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As we all know, contributions to 403(b) accounts are deducted pre-tax. This is supposed to result in savings over the long run, but does it?
I think there are some monetary repercussions of pre-tax deductions that are ignored in discussions of retirement planning.
When your money comes out pre-tax, your federal adjusted gross income is lower. However, your average annual salary is also lower. Your contributions to social security are lower. If you participate in a state pension plan (such as KPERS here in KS), and you probably do participate in such a plan if you are eligible for a 403(b), then your average annual salary is also going to be lower.
What does this mean? It means that, when you retire, the amount that you receive from your pension and from social security will be significantly less than they would be if you made your retirement contributions after tax.
I don't have time right now to try to calculate whether or not this difference is greater than the tax advantage earned by pre-tax deduction (and I suspect I lack enough info. and math skills!). However, I think that the old rule of thumb assumptions about annual returns on investments are now inflated. I don't think we will see 12% returns over the next decade on index funds for example, maybe not even 8%. Assuming that we actually receive social security and state pension checks, I think that the potential additional payout from a higher average salary could be significant. If one participates in annuity plans and makes contributions pre-tax, I think one should at least consider the lost future income that results when calculating the pre-tax savings that is said to be so advantageous.
If lawmakers really wanted to help public employees, they would
report gross earnings as average salaries for employees participating in 403(b) and state pension plans. When I look at my state pension plan statement, it appears that they use adjusted earnings that reflect the deductions made pre-tax (and perhaps even the contributions to the state pension plan that are not federally taxed).

I have not worked all this out, but I think it is worth looking into!
Mudster
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While I agree that it is something to consider for some people, I think the key sentence in your discussion is:
Assuming that we actually receive social security and state pension checks, I think that the
potential additional payout from a higher average salary could be significant.


If you are only a few years away from retirement, this issue could be significant, since 1) you can be pretty certain that you will be receiving SOMEthing in SS or pensions, 2) it is likely that you are in your highest earning years, so the % going to 403b is significant, and 3) you won't have much time for the 403b money to compound.

But for someone like me who is many years from retirement, the chances of SS being there are pretty bad, and this problem is likely insignificant.

FG
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I apologize for the lack of clarity in my last post. It is my lunch break and I am being interrupted frequently. Upon re-reading, it is confusing.
What I am saying is this: Pre-tax contributions leads to a lower average salary when one retires. I believe it also results in lower contributions to social security.
Lower social security contributions = less payout from SS when you retire.
Lower average salary = lower payments from state retirement plans when you retire.

I have never seen this lost income considered in discussions of the "pre-tax advantage." I am not convinced (at this point) that I could not do better taking my money post-tax and making my own investments, rather than rely on pre-tax contributions to annuities (the only 403(b) option available to me through my employer.

mud
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Mudster writes:

As we all know, contributions to 403(b) accounts are deducted pre-tax. This is supposed to result in savings over the long run, but does it?
I think there are some monetary repercussions of pre-tax deductions that are ignored in discussions of retirement planning.
When your money comes out pre-tax, your federal adjusted gross income is lower. However, your average annual salary is also lower.


You are laboring under a gross misconception here. While your taxable salary is lower because of the deduction of the 403b contribution, your gross average annual salary is unaffected. If you make $30K and elect to have $10K contributed to a 403b plan, your taxable salary becomes $20K. Your gross salary, though, remains precisely what is was before, $30K.

Your contributions to social security are lower.

That is totally incorrect. Your Social Security contributions will be based on your salary before the 403b contribution takes place, not on your taxable salary after those contributions.


If you participate in a state pension plan (such as KPERS here in KS), and you probably do participate in such a plan if you are eligible for a 403(b), then your average annual salary is also going to be lower.

While it might be possible 403b participation affects what you would get in your KY state pension (and in that sense affect your average annual salary used to compute that pension), It's my understanding that in most states such a situation is untrue. Usually, the state pension program and the 403b plan are separate entities neither of which is affected by your participation in the other. Even in those states wherein there may be an impact, that impact is a result of the state providing some kind of match to the 403b plan. That match is then used to justify a reduction in the pension.

What does this mean? It means that, when you retire, the amount that you receive from your pension and from social security will be significantly less than they would be if you made your retirement contributions after tax.

Maybe true of the pension, but definitely untrue of Social Security.

If lawmakers really wanted to help public employees, they would
report gross earnings as average salaries for employees participating in 403(b) and state pension plans. When I look at my state pension plan statement, it appears that they use adjusted earnings that reflect the deductions made pre-tax (and perhaps even the contributions to the state pension plan that are not federally taxed).

I have not worked all this out, but I think it is worth looking into!


As I said, I think you are highly mistaken in your conception. To learn more, perhaps you should talk to your HR folks about exactly what's happening between your pension and your 403b plan. Then you will be in a far better position to judge whether you should participate or not. As it stands now, I suspicion you are armed with too much misinformation to make that call.

Regards..Pixy

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As we all know, contributions to 403(b) accounts are deducted pre-tax. This is supposed to result in savings over the long run, but does it?

The greater issues with 403(b)s are:
- when you withdraw, the whole thing is taxed at your marginal income rate. If you didn't contribute to a 403(b) but instead invested in a tax-efficient mutual fund in a regular taxable account, any gains would be taxed at 20% capital gains rate.
- quite often the choices in the plan are mediocre and/or the plan has high fees; fortunately it is possible to transfer to another plan
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"- quite often the choices in the plan are mediocre and/or the plan has high fees"


And there is the real reason you might choose not to contribute to a 403b plan. If the choices are limited and generally lousy, you may well do a lot better to simply hold an index fund or a non-dividend-paying growth stock in a taxable account and dollar-cost-average into it every payday. Do you have the discipline to do it?
If you DO contribute to the 403b, your payroll department will take your contribution out of your paycheck each and every payday, and little by little, the amount of your retirement savings will mount.
You CAN do-it-yourself. Will you?
Best wishes, Chris
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That is totally incorrect. Your Social Security contributions will be based on your salary before the 403b contribution takes place, not on your taxable salary after those contributions.

I stand corrected, thank you. In looking at the Social Security estimated forms I have received, it is hard for me to get the same average figures estimated, so I must have misunderstood the discrepancy. I will have to seek an alternate explanation, which is probably glaringly simple now that I've embarrassed myself!
That being said, the reason I raised the question was to find out more informed opinions and information.



While it might be possible 403b participation affects what you would get in your KY state pension (and in that sense affect your average annual salary used to compute that pension), It's my understanding that in most states such a situation is untrue. Usually, the state pension program and the 403b plan are separate entities neither of which is affected by your participation in the other. Even in those states wherein there may be an impact, that impact is a result of the state providing some kind of match to the 403b plan. That match is then used to justify a reduction in the pension.

First of all, I must have made myself unclear. The 403(b) IS seperate from the pension plan, but the salary that is being estimated as my "estimated average salary at time of retirement" [which is based on current salary to date] appears to be based on my salary minus the 403(b), although in light of my complete screwup with social security, I should go back and re-examine this for other alternative explanations.
So, we are not talking about the exact same thing here. I am saying that my pension (not 403(b))returns will be less if my average salary is, in fact, reduced by contributions to the 403(b). In the district where I work, there is no match by the district for 403(b) contributions, although I know that occurs in some other states (and perhaps other districts in my state, although I have never heard of it).

I apologize for any misinformation. Obviously I am not a financial expert. I still think the question was worth asking.

mud
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Obviously I am not a financial expert. I still think the question was worth asking.

As long as you don't understand something, it's worth asking. How else do you learn? Or get answers? There are many knowledgeable posters on these boards, and we all benefit from the questions and answers.

Do you have any more questions?

Cosmos
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So, we are not talking about the exact same thing here. I am saying that my pension (not 403(b))returns will be less if my average salary is, in fact, reduced by contributions to the 403(b). In the district where I work, there is no match by the district for 403(b) contributions, although I know that occurs in some other states (and perhaps other districts in my state, although I have never heard of it).

While I seriously doubt your actual pension will be computed based on your average annual salary that excludes 403(b) contributions, only your HR folks can tell you the actual formula that will be used to compute that pension. Thus, to have a clear understanding of how your pension plan and your 403(b) plan interact, you must talk to the folks who know what the pension plan specifications are. Once you have that data, then you will be in a far better position to decide whether or not you wish to use the 403(b) plan.

In that regard, don't get too hung up with the income tax savings issue. In the absence of a match to your plan, it's possible you may be better off using a traditional or Roth IRA in conjunction with a fully taxable investment. That would be especially true if your 403(b) is restricted to poor mutual fund choices or poor annuities. Even then, though, you would have to do an analysis between the 403(b) and your alternative(s) to see which might be better on an after-tax basis. I suggest one way to do such an analysis in Step 4 of my 13 Steps to Foolish Retirement Planning at http://www.fool.com/Retirement/RetirementStep4.htm. But a major word of warning if you elect NOT to use the 403(b): You "... must be just as dedicated and disciplined within that investment as you would have been within the [403(b)]. That means you must make your deposits in that investment each and every payday without fail. It also means your deposit must increase at the same time and at the same rate as your pay does. Fail to adhere to that regimen, and you will neither equal nor beat the [403(b)]. The [403(b)] demands these contributions and increases via automatic payroll deduction, so to keep pace with or to better that vehicle you must apply the same technique in any alternative."

I apologize for any misinformation. Obviously I am not a financial expert. I still think the question was worth asking.

No apologies are necessary. Any question to which you don't know the answer is worth asking. Many times you will find someone on these boards who is able to give you a completely accurate answer. Other times -- like with this question -- the correct information may only be found elsewhere. In this case, the complete information rests within the pension plan documents themselves.

Regards..Pixy
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But a major word of warning if you elect NOT to use the 403(b): You "... must be just as dedicated and disciplined within that investment as you would have been within the [403(b)]. That means you must make your deposits in that investment each and every payday without fail. It also means your deposit must increase at the same time and at the same rate as your pay does. Fail to adhere to that regimen, and you will neither equal nor beat the [403(b)].

This I can do, and have TMF to thank. When I first began to read TMF website 4 year or so ago (after having read a book by the founders) I took the thirteen steps to heart. Several Fools, recommended the book "The Richest Man in Babylon." I know some don't like it, but I had never been exposed to these very basic principles and they really hit home to me. Specifically, I knew I had to get out of debt, so I focused on that and, although it took years, I accomplished it. I have religiously put 10% (of gross pay) into savings ever since I was out of debt (my wife does as well).
A few years ago, I would not have had the discipline, but now I am certain that I do. I get a sense of satisfaction in sticking with the routine. It is actually the first check I write when I get paid (I keep the savings in a different bank than my paycheck goes to, as I find the phyical seperation makes it easier to refrain from even thinking about dipping into it). I have recently gotten into DRIP investing, and I find that I have the discipline to do that (although some of these are auto-withdrawls, some are not as I like to vary the contribution amounts).
If anyone here has not gotten out of debt, I strongly suggest going back to those 13 steps and reviewing those pertaining to debt. The sense of satisfaction one gets from not having debt is incredible. The discipline I learned along the way continues to serve me well.
I will always wonder why the basic lessons taught in "The richest man in Babylon" were not taught to me in high school or by my parents. I recently loaned the book to a friend of mine who comes from the same hometown as I do. He made the same remark after reading the book.

Ok, I'm rambling now.
Thanks for all your advice. You are right, I need to find more information. I have been frustrated with the quality of the mutual fund options offered through my annuity. The fixed interest account pays too low a return to consider, but the other funds have not performed well. The choices are simply too limited. That is why I am looking at my alternatives.
Mud
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Question, I read that book YEARS ago. Who wrote it and where can you find a copy? I barely remember it but loved the way it put forth its wisdom and would love to get copies for my two youngest kids.

magique
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Greetings magique, the author is George Clason, and I believe it was originally written in 1972, and has been reissued several times since. I found the most recent (Jan, 2002) at both barnesandnoble.com and Amazon.com for $6.99, see:

http://shop.barnesandnoble.com/booksearch/isbnInquiry.asp?userid=54SVSXZ26U&mscssid=RGEHB18AVNUR9NK0L4WQP5NKK0XP986B&isbn=0451205367

http://www.amazon.com/exec/obidos/ASIN/0451205367/qid=1020943095/sr=2-1/ref=sr_2_1/103-9982035-2227860

HTH

Bookm
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Book thank you so much. I am sorry to see that it is out of print though. It contained so much simple wisdom. I am definitely going to pursue it though.
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Hi Mud
I too have a state pension plan and a 403b. You said you're in Kansas? well, I don't know about Kansas, but in missouri, I'm almost certain that the average income considered for your pension benefits are pre 403b. What kinds of choices do you have for your 403b? I have my 403b thru TIAA-CREF and they seem to have an excellent reputation. We didn't have TIAA-CREF as a choice of providers, but all I had to do was get 9 more people to sign up with me and asked our HR to add it to our list.

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