Should I contribute to Taxable account instead of my 403b?

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Should I contribute to Taxable account instead of my 403b?

Postby katnok » Sun Mar 24, 2013 12:35 pm

Please help me determine if it makes sense to stop contributing to employer sponsored 403b (high expense ratio), and open a taxable account at Vanguard and contribute to it instead.

Background:
Me:35, Spouse:32 (Wife is a student and is not making any money at this point)
Mattied filing jointly
Marginal tax rate: 28% federal; 3.07% state

Currently I max out my 403b. No employer match.
Entire contribution is invested in Target Retirement Fund 2040 with an ER of 1.65.
Other available options have ERs mostly between 1.6 - 1.97

We are likely to be in 28-33% federal tax bracket when we retire. Based on this, I tried to calculate how much we will have in my have in my 403b at the time of retirement. I used the following math to see if I should stop contributing to 403b, and constribute to a taxable account such as Vanguard TR 2040, which has an ER of 0.18. Please tell me if it makes sense.

1. If I contribute 17500/12 = $1,458.3/mo for 25 yrs with an expected return rate of 6%, I will have $986,236.49 pre-tax, and $710,090.2 after tax (fed tax rate of 28%) in my 403b.

2. Instead, if I contributed the same amount, but after tax@my current rate of 28% ($1,049.97/mo), BUT with an expected return rate of 7% (I added 1% keeping the difference in ERs between my 403b and Vanguard TR fund in mind (difference is actually 1.47%)), I will have $822,121.10 before capital gains tax, and $720,695.44 after capital gains tax (@20%).

Finally, I will have ~$10,000 more if put the money in tax efficient taxable account rather than tax-advantaged 403b.

I know I have made some assumptions such as my current fed tax rate, tax rate at retirement and capital gains rate staying the same 25 yrs later, but based in this assumption, does the above math make sense, and if it does, should I stop contributing to 403b?

Thanks in advance.
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Re: Should I contribute to Taxable account instead of my 40

Postby ObliviousInvestor » Sun Mar 24, 2013 12:43 pm

It looks to me like you are also assuming that you stay at the current job until retirement and that 100% of your returns comes from capital gains rather than dividends or interest. The first assumption seems reasonable, if you do in fact have reason to make that assumption. The second assumption doesn't make sense to me.
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Re: Should I contribute to Taxable account instead of my 40

Postby zebrafish » Sun Mar 24, 2013 1:31 pm

No one knows what tax rates will be in 20 years. However, most people's tax brackets are lower in retirement.

You are leaving money on the table now by bypassing tax-deferred savings (you are choosing to pay more taxes now).

If you did move jobs, you could roll over and reduce your expenses.

Just some things to think about.
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 2:30 pm

ObliviousInvestor wrote:It looks to me like you are also assuming that you stay at the current job until retirement and that 100% of your returns comes from capital gains rather than dividends or interest. The first assumption seems reasonable, if you do in fact have reason to make that assumption. The second assumption doesn't make sense to me.


Thank you for your input, ObliviousInvestor. Chances of staying with my current employer for the next 25 yrs are close to zero, but I thought I could switch to future employer sponsored plan, if it has better options.

I have to admit that my assumption that all the returns are from capital gains is incorrect.

Given that there isn't a big difference in final net value, atleast one advantage that I see with a taxable account is that I dont have to pay 10% penalty for early withdrawal (not that I want to).
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Re: Should I contribute to Taxable account instead of my 40

Postby rr2 » Sun Mar 24, 2013 2:48 pm

This topic has been discussed many times. The tax from your contributions is at your marginal tax rate 28%. In retirement, assuming no other income sources, your withdrawals will be taxed at your average tax rate -- some at 0, 10, 15, 25, 28, etc. Therefore, it is likely that you will come out ahead.
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 2:56 pm

rr2 wrote:This topic has been discussed many times. The tax from your contributions is at your marginal tax rate 28%. In retirement, assuming no other income sources, your withdrawals will be taxed at your average tax rate -- some at 0, 10, 15, 25, 28, etc. Therefore, it is likely that you will come out ahead.


I wasnt sure if it was wise enough to continue with my 403b given very high ER (1.65%).
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Re: Should I contribute to Taxable account instead of my 40

Postby stevep001 » Sun Mar 24, 2013 2:58 pm

Want to point out that, upon leaving an employer, it's usually better to roll your plan over into an IRA, rather than into your new employer's plan.

a. Generally you can get a better deal on costs as compared to an employer plan, unless you work for a large employer who has done a good job of negotiating and has considered costs
b. Unlikely, but some folks have temporarily lost access to their retirement money when the plan sponsor (employer) went bankrupt.

On the flip side, one important benefit you lose by rolling into an IRA is any sort of loan feature.
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Re: Should I contribute to Taxable account instead of my 40

Postby rr2 » Sun Mar 24, 2013 3:06 pm

katnok wrote:
rr2 wrote:This topic has been discussed many times. The tax from your contributions is at your marginal tax rate 28%. In retirement, assuming no other income sources, your withdrawals will be taxed at your average tax rate -- some at 0, 10, 15, 25, 28, etc. Therefore, it is likely that you will come out ahead.


I wasnt sure if it was wise enough to continue with my 403b given very high ER (1.65%).

Is there any possibility to request better options in your 403b plan? I am fortunate enough to have a 403b with TIAA CREF. The costs are below .5% for most options.
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Re: Should I contribute to Taxable account instead of my 40

Postby grabiner » Sun Mar 24, 2013 3:23 pm

katnok wrote:Me:35, Spouse:32 (Wife is a student and is not making any money at this point)

Currently I max out my 403b. No employer match.
Entire contribution is invested in Target Retirement Fund 2040 with an ER of 1.65.
Other available options have ERs mostly between 1.6 - 1.97.


Before you do any taxable investing, do you have tax-favored options? Max out your Roth IRAs. If you have children, put their college savings in a 529. If your wife has student loans, you may want to pay them off (or save the money now and pay them off when the subsidy ends),

Are you confident that you will stay in the same job for more than 20 years (for example, are you a tenured teacher)? If you are, then a taxable investment might be better; you'll lose about 30% of your taxable investment to taxes, but if you stay more than 20 years with an ER 1.5% higher than you can get in your taxable account, you'll lose 30% to expenses. (Once you leave the job, you can roll your 403(b) into an IRA and get the benefit of tax deferral without the high expenses.)

There is one other advantage of taxable investing: you can move the money somewhere else if appropriate. If you don't have any children yet, then when you do have children, you can use the taxable investments to fund their 529 plans. In addition, if your wife starts working at a job with a better plan, you can deplete your taxable savings to max out her 401(k).

Note that you will have to reconsider this decision every year. If you expect to retire at 65, then at around age 45, you should start investing in the 403(b) even if you are sure you will stay there.
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Re: Should I contribute to Taxable account instead of my 40

Postby Artsdoctor » Sun Mar 24, 2013 3:39 pm

Katnok,

Grabiner is totally on the mark, and he's helped me with this same decision as well. The ER is just too high and over many years could really eat into your return. However, given your age and the sentiment that you're unlikely to stay at your current job for a long time, it could be very much worth it to take advantage of the 403b and capture the immediate tax savings. Once you leave, you'll almost certainly be better off rolling it over into your own Rollover IRA since you'll have many more choices at a reduced cost (it would be a very rare work-related plan where you'd have better choices and cheaper funds than what you'd direct yourself although not impossible).

And you don't have to do just one or the other. You can contribute half, for example, to the 403b and the other half to a taxable account (or Roth). Since no one can really predict tax rates 35 years into the future (your time frame), there is some benefit to tax diversification (taxable, Roth, and tIRAs).

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Re: Should I contribute to Taxable account instead of my 40

Postby Bob's not my name » Sun Mar 24, 2013 3:52 pm

To be in the 28% bracket your gross income must be over about $190,000, and your MAGI must be over about $170,000. This means that when your wife starts work your MAGI will likely be above the limit for direct Roth IRA contributions. For this reason your wife should probably contribute to a Roth IRA rather than a spousal TIRA -- you are under both MAGI limits right now (they're the same), but an existing pre-tax TIRA complicates doing back door Roth IRA contributions in the future. The same issue will apply if you leave your employer and roll your 403b into a TIRA, but you will probably be able to roll it into your new employer's plan instead, which solves the problem.

You can put 2 x $5,500 into two Roth IRAs for 2013, and there's still time to put 2 x $5,000 into two Roth IRAs for 2012.

I believe Pennsylvania treats everything like a Roth, so that's not a factor in the decision. In PA there are often local taxes (e.g., in Philadelphia) on interest, dividends, and STCG, which you should take into account when considering putting taxable investing ahead of tax-advantaged.
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 3:57 pm

rr2 wrote:Is there any possibility to request better options in your 403b plan? I am fortunate enough to have a 403b with TIAA CREF. The costs are below .5% for most options.

I did but that fell on deaf ears.
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Re: Should I contribute to Taxable account instead of my 40

Postby retiredjg » Sun Mar 24, 2013 4:03 pm

Don't forget that taxable is not the only choice. The rules are complex and I tend to get them confused (see the link), but if you do not use the plan at work, I think you can deduct contributions to tIRA. So could your spouse. So the first $11k should go to tIRA, not taxable if you decide not to use the 403b.

http://www.irs.gov/Retirement-Plans/IRA ... ion-Limits

In general, I'd support using the 403b unless you will be there a very long time, as discussed by Grabiner.
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 4:09 pm

grabiner wrote:
katnok wrote:Me:35, Spouse:32 (Wife is a student and is not making any money at this point)

Currently I max out my 403b. No employer match.
Entire contribution is invested in Target Retirement Fund 2040 with an ER of 1.65.
Other available options have ERs mostly between 1.6 - 1.97.


Before you do any taxable investing, do you have tax-favored options? Max out your Roth IRAs. If you have children, put their college savings in a 529. If your wife has student loans, you may want to pay them off (or save the money now and pay them off when the subsidy ends),

Are you confident that you will stay in the same job for more than 20 years (for example, are you a tenured teacher)? If you are, then a taxable investment might be better; you'll lose about 30% of your taxable investment to taxes, but if you stay more than 20 years with an ER 1.5% higher than you can get in your taxable account, you'll lose 30% to expenses. (Once you leave the job, you can roll your 403(b) into an IRA and get the benefit of tax deferral without the high expenses.)

There is one other advantage of taxable investing: you can move the money somewhere else if appropriate. If you don't have any children yet, then when you do have children, you can use the taxable investments to fund their 529 plans. In addition, if your wife starts working at a job with a better plan, you can deplete your taxable savings to max out her 401(k).

Note that you will have to reconsider this decision every year. If you expect to retire at 65, then at around age 45, you should start investing in the 403(b) even if you are sure you will stay there.


Thanks for your advice grabiner! I am very unlikely to stay with my current employer for longer than another 5-10 yrs.
Neither of us have any student loans. We do have two young kids (1&3), and we are going to open 529s later this year.
We will still be left with about 25-30k after contributing max allowed to 529s for both kids, backdoor Roths and 403b. I also have access to 457 (non governmental and the options are exactly the same with same high ERs), but we have decided not contribute to it.
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Re: Should I contribute to Taxable account instead of my 40

Postby Bob's not my name » Sun Mar 24, 2013 4:17 pm

These are better than 1.65%:
3. Principal global investors
Large cap S&P 500 index R1 fund ------------------------------------ PLPIX – 1.04
4. Principal Global Investors
Midcap S&P 400 Index R1 Fund ------------------------------------- PMSSX – 1.05
6. Principal Global Investors
Small Cap S&P 600 Index R1 Fund ---------------------------------- PSAPX – 1.06
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 4:22 pm

Bob's not my name wrote:To be in the 28% bracket your gross income must be over about $190,000, and your MAGI must be over about $170,000. This means that when your wife starts work your MAGI will likely be above the limit for direct Roth IRA contributions. For this reason your wife should probably contribute to a Roth IRA rather than a spousal TIRA -- you are under both MAGI limits right now (they're the same), but an existing pre-tax TIRA complicates doing back door Roth IRA contributions in the future. The same issue will apply if you leave your employer and roll your 403b into a TIRA, but you will probably be able to roll it into your new employer's plan instead, which solves the problem.

You can put 2 x $5,500 into two Roth IRAs for 2013, and there's still time to put 2 x $5,000 into two Roth IRAs for 2012.

I believe Pennsylvania treats everything like a Roth, so that's not a factor in the decision. In PA there are often local taxes (e.g., in Philadelphia) on interest, dividends, and STCG, which you should take into account when considering putting taxable investing ahead of tax-advantaged.


We did not qualify (MAGI was 185k) for a direct Roth for 2012. I dont have any IRA account other than 403b.
If i want to open an IRA and convert that to Roth (for 2012), is there any paperwork that I will have to go through as far as 2012 tax returns are concerned, as I have already filed 2012 returns?
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 4:27 pm

Bob's not my name wrote:These are better than 1.65%:
3. Principal global investors
Large cap S&P 500 index R1 fund ------------------------------------ PLPIX – 1.04
4. Principal Global Investors
Midcap S&P 400 Index R1 Fund ------------------------------------- PMSSX – 1.05
6. Principal Global Investors
Small Cap S&P 600 Index R1 Fund ---------------------------------- PSAPX – 1.06


I chose TR 2040 fund as I did not know much about different asset classes, funds and how they worked. Even at this point, I am not sure I totally understand how these smallcap, midcap and large cap funds fit into my retirement goals.
Given my age(35) and medium risk tolerance, what would be your recommendation as to how much I put into those funds?

Thank you.
Last edited by katnok on Sun Mar 24, 2013 4:32 pm, edited 1 time in total.
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Re: Should I contribute to Taxable account instead of my 40

Postby Bob's not my name » Sun Mar 24, 2013 4:31 pm

Yes, I made a mistake in assuming the minimum MAGI was also the maximum :)

I'm a little confused about your back door Roths because I understood your earlier post to say you are already doing them.

I would use the index funds in the 403b/457 and hold bonds in your Roths and international stocks in your taxable account. Typical recommendation for your age would be something like 45% domestic stock, 20% international stock, 35% bonds. $17,500 in your 403b and $11,000 in your Roths every year works out pretty close to that.
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 4:40 pm

Bob's not my name wrote:I'm a little confused about your back door Roths because I understood your earlier post to say you are already doing them.
.


Sorry for the confusion. What I meant in my earlier post was, even after contributing to Roths we would still have money left over as we move forward. We invested most of our savings (except contributions to 403b) from the last few yrs in real estate in India, but we are done with it, and now want to focus on investing everything here in the US.
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 4:43 pm

Bob's not my name wrote:I would use the index funds in the 403b/457 and hold bonds in your Roths and international stocks in your taxable account. Typical recommendation for your age would be something like 45% domestic stock, 20% international stock, 35% bonds. $17,500 in your 403b and $11,000 in your Roths every year works out pretty close to that.


Thank you bob's not my name, but how do I choose from the above 3 index funds? Should I put equal amounts in each one of those 3 funds?
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Re: Should I contribute to Taxable account instead of my 40

Postby retiredjg » Sun Mar 24, 2013 4:44 pm

katnok wrote: Even at this point, I am not sure I totally understand how these smallcap, midcap and large cap funds fit into my retirement goals.

This is basic info you need to understand what you are doing. The stock market is divided into large, midsize, and smaller companies. The "cap" comes from "capitalization" meaning how much money they have.

The stock market is roughly 70% large cap, 20% mid cap, and 10% small cap. This is just by a definition that many people use. Nothing magic about it and different companies may categorize things a little differently.

See this link and see if you can find those funds (S&P 500, 400, and 600) in there and consider using those percentages to make up something that is similar to the total stock market. Wiki article link: Approximating Total Stock Market
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Re: Should I contribute to Taxable account instead of my 40

Postby katnok » Sun Mar 24, 2013 4:48 pm

retiredjg wrote:
katnok wrote: Even at this point, I am not sure I totally understand how these smallcap, midcap and large cap funds fit into my retirement goals.

This is basic info you need to understand what you are doing. The stock market is divided into large, midsize, and smaller companies. The "cap" comes from "capitalization" meaning how much money they have.

The stock market is roughly 70% large cap, 20% mid cap, and 10% small cap. This is just by a definition that many people use. Nothing magic about it and different companies may categorize things a little differently.

See this link and see if you can find those funds (S&P 500, 400, and 600) in there and consider using those percentages to make up something that is similar to the total stock market. Wiki article link: Approximating Total Stock Market

Thanks for the link, retiredjg. I knew what those caps meant but I did not how to choose one over the other or how much to allocate to them.
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Re: Should I contribute to Taxable account instead of my 40

Postby retiredjg » Sun Mar 24, 2013 5:09 pm

katnok wrote: I knew what those caps meant but I did not how to choose one over the other or how much to allocate to them.

I hope you do now! :wink:
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Re: Should I contribute to Taxable account instead of my 40

Postby dickenjb » Sun Mar 24, 2013 5:14 pm

katnok wrote:
Bob's not my name wrote:These are better than 1.65%:
3. Principal global investors
Large cap S&P 500 index R1 fund ------------------------------------ PLPIX – 1.04
4. Principal Global Investors
Midcap S&P 400 Index R1 Fund ------------------------------------- PMSSX – 1.05
6. Principal Global Investors
Small Cap S&P 600 Index R1 Fund ---------------------------------- PSAPX – 1.06


I chose TR 2040 fund as I did not know much about different asset classes, funds and how they worked. Even at this point, I am not sure I totally understand how these smallcap, midcap and large cap funds fit into my retirement goals.
Given my age(35) and medium risk tolerance, what would be your recommendation as to how much I put into those funds?

Thank you.


Where did these choices appear from? Does NOTBOB work for the same company as KATNOK?

KATNOK if you want useful advice post ALL your 403(b) choices. You are barking up the wrong tree looking at taxable as others have pointed out.
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Re: Should I contribute to Taxable account instead of my 40

Postby ObliviousInvestor » Sun Mar 24, 2013 5:20 pm

katnok wrote:
ObliviousInvestor wrote:It looks to me like you are also assuming that you stay at the current job until retirement and that 100% of your returns comes from capital gains rather than dividends or interest. The first assumption seems reasonable, if you do in fact have reason to make that assumption. The second assumption doesn't make sense to me.


Thank you for your input, ObliviousInvestor. Chances of staying with my current employer for the next 25 yrs are close to zero, but I thought I could switch to future employer sponsored plan, if it has better options.

Indeed. My point here was that if you expect to leave your current employer within, say, 5 years, then in your calculations you would only want to include higher costs for the first 5 years.
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Re: Should I contribute to Taxable account instead of my 40

Postby grabiner » Mon Mar 25, 2013 2:01 pm

katnok wrote:I am very unlikely to stay with my current employer for longer than another 5-10 yrs.


In that case, you should use the 403(b); ten years of high costs will cost you 15% (and now only 9% if you use the index funds that non-Bob found for you), and you'll surely lose more than 15% of your taxable investment to taxes. (Even if you never have any taxable dividends, you'll pay 15% federal tax and 3.07% PA tax on any capital gains.)

And when you change employers, you can roll the 403(b) into an IRA, or into your new employer's plan if it is good.
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