Reshuffle Your Retirement

For some reason, it took me awhile to figure this out, but… While I was preparing our taxes this year I decided that we need to change the way that we’re saving for retirement. Since my employer provides a dollar-for-dollar match on retirement contributions up to 5% of my salary to our tax-deductible 403(b) plan, the initial 5% contribution is a no-brainer. However, we’ve also been making additional contributions to my employer’s retirement plan, and this is where I think that I’ve gone wrong.

I started out by contributing an extra 5% of my salary to my employer’s retirement account, although I’ve increased that by 1% each year when I’ve gotten a raise. Thus, as of this year I’ve been contributing the 5% to get the match plus an additional 8%. But at the same time, we weren’t fully funding our Roth IRAs. In fact, although we’ve been socking away some additional money into my wife’s Roth (she’s a stay-at-home mom), we haven’t been making any contributions to mine. Given that we expect to be facing an equal or higher federal tax rate at retirement relative to what we are facing right now, paying our taxes up front in return for tax free withdrawals thirty-some years from now makes a lot of sense. So here’s what we’ve decided to do…

We’re going to continue making the 5% contributions to my 403(b) to capture all of the matching dollars, but we’ve suspended the additional contributions. Those dollars are now destined for our Roth IRAs. As before, we will continue increasing the amount that we are putting toward retirement by 1% (or more) of my salary per year. However, these additional funds will continue to flow into the Roth IRAs until we get to a point at which we are maxing them both out every year. At that point, we’ll continue maxing our Roths, and the additional annual increments will be thrown on top of the 403(b) contributions.

The main caveat in implementing this, of course, is that by realizing more income right now, you’ll end up increasing your immediate tax burden. Thus, if you’re thinking about doing something like this, you need to make sure that you’ll be able to contribute the same amount after taxes as you otherwise would have contributed to a tex-deferred account. If not, then this might not be the best strategy for you. Similarly, if you expect to be in a lower tax bracket at retirement than you are right now, then the up front deduction might be best for you. Run the numbers and see what works best for you.

Here’s a link to a brief discussion of of Roth IRAs vs. employer plans, and here’s a link to a brief discussion of Roth IRAs vs. Traditional (Deductible) IRAs, which is a very similar situation.