because I am paying the taxes now so I don’t have to pay the taxes later when I’m taking out this money in retirement. So the lottery example, you know, so if you win $1,000,000, you’re still going to have to pay taxes on those lottery earnings.
And so, it’s kind of that forward thinking of, “okay, I’m putting this money in now. I’ve already paid the taxes on the money so I don’t have to pay the taxes.” I can just… it’s like winning the lottery when I’m when I take out my DCP earnings.
Seth
And you get the full million dollars, instead of $500,000 after taxes or something. Yeah. I hadn’t ever heard that example, but I like thinking about it as far as if you look at your account balance, you actually know exactly how much money is in there.
Jenny
That’s true.
Seth
You know, I’ve got $500,000 or $50,000 I don’t have to worry about: “Well, how much is tax withholding going to be if I take this out in one year? If I take this out ten years from now, do I need to spread it out or can I take it all out at one time?” So, it’s maybe a way to see exactly how much money you have in the account.
Catherine
And there are some people who it is better for them to pay taxes now while they are working because they have discretionary income. Whereas with other folks this is a tight time. They may have kids, they may have other expenses and really not have much discretionary income beyond that. And it makes more sense for them to pay it later. Roth is not better than pretax.
Jenny
Yeah, of course. Like you said, there are various reasons why people choose one option or the other, but it is just nice to have those options.
Catherine
Well, what’s even nicer is that you can do both. You can save through Roth. You can save through pretax. Pretax would lower your adjustable gross income, you’re going to be paying less in taxes now. Also, something nice about that is if you want to purchase a plan annuity, you can use pretax dollars, whereas you cannot use Roth dollars to purchase a plan annuity at retirement.
Jenny
That’s a good point.
Seth
Yeah. One of our coworkers describes this as tax diversification. When you’re retired, you have different buckets of money to pull from. And so, depending on how you want to pay taxes or need to pay taxes, you can pull from these different buckets of money to kind of… I don’t want to say like game or trick the system, but you can adjust what your taxable income looks like by pulling out of those different buckets.
So, if you get an inheritance and you’ve got this big increase in your income, maybe you’re going to not need to pull out of your taxable income because you don’t want your income to be even higher. Yeah, it just gives you more flexibility, I think, if you have those two buckets.
Catherine
It certainly does. And some folks will actually be receiving more or have more income in retirement, some will have less. Some I think of the scenario of the person who retires in their mid-sixties but defers their Social Security till 70, let’s say, because they’re going to make more money from Social Security. And this, by the way, is a strategy that the Social Security Administration has been pushing, particularly for women.
And so, I think about this season, if you leave and there is a window where you don’t have as high of an income in retirement, that might be a great time to convert funds from pretax into Roth for the future. And I’ve heard this comment by some members. They are very unsure what the taxes are going to be in the future, what their taxes are going to be.
They’re younger. They don’t know how much they’re going to be making in the future. They’re fearful that Social Security is not going to be around. They’re particularly drawn to an account where it’s all theirs, what they have in it, what it has earned, it’s all theirs. Now, there are some requirements for it being yours. The money has to be in there five years from the date of the first contribution to the Roth, and you cannot withdraw it prior to 59 and a half [years old]. If you want the earnings to be tax free.
Jenny
Yeah, that’s definitely a key distinction that we try to remind people of.
Seth
Catherine, you also mentioned in your earlier comments about converting money. “I’ve been saving in DCP for a really long time and I’ve got this account balance of all pretax money and now I’m interested in converting some of that money over to the Roth type of money in the account.” Could you just talk a little bit about what that process looks like and what people might need to take into consideration if they’re interested in doing that?
Catherine
Good question. Yes, that’s a very important thing to consider. Certainly, you want to be mindful that that five-year clock starts when you put your first contribution into Roth. So, a lot of people may be drawn to start it this year in the fall because 2023 then you’d have five years out. But you also need to remember that this is not a withdrawal.
We cannot withhold taxes for you. When you convert dollars, you have to have another source of funds to pay for those taxes. So, imagine this: You make a certain amount of money this year. If you convert $100,000 from your pretax account, your total tax bill will be based on the amount of money you make from your employer and that $100,000, you’re going to be paying a boatload of taxes.
So that’s something to consider. And we can’t withhold it because it’s a conversion, not a withdrawal.
Seth
Yeah, it’s definitely one of things I’m a little bit nervous in this process, because I know there are some people that are really excited about Roth. And if you have, as you said, $100,000 in there and you currently make $50,000 in your job, if you convert all of that money, your income is going to show as $150,000.
The next year, you’re going to have a lot of taxes that you’re going to owe. And maybe somebody has been saving for that. And they have that money in their bank account and they can pay the taxes on it. Great. That’s part of their plan. But it’s just something we really want to make sure people are aware of that If you are converting money that’s like you got paid the money and you’re going to owe taxes on it all the following year.
Catherine
Well, the nice thing is that you do not have to convert the entire amount. If you want to convert something great, you can convert the entire amount if you have another source of money for that tax. But you could potentially convert a smaller amount and maybe do so later on. It’s not one and done.
Seth
Yeah, you gave a great example of somebody converting later on in their life or you could do it… You could convert a little bit every year and kind of slowly move the money over to Roth. If once again, if that’s what you want to do, some people want to keep all of that money in pretax and there’s no need for them to worry about doing any sort of conversion.
But you’ve got flexibility. And that’s, I think, one of the things we want to make sure people are aware [of]. Yeah, I thought of one other thing. The investment options are going to be the same. Whether you’re in pretax money or Roth money. So, it’s the same investment options for people who are in DCP. And that’s just maybe something to keep in mind.
I think we have good investment options and sometimes people want to invest in other things, and that’s where if you have a Roth IRA or some other investment account that you can go out and do that in other investment vehicles, but that DCP has specific investments that are going to be true for either if you’re putting the money in pretax or after tax.
Catherine
True.
Jenny
So, you are saying you can choose your investments. Is that only if you’re in Plan 3?
Catherine
No.
Jenny
Okay. So, if I’m in Plan 2, I can open a Roth account and I can still choose those…
Catherine
Well, there are pre-selected investments — preselected by the Washington State Investment Board, which, I mean, they’ve done a bang-up job. Heck, 75% of what is paid out to retirees comes from their earnings. They know what they’re doing. And they have pre-selected seven different funds that they called build and monitor. Where you can as a member can create your own portfolio.
And they range these funds range from less risk to more risk, less return to more return. But if you do a build and monitor scenario, you are responsible for diversification of the funds. You are responsible to rebalance when the market fluctuates and to adjust as you age. There are people who watch the stock market and prefer to manage their own funds.
That’s one option. Then there’s the target funds. The generic term is target funds in Washington State, we call them retirement strategy funds. Each of these funds is a mix of stocks and bonds that’s automatically diversified, automatically adjusted as you age and rebalanced as the market fluctuates. So those are the investments that you can choose from.
Seth
Yeah. So, the investment lineup is the same for DCP members.
Jenny
And you still have those options of, “okay, if I want to choose my own investments, I can do that. Or if I want to have my investments managed for me…”
Seth
In one of those target date funds, yes.
Catherine
What I love about DCP. Yeah, I’m not a financial advisor, but I love it because it is so easy to access. If you have signed up for your online account page, which everybody should do, there is going to be a link on that page and you can just link over to your DCP page, see your balance. You can change your contribution rate, you can stop your contribution rate.
You can start it up again. You can change your investments. There’s a call-in feature, there’s a live chat feature. It’s accessible, it’s easy. And I say this as someone who went through her credit union to open up a Roth IRA, that wasn’t easy. And what I get in the mail from them is not easy to understand, to read. But it’s easy. It’s accessible. I really like it.
Seth
I think one other thing we wanted to make sure we plugged, and Catherine, you talked a little bit about this already, but part of what you do in your day job is educate DRS customers on all things about their retirement. We produce a lot of videos and webinars for the education of our customers, about retirement in general, about their pension information, but also a lot of information about the Deferred Compensation Program.
And we’re doing a lot of education over the next couple of weeks and months and really through the rest of 2023 and probably into 2024, about Roth specifically because it’s new. We want to make sure people are taking advantage of that and going and watching you and your colleagues present and answer questions. When people have additional questions about Roth because we know this is a new feature for folks. And so, it might not be something they’re aware of.
Jenny
Kind of just to reiterate, so coming in October, we’re going to have lots of webinars for specific age groups too, which I like early career or if you’re near retirement, you can attend a webinar that’s specifically for “what are my Roth options for this?”
Catherine
Well, I think what’s even better is you can just sit in on a DCP training because the Roth component has been incorporated into it. If you want to sign up for email notification of that, you can do that today. Go to our website: drs.wa.gov. It’s easy.
Seth
Yeah. And I think the other thing that we should say is just because people can listen to a podcast whenever, you know, you might listen to this podcast in 2026, there’s always webinars and videos and educational resources available on our website. They can go out and view a live webinar and ask Q&A sort of questions, or they can watch a recorded video at three in the morning because… they can’t sleep. And listening about retirement maybe helps you sleep.
Catherine
So, this is a question that I have heard and people are interested in rolling over funds from other accounts. And whereas, yes, if you had a Roth 457(b) with another organization or a Roth 401(k) with another organization, it could be rolled over into the new Roth, the DCP Roth. However, a Roth IRA cannot be rolled over into the DCP Roth, and that is an IRS restriction.
So, I just wanted to mention that that was the thing I thought of first. Oh great. I can now roll over this irritating Roth IRA. And no, the answer is no, you cannot. However, if you have another type of Roth, like a 410(k) Roth, a 403(b) Roth, 457(b) Roth. Maybe you were working out of state for a public employer and they had one. You could roll it over into the DRS DCP Roth, once you open your account.
Jenny
Yeah. So really the key word is individual. So, the IRA, Individual Retirement Account, it is individual to me always has to be just separate.
Seth
It’s yours and managed by you.
Jenny
Yeah. Or whichever company that I’m using to manage that.
Seth
I think. Catherine, you made a good point and you mentioned this earlier as well that Roth features within retirement plans have been around for a while now and so it is becoming much more common. And so, folks might have some of these other accounts spread out across multiple employers and I think there is always this question of should I consolidate my funds into fewer accounts?
It’s definitely something to consider and look to see what you can do and what maybe the IRS doesn’t allow you to do.
Jenny
Another question that might come up frequently is: If I already have a Roth IRA account within a private company, am I also allowed to open up a Roth 457 with DCP?
Catherine
Well, yes. If you have a 457(b) Roth, you’re asking? Yes. Yes, you can. An IRA is separate than a 457(b).
Jenny
So basically, I’ll end up with two Roth accounts.
Catherine
You can max out that account and max out your 457(b), you can also have a 403(b). A maximum contribution on one type of product like a IRA or a 403(b) does not affect your contribution to your 457. Now, with that being said, you need to be aware that if you have two, 457(b) accounts, you have one maximum.
The employee needs to monitor to make sure that they do not contribute more than the annual maximum between the two accounts.
Seth
But that’s when it is the same type of an account. So, Jenny, your question is great because it’s a question we’ve heard a lot already when we’ve been doing this education is that people say, “oh, I already have a Roth IRA, I’m not going to I’m not going to contribute to DCP because of that.” Well, if you’re already contributing the max, the $6,000 or $6,500 and you want to contribute more, great start a DCP Roth option and then you can contribute even more.
I actually heard a story once about a teacher who was maxing out their 457 and their 403(b) and yeah, so they had access to these multiple different types of retirement vehicles and they were saving in all of them. And so, sometimes I think people in public employment don’t realize they have some of these advantages, to save in multiple vehicles, some through your employer and some through kind of the private sector.
Catherine
And I will throw this in right now because the time of year, school employees in particular seem to be unaware of this savings option, the 457(b), whereas many school employees will have heard of a 403(b), they will not be aware of what a 457(b) is, and it can be a great saving vehicle. And, don’t get me started. I can get on a soapbox really quickly to talk about how wonderful a 457(b) is in comparison with a 403(b) or something else. So, it’s important to learn what is available to you.
Jenny
Yeah, and I think to your point, your savings is compounded with compound interest. And it’s not just like a normal savings account. This is being invested smartly so that you can maximize on those retirement contributions.
Catherine
Yes. The other day someone said, “well, when you’re in the market, it just goes up and down, up and down.” Uh, yes, it does go up and down, up and down. But historically, it has gone up more than it has gone down. And instead of being a flat up and down, up and down, it’s on an incline.
And so that is why you got to be in the market. If you’re going to make money in a savings vehicle. Putting money in a financial institution like a bank, that’s good. You should have an emergency fund, right? It’s always good to save for projects around the house, other things like that. But the amount that you’re going to earn, it may keep up with inflation. It may not.
Seth
Yeah, it’s something we’ve talked about a number of times about building wealth is really what you’re talking about here. And sometimes thinking about that versus savings, really, you’re trying to build wealth for the distant future for some folks and sometimes more in the immediate future with retirement pending.
Catherine
For those folks who are close to retirement such as yours truly, I’m pretty close to it. It’s important to remember that people are living longer now, longer than they ever used to live. And the truth is, we might not need all of our money for the moment we retire. We certainly will need it when we’re significantly older and our health starts going downhill.
There could be a 20 to 30 year span between retiring and passing, and so it’s another good reason to look at a 457(b) and perhaps a Roth in particular for those future years.
Seth
That’s great. Thanks, Catherine.
Catherine
Oh, it’s been fun.
Jenny
Yeah. So and again, for more information, you can go to drs.wa.gov/dcp to learn more about Roth and pretax options.
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Disclaimer
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