Slightly Newbie question... I have the opportunity to invest in both a Roth IRA and a 403b, but I don't feel that I have the funds to max out both contributions. Anyone with strong or even lukewarm feelings on which contribution to max out first?Thanks.Noah
Anyone with strong or even lukewarm feelings on which contribution to max out first?Do you expect your retirement tax rate to be higher than your current wage-earning tax rate (favor the Roth IRA), or less (favor the 403(b)), or about the same?Is your emergency fund fully funded? (No: max the Roth IRA first because you can withdraw regular contributions at any time, any purpose, without tax nor penalty. I don't recommend tapping one's Roth IRA, but if you are going to tap into any retirement accounts, at least you wouldn't be hit with taxes and penalties for withdrawing your contributions. Some people would argue for the 403(b) so you could make a loan from the 403(b), but it is unlikely you would be able to take out a loan from the 403(b) if you become separated from service.)Are you financially disciplined to make the Roth IRA contributions, or can arrange to put those contributions on autopilot? If not, the 403(b) has the advantage of being on autopilot--specifically, payroll deductions.Is your occupation one that tends to attract lawsuits? If so, the 403(b) is federally protected from creditors under ERISA (but not from divorce), but the Roth IRA might or might not be protected from creditors, depending on state laws.Be sure to check expenses. Many 403(b) providers are expensive, so compare the expenses of your 403(b) (both "investment advisory fees" and "M&E expenses" if they are annuity products, or "expense ratios" if they are mutual funds). TIAA-CREF and Vanguard are well-known for low expenses (the Vanguard Total Stock Market Fund and Vanguard 500 Fund have a lower expense ratio than TIAA-CREF, but TIAA-CREF Equity Index is great if you don't have Vanguard).Unfortunately, many employers that offer 403(b) plans have providers with high expenses, either annuities with high expenses (Vanguard and TIAA-CREF being the exception to high expenses) or mutual funds with high expense ratios. So look at what your total expenses will be, whether or not any insurance component would be worth the drag on returns, and compare that with what you can do with the Roth IRA. The expenses may tip the scale in favor of the Roth IRA unless you have very small expenses in the 403(b) or investment options in the 403(b) that are not available elsewhere."Rule of thumb" advice is generally:1. Eliminate high-interest debt,2. contribute to the employer's plan up to the matched amount,3. contribute to your (and your spouse's) Roth IRA up to the legal limit,4. the contribute to your employer's plan up to your legal limit.However, "rule of thumbs" often don't match one's situation so one should consider the whole picture, not just a rule of thumb. 8)
Be sure to check expenses. Many 403(b) providers are expensive, so compare the expenses of your 403(b) (both "investment advisory fees" and "M&E expenses" if they are annuity products, or "expense ratios" if they are mutual funds). TIAA-CREF and Vanguard are well-known for low expenses (the Vanguard Total Stock Market Fund and Vanguard 500 Fund have a lower expense ratio than TIAA-CREF, but TIAA-CREF Equity Index is great if you don't have Vanguard).Be careful with the term "expense ratio". What is actually germane are transaction fees and management expenses taken by the offering company or load fees (commissions) taken by the fund. What most people seem to miss is that money represented by the expense ratio is subtracted out of gross proceeds BEFORE computing a fund's yield. A fund which has a long term yield of 12% and an expense ratio of 3% is definitely a better bet than one with a yield of 11% and an expense ratio of 0.5%. The first has an actual yield 1% greater than the second; the expense ratio has no direct effect.Expense ratio has an indirect effect, however. It does represent money that is taken out of the gross proceeds in order to pay for all the management which takes care of the fund, leaving less to split up amoungst the holders of the fund shares. But a company having a high expense ratio may be spending this money efficiently on research or other factors which are creating greater gross proceeds for the fund. There are some statistical studies that show a MODERATE correlation between expense ratios and fund yield over long periods of time, but it is definitely not the rule that you will ALWAYS do better in a fund with a lower expense ratio. One classic example is Schroder Ultra Inv (SMCFX) which has an expense ratio of 3.0% but a 3 year CAGR of 100%. Yes, it has doubled in value EVERY year for the past 3 years, with no appreciable hiccups anywhere on its growth curve. I'd pay 15% in commissions and wouldn't care if the expense ratio were 10% if I could get hold of a fund that performed like that!!! (Unfortunately this fund is now closed to new investors).
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