Q: I am 41 years old, and my wife and I are both public school teachers. We’ve been contributing to our 403(b) accounts in order to supplement our pensions, and we’ve each accumulated about $100,000. Because we are in a position to save more, we’re wondering if we should increase our contributions to our 403(b)s, save in Roth 403(b)s, or save in Roth IRAs. What is your opinion?
A: That’s a tricky question, because the answer is based entirely upon future tax laws, which are next to impossible to predict. Your current retirement savings into 403(b)s provides tax benefits to you now, but may or may not be the best for you in the long term. As with 401(k) plans, you receive a tax deduction for any contributions you make to a 403(b), which reduces your current income-tax bill, but, although your account grows tax-deferred, all withdrawals will be taxable when you are retired and pulling income from the account.
If we could know for certain that you are in a higher tax bracket today than you will be in retirement, there would be no question you should keep funding your 403(b)s and ignore the Roth options.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The problem is, of course, that we don’t know what your future tax situation will look like.
A Roth option, whether it be a Roth 403(b), or a Roth IRA, will not provide you with any current tax savings, but your account will grow tax-deferred and your withdrawals will NOT be subject to income taxes when you are retired and withdrawing the funds.
The challenge for those people who are still decades away from retirement is that we have no idea what the tax code will look like in the 20 or 30 years. The tax code, as complex as it is, hasn’t really changed that much in the past three decades. Tax rates are progressive, meaning the higher your income, the larger the percentage of your income that will be taken out for taxes.
What might the tax code look like in another 20 or 30 years? What if the progressive income tax system that we currently have is eventually replaced with a flat tax? Or a national sales tax? It would be a real bummer to use a Roth 403(b) or a Roth IRA for your retirement savings, only to have our tax system get replaced by a national value added tax (VAT) and a relatively low flat income tax.
Another factor to consider is the state in which you are working versus the state in which you plan to spend your retirement years. For example, if you are working in New York, with a high state income-tax structure, yet plan to retire in Florida, one of nine states with no income taxes, a Roth IRA or a 403(b) might not be helpful at all. In a situation like this, a traditional 403(b) (or an IRA) would be much more beneficial, at least as far as state income taxes are concerned.
Because it’s anyone’s guess as to what the tax structure will look like in the future, it’s probably best to have a diversified approach to your tax planning in the same manner you would have a diversified approach to your investments. Odds are, you don’t have your entire 403(b) plan balance in just one type of investment. Why? Because you know that having your investments spread around will provide you with the highest degree of certainty with your retirement savings.
You should have a similar approach with your income tax strategy. Ideally, you reach retirement with a number of different types of retirement plans. In a perfect situation, you’d have your 403(b) plans, some money in Roth IRAs (or 403(b)s), some investments held outside of your retirement plans, perhaps some income-producing real estate, etc.
If I were in your shoes, I’d contribute about 80% of my retirement savings to a traditional 403(b), and the remaining 20% to a Roth IRA. This would enable you to take advantage of the current tax savings that your 403(b) provides, while also allowing you to accumulate a nice chunk of cash that will not be subject to income taxes once you retire.
In regard to whether you should contribute to a Roth 403(b), or a Roth IRA, from an income standpoint, it really doesn’t matter that much, as both plans allow for tax-free retirement income. There are a few minor nuances between the two, but what I prefer with the Roth IRA is the investment flexibility. With a 403(b), your employer dictates which providers you can work with, whereas you have full discretion over a Roth IRA.
By the way, you are wise to be thinking about your retirement savings at such a young age. Far too many people wait until late in life to get serious about their savings, and the longer you wait, the tougher it is.
Scott Hanson, CFP, answers your questions on a variety of topics and also co-hosts a weekly call-in radio program. Visit MoneyMatters.com to ask a question or to hear his show. Follow him on Twitter at @scotthansoncfp.
-
Risk Is Off Again, Dow Falls 397 Points: Stock Market TodayMarket participants are weighing still-solid earnings against both expectations and an increasingly opaque economic picture.
-
I Inherited $50,000, and My Retirement is Already Fully Funded. Where's the Best Place to Store It for Maximum Growth?These savings solutions can help you maximize returns without the risk.
-
Parents and Caregivers: Don't Miss Your Roth Conversion WindowCaring for a child or parent can mean a drop in income and a lower tax bracket. Why not take advantage by moving money into a Roth account? Here's how it works.
-
Testing the Retirement Waters in Florida? A Partial Plunge May Negate Tax BreaksMost folks know Florida is a tax-friendly state, but they might not know that part-time residents may not qualify, as our cautionary tale shows.
-
Catch-Up Contributions for Higher Earners in 457(b) Plans: What You Need to KnowGovernment 457(b) plans are about to get more complex as new Roth catch-up requirements come into force. Here's how to prepare for the changes.
-
I'm a Financial Planner: This Is Why Commitment, Not Perfection, Drives Financial SuccessMeeting your goals is more likely if you stick to your strategy despite market volatility and scary headlines. Consistency makes a difference.
-
I'm a Financial Professional: This Is Why Now Is the Time for Investors to Look AbroadExtreme U.S. market concentration has made international equities not just a diversification play, but a timely opportunity.
-
Your Estate Plan Isn't 'Done' Until You've Completed These Five Steps, From an Estate Planning AttorneyCongratulations on getting your estate plan in order. Now, you need to communicate the relevant details to ensure your plan is effectively carried out.
-
Eight Steps to Help Get You Through the Open Enrollment Jungle at WorkWondering how to survive open enrollment this year? Arm yourself with these tools to cut through the process and get the best workplace benefits for you.
-
Seven Moves for High-Net-Worth People to Make Before End of 2025, From a Financial PlannerIt's time to focus on how they can potentially reduce their taxes, align their finances with family goals and build their financial confidence for the new year.
