Max-out 403b or Start Taxable Account

[mjukr]

Hello all! I'm very glad to have found these forums... I've been wracking my brain trying to decide what to do with additional income from a recent promotion.

I'm currently in my late-20s, married, with one small child. I currently have a 10% employer-contributed 403b and max out my Roth IRA. My wife has an employer pension, 3% 401k match, and another 3% employer-contributed 403-type account.

Now, I really like the idea of FIRE. Ideally, I would like to stop my "career" no later than age 50. I would most likely work part-time (<$10k yr) just to stay busy. Ditto for DW, who would formally retire when eligible for pension (early-mid 50s).

My big headache is this: with the extra money we now have, should I start a taxable account, or contribute it to another 403b/457 account (I can do either through my employer)? I guess I'm not sure how to cover income between the time I retire and when I can start withdrawing money from tax-advantaged accounts without penalty. I know there are 72t options as well.

Is maxing out tax-advantaged accounts always of primary concern?

Thanks for any advice!!!

 

[rogersteciak]

I was advised many years ago by my financial advisor to contribute the maximum possible amounts allowed by law to tax-advantaged accounts and then to put an additional 10% (or more) of my gross income in taxable investment accounts.

This approach works wonders if:

(1) You have enough of a cash cushion (3 to 6 months or more of living expenses in your checking account) to be able to handle the financial emergencies that always seem to come up. Credit lines (e.g., credit cards and a HELOC) can also be part of your "emergency reserve" in that you will be able to tap into cash quickly when an emergency arises, but you have to have enough discipline to avoid abusing these lines of credit.

(2) You have enough income to be able to invest according to this plan.

If either of the above conditions are not true, then you will have to implement a scaled-back plan. But the important thing is that you are "paying yourself first" by putting your investing on autopilot.

When I started contributing to my 401K, I could only afford to contribute 2% of my income at first. But I discovered that I could increase that contribution to the full amount (which was 15% at the time) after the initial six months. It's OK to start small at first, in other words, if that is what you have to do.

 

[Marquette]

You know about 72t, do you want to do it or not? If you're leery, then you may want to start the taxable.

Are you on a tax threshold where contributing more pre-tax will get you into a lower tax bracket?

Are you in a high tax bracket?

If it were me, and contributing more wouldn't result in a decent tax savings, then I think I would start a taxable account and concentrate my tax-efficient assets there.

I'm going through a similar exercise with getting a better handle on treating all of our accounts as a single portfolio rather than a hodge-podge of unrelated accounts (our AA is where I want it, but I can realize some decent expense savings by shuffling)

 

[mjukr]

You know about 72t, do you want to do it or not? If you're leery, then you may want to start the taxable.

I'm definitely ambivalent... tough to predict how things will be in 15-20 years.

Are you on a tax threshold where contributing more pre-tax will get you into a lower tax bracket?

Are you in a high tax bracket?

Nope, smack in the middle of the 25% (filing jointly).

If it were me, and contributing more wouldn't result in a decent tax savings, then I think I would start a taxable account and concentrate my tax-efficient assets there.

I think it's going to come down to a solid commitment to FIRE on my part. My fear now is that for some reason I end up having to (or wanting to...) work in my career until traditional retirement age and losing out on the tax-deferred growth...

I'm going through a similar exercise with getting a better handle on treating all of our accounts as a single portfolio rather than a hodge-podge of unrelated accounts (our AA is where I want it, but I can realize some decent expense savings by shuffling)

Just did this myself, actually. It was easier to manage as two separate AA "buckets", but most of my wife's fund choices have such high ERs that I eventually took the one-portfolio approach.

Thanks for the comments! I've got some more thinking to do...

 

[cute fuzzy bunny]

You'll have to measure the expenses incurred in the 403b, work in your retirement horizon and your tax rates and go from there. Unfortunately you may have to read 500-600 pages of stuff from the 403b provider before you have an accurate picture as to the actual expenses.

My wife used to have a 403b and basically after thorough analysis I determined we could save about 2% a year in expenses if we stopped funding it and took the money into a taxable account where I could choose cheaper and better fund alternatives. Since its going to be 20+ years before we tap into the retirement funds, we'd be paying a heck of a lot more than the fairly weak tax hit we take by avoiding the tax deferred options.

But if you're being taxed at a 20-something% level and want to invest in very actively managed bond funds in your taxable accounts while earning six figures...err...the 403b might be an okay choice.

 

[mjukr]

My 403/457 choices are pretty good, fortunately, so that will play less of a role in my (in)decision...

 

[DblDoc]

The general rules are:

401k/403b to the match
Roth
maximize 401k/403b
taxable

But as pointed out with FIRE and poor 401k/403b plans this may need to be fudged. Additionally having a taxable account can be helpfull when trying to manage your taxes in retirement.

DD

 

[ziggy29]

The general rules are:

401k/403b to the match
Roth
maximize 401k/403b
taxable

But as pointed out with FIRE and poor 401k/403b plans this may need to be fudged. Additionally having a taxable account can be helpfull when trying to manage your taxes in retirement.

Agreed. But to elevate a taxable account over a bad 401k/403b, you need to make a few assumptions:

* Holdings are very long term buy and hold (i.e. no churning that produces short term capital gains)

* Dividends and long-term capital gains will continue to have preferential tax rates (even if a bit higher than now, still lower than 'ordinary income' for most taxpayers).

If we returned to the days where all cap gains and dividends were taxed as ordinary income, it would be much harder to favor taxable over even a fairly bad 401k.

If those assumptions are valid, then I'd agree with more into the taxable, maybe even before a 401k/403b is funded to the max. I think a three-pronged portfolio with traditional tax-deferred, Roth and taxable accounts give the maximum flexibility in determining how to "engineer" as much retirement income as possible with the lowest tax bite.

 

[mjukr]

Thanks for the additional thoughts. I did discover today that our optional 457(b) plan is indeed self-directed, with funds either through Fidelity or TIAA-CREF.

That's an attractive option given the reasonable fund expenses (I'm an index junkie) and the fact that the 457(b) allows withdrawals upon employment termination without penalty, even if younger than 59 1/2 years old.

This would serve to balance the Roth and employer-contributed 403(b)...

It will be a few months before I'm in a position to begin these contributions, so I've still got some time for internal debate

 

[Marquette]

If those assumptions are valid, then I'd agree with more into the taxable, maybe even before a 401k/403b is funded to the max. I think a three-pronged portfolio with traditional tax-deferred, Roth and taxable accounts give the maximum flexibility in determining how to "engineer" as much retirement income as possible with the lowest tax bite.

FWIW, here's our current plan of attack.. will take a bit to see how it plans out.

Taxable
Vanguard FTSE All-World ex-US

His SEP-IRA
Vanguard Total Intl Stock Index

Her SEP-IRA
Vanguard Total Intl Stock Index
Vanguard Small Cap Value Index

His Roth 401(k) /401(k)
[Internal] Intermediate Bond Fund
[Internal] S&P 500 Equity Index Fund

Her 401k
BGI S&P 500 Equity Index

Non-qualified traditional IRA
REIT (just need to settle on a REIT now)

The two internal funds in his Roth are zero expense and her S&P index is 0.09%... if we had more room in taxable then we would add the Vanguard Total Stock Market.

We'll be making after-tax contributions to fund the IRA to buy the REIT. A Vanguard VA filled with REITs would actually be an interesting option if we needed it.

I agree with you completely on the tax engineering aspect. While may be stupid, that's one reason we're funding my Roth 401(k) even though it'd probably be to our advantage to shelter as much as possible now (no house, no kids, higher tax bracket).