Where to keep your cash?

Federal MMFs are essentially just as safe as a bank deposit product, because the FDIC insurance at a bank is guarantied by the federal government, which is also the issuer of the bonds on the MMF.

Vanguard and Fidelity both invest your cash in a federal MMF by default. There's nothing you need to do. They are currently paying about 3.5%+ APY.

But if you live in a state with income tax, you might be better off investing into a federal MMF that is exempt from state taxes. This is definitely a benefit of MMFs that you didn't get in a bank deposit product.

There are also MMF-like ETFs that pay a high yield, too. This can be helpful in cases where your brokerage doesn't offer good choices, or you prefer the higher yield over an auto-liquidating feature (in Fidelity, for example).

Fidelity auto-liquidates the default MMF (SPAXX) as well as most of their popular other MMFs. This means if you ever a purchase order, or use a cash feature, you don't have to sell the MMF first, even if you're not using the default cash position. I use my Fidelity brokerage account as my primary bank account, so this is super helpful for ACH auto drafts, Bill Pay, check writing (shudder!), etc.

And in my Fidelity account I'm currently using FDLXX instead of the default SPAXX, so I created an auto invest rule that automatically buys $8k of FDLXX on Thursdays, the day my paycheck deposits. This is higher than my paycheck, so what happens is the purchase first liquidates all cash (my paycheck since it's the same day), all SPAXX positions (from any miscellaneous deposits since the last Thursday), and then the balance from FDLXX to cover $8k. And finally it purchases $8k of FDLXX. Strange trick, but it works great, and keeps nearly all of my cash in FDLXX earning the higher yield.

You can see the current yields for the must popular MMFs at Fidelity, Vanguard, Schwab, and MMF-like ETFs in the MMF Yields tab of my rebalance calculator

. It updates whenever I open the workbook, which is usually every 1-2 weeks. And if you enter your tax rates at the top, it will calculate the best after-tax yield for you. Enjoy!

Building your cash allocation by directing savings into a MMF is a fine approach. I'm retiring next year and am splitting my savings between investments and cash (MMF).

Some additional things you can do to fill your cash allocation are:

1. Rebalance into your cash allocation. Instead of deciding to hold X number of years of cash, you should set an allocation to cash just like any other asset class. Keep your cash allocation under 10% so that it doesn't create a drag on growth for the overall portfolio. Be mindful of tax consequences when rebalancing.
2. If you have an asset class that is above its target allocation, you could direct those savings to cash and continue to contribute in your 457 to asset classes that are below their target allocations. Example: if you're contributing half of savings to a stock fund that is above its target and half of savings to a bond fund that is below its target, you could redirect just the savings for the stock fund into cash and continue to buy into your bond fund which is below its allocation. This is a gradual form of rebalancing.
3. Turn off DRIP on the accounts where you want to accumulate the cash. Let the dividends and in-fund capital gains accumulate as cash in the core account. The core accounts at Fidelity and Vanguard are by default MMFs so there would be no further action needed on your part unless you had changed your core position to cash sweep. The core account at Schwab is a cash sweep so would require action on your part to purchase a MMF each time cash lands in the core account.

In general, that seems like the right approach. It sounds like the main thing you want to consider is whether you might be better served contributing to the 457 and holding the cash in there, or instead holding the cash in a taxable brokerage. The way to decide that is to look at your marginal tax rate now versus what it will be in retirement.

I.e., suppose your income puts you in the 22% bracket today, but in retirement you will only withdraw an amount that puts you in the 10% bracket. Given how close you are to retirement (i.e., 3 years rather than 30 years), it seems sensible to consider that the tax rates will remain roughly the same. If you contribute to the 457 (pre-tax) then you are avoiding the 22% tax on that money, and if you plan to turn around and start withdrawing in about 3 years while remaining in the 10% (or even 12%) tax bracket, then you come ahead. In this scenario, if you instead contribute to the after-tax brokerage, then you lock in the 22% tax rate on the income right away.

Note that this is a special ability of the 457 plan specifically (i.e., than you can begin accessing the money located there immediately upon separating from service without penalty). You only have to pay the income tax (as is the case with any pre-tax advantaged retirement account), but there is no "penalty" (i.e., additional tax for withdrawals prior to age 59.5).