Reshuffle Your Retirement, Part Deux

Not long ago, I wrote about rethinking your retirement contributions. In short, I suggested that you might want to consider sending excess contributions (those that go beyond what is necessary to get your employer’s match) to a Roth IRA rather than sending them to your 401(k) or 403(b). When I first started my current job, I opted to contribute 5% to get my employer’s dollar-for-dollar match, as well as an additional (unmatched) 5%. Each year since then I’ve increase my unmatched contribution by 1%. As of this year, this worked out to an extra 8% of my income going to my tax-deferred retirement account. During this time, however, I was neglecting my Roth IRA.

I’ve now adjusted my payroll paperwork to reduce my retirement contributions to just the 5% necessary to get my employer’s match. When I first suggested this strategy, I noted that you’ll be increasing your immediate tax burden. Thus, although the size of your paycheck will increase, it won’t increase in lockstep with your reduced retirement contributions – rather, your tax withholding will increase, thereby taking a bite out of what you need to be sending to your Roth. The point here is that, for this plan to work, you need to be sure that you can continue contributing the same amount to your Roth as you were contributing to your tax deferred employer plan. At the very least, factor any possible decrease in your contributions into your calculations when deciding whether or not this sort of a switch is in your best interest.

Anyway, to make a long story short, I’ve received my first payroll advisement following the changes that I made, and I’m pleased to report that this strategy will have almost no net effect on my monthly takehome pay. I’m realizing an additional 8% of my income, yet my withholding has increased only slightly (< $10/month). Thus, it will be very easy for me to simply slide that extra 8% from my bank account over to Vanguard (my Roth IRA custodian) each month with barely a hiccup in my take home pay. Of course, the increased tax burden won’t really come home to roost until taxes come due. However, for a variety of reasons that I won’t go into right now, I usually end up with a fairly substantial tax return. Thus, I don’t anticipate feeling the pain when my 2005 taxes come due, although my return will end up being somewhat smaller than usual.