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If I contribute to a 403b bi-monthly through my job, and my employer contributes equal to 7% of my salary into a pension plan, should I also open a stock driven Roth IRA? I was also planning to open up some DRP accounts. How do I prioritize where my money should go? I currently have 2 mutual funds and a money market fund. Am I spreading myself too thin?

Thank you for any advice you send.
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Here are my thoughts:

1. 401k (403b) to get maximum employer match.
2. Roth IRA
3. Max out 403b
4. Taxable accounts
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My preference is to change the order from Ringfinger's ordering.

1. max 401(k) or 403(b)
2. traditional IRA (if AGI permits)
3. Roth IRA
4. Possibly other tax deferred accounts such as annuity accounts - this really depends upon your situation and should be considered closely before jumping in.
5. taxable account

I prefer to max out my 401(k) because it gives you a lot of bang for the short term buck even if you go beyond the matching percentage. Every dollar that goes into a 401(k) reduces your AGI (and taxable income) dollar for dollar. So you get to save immediate tax dollars that could then be used to fund a traditional or Roth IRA. Almost like a one-two punch. My general philosophy is to delay paying any tax as long as possible, so I strive to maximize vehicles which defer tax in the current tax year first. The other vehicles fall into place after that.

Regards,
LooseChange
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LooseChange,

What if you don't have enough to do all 5 of your steps? Is there such a thing as too much tax free/deferred investing? Are you ever concerned about having all of your funds tied up in somewhat untouchable investments? I would think some percentage of investments in taxable instruments so that you can get to it if necessary.

Any thoughts on this?

c130king
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LooseChange: "My preference is to change the order from Ringfinger's ordering.

1. max 401(k) or 403(b)
2. traditional IRA (if AGI permits)
3. Roth IRA
4. Possibly other tax deferred accounts such as annuity accounts - this really depends upon your situation and should be considered closely before jumping in.
5. taxable account

I prefer to max out my 401(k) because it gives you a lot of bang for the short term buck even if you go beyond the matching percentage. Every dollar that goes into a 401(k) reduces your AGI (and taxable income) dollar for dollar. So you get to save immediate tax dollars that could then be used to fund a traditional or Roth IRA. Almost like a one-two punch. My general philosophy is to delay paying any tax as long as possible, so I strive to maximize vehicles which defer tax in the current tax year first. The other vehicles fall into place after that."


A clarification and a two quibbles.

"Every dollar that goes into a 401(k) reduces your AGI (and taxable income) dollar for dollar."

The original poster knows this I am sure, but your taxes are not reduced dollar for dollar as taxable income declines. The savings are only at your marginal tax rate times the reduction.

"So you get to save immediate tax dollars that could then be used to fund a traditional or Roth IRA."

These dollars may not be large enough to fully fund an IRA, depending upon the tax bracket you are in. For someone in the 15% bracket (even fully funding a 401-k at 10,500 [assuming that LBYM permits that much savings]) saves $1575 in taxes, some $425 dollars short of the current $2000 IRA cap.

Choosing a tax-deferred regular IRA (when AGI permits) versus a Roth IRA really requires assumptions about the tax system and one's marginal rate now (known) versus one's margianl rate in the future (unknown). I can certainly understand the "bird in hand" preferrence, but I do not think that it is a clear cut choice.

Furthermore, annuity accounts have expenses and withdrawals are usually taxed at ordinary income rates. LTBH with stocks with stocks that pay zero or little dividend but appreciate can permit the accumulation of more wealth because the LTCG is lawyas less the ordinary rate (in teh current system).

Ultimately (for most people), the goal is to have more dollars after taxes are paid, not simply to pay the least amount of taxes.

Just my $0.02. Regards, JAFO
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c130king, you asked:

<< What if you don't have enough to do all 5 of your steps? Is there such a thing as too much tax free/deferred investing? Are you ever concerned about having all of your funds tied up in somewhat untouchable investments? I would think some percentage of investments in taxable instruments so that you can get to it if necessary.

Any thoughts on this?
>>

That's a VERY, very, very good point and question. Too often in this forum the idea of an Emergency Fund goes without any consideration. I suppose that's because the thinking around here tends to be focused on maximum return without taking other things into consideration (e.g. risk tolerance).

An Emergency Fund is indeed part of one's total asset allocation and is indeed a place where you would look to so that "you can get to it if necessary". So, my thoughts as to "what comes first" are that one should put a high priority on establishing an Emergency Fund. Then if one has a company 401(k) with employer matching, that would be the next item on the list as the employer matching is thing to take advantage of. After that, it really DEPENDS on you and what YOUR situation is , your personal philosophies and what your specific short term and long term goals and objectives are. There's no cookie cutter way that's “right” for everyone. What's right for me may not be right for you - what feels comfortable for me may not feel comfortable for you. There are all kinds of way to succeed financially. A key thing I've found in really successful people is that they have a good idea where they want to go and how to get there . . .and STICK TO IT (they don't get sidetracked easily – especially by what they may want to buy for themselves . . . not using debt except to leverage earning power).

I hope these thoughts are helpful.
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<<<? Are you ever concerned about having all of your funds tied up in somewhat untouchable investments? I would think some percentage of investments in taxable instruments so that you can get to it if necessary.>>>

That what the proverbial emergency fund is for. Save about 3-6 months of living expenses in a money market fund. Why not stocks? Imagine this past September or October you got in a car wreck, along with your stocks in the emergency fund.

JLC
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I agree with both JLC and LooseChange on the Emergency Fund. I have 4-6 months worth of living expenses in various forms (cash, savings bonds, money market fund) but I know that I will eventually have to pay for my daughter's wedding, my son's and daughter's college education, and my retirement home when I get out of the USAF.

I feel like I need some funds that aren't tax deferred so that I have access when I need it. I have the oppurtunity to join the military Thrift Savings Plan (TSP) which I belive is similar to a 401K but without fund matching. If I max out my contribution to it and my Roth IRAs there won't be much left over for investing in regular funds/stocks.

I have a pretty nice next egg in those "regular" investments and I plan to let them sit and grow. But for now (starting Jan 02 when the TSP is available to me) I will stop investing in the taxable funds to ensure I max my TSP and Roth IRAs.

Am I wrong in any of my assumptions? I am still in the learning process and trying to figure out how I will deal with this situation.

c130king

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Oops...

I mean "nest egg" not "next egg"

c130king
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To keep it simple, I would donate the max to the 403. Then if you are eligible, and have cash to save, to the Roth.
Drips are nice, but picture the ammount of paperwork after a few years that will be required to figure your Basis. It is not a trivial exercise.
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I follow the logic presented, but I am of the thought to have more tax-free income when I retire as opposed to deferring taxes now. Just my feelings.
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<<<Am I wrong in any of my assumptions? I am still in the learning process and trying to figure out how I will deal with this situation.>>>

Don't know anything about the TSP, but follow the Foolish rules. Invest in an S&P index if possible, avoid annuities, and don't make a common mistake of investing in tax free or tax deffered investments in a tax deffered of tax deffered account. For example, holding tax free municiple bonds in an IRA.

Don't stash away so much money that you live like a pauper today. Enjoy life.

JLC
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Author: c130king Date: 2/16/01 7:12 PM Number: 27947

Is there such a thing as too much tax free/deferred investing? Are you ever concerned about having all of your funds tied up in somewhat untouchable investments? I would think some percentage of investments in taxable instruments so that you can get to it if necessary.

I have mentioned this previously, but thought it might be worthwhile to repeat it.

I did some research a while back, and found that the Vanguard Tax Managed Growth and Income fund, VTGIX, appears to be just about as good as an IRA for sheltering longterm growth from taxes. This fund tracks the S&P 500 Index and, because it is managed, it distributes very little dividends and capital gains each year. The expense ratio is only 0.19%, and the distributions and dividends are only 1.0%.

Of course, the really big advantage to this fund, like any other longterm investment, occurs when you sell it. Then, assuming you have held it long enough, you only pay a maximum of 18% tax on the gains. In an IRA, you have to pay taxes on all gains at your marginal income tax rates when you take the money out.

I have run spreadsheets that show that the longterm results of investing in an Index Fund inside an IRA vs. VTGIX in a taxable account are nearly identical.

However, there are catches:
* there is a $10,000 minimum initial investment.
* there is a 2% redemption fee if you take your money out the first year, and a 1% redemption fee if you take your money out before 5 years. After that there are no more fees. This redemption fee money is then plowed back into the fund to offset the distribution of capital gains costs that are incurred when people sell out. There are no loads or 12b-1 fees on this fund.

So, if you have enough for the initial investment, and your horizon is at least five years out, before selling any shares, this fund will give you total returns nearly equal to an IRA, without tieing the money up (subject to a 10% penalty).

The other advantage of this fund over an IRA is that there are obviously no RMD's (Required Minimum Distributions) at age 70.5. In large IRA's, these RMD's can cause much higher income taxes, because they push you up into higher marginal brackets than you need to be.

(Disclosure: I don't have any affiliation with Vanguard other than being a loyal customer.)

Russ
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I'll post my reasoning as well as the nest (next?) egg priorities and you can see if the reasons make sense to you.

Am I spreading myself too thin?

This really depends on your plans. Generally, after getting high-interest debt paid off, it is a good idea to build up an emergency fund with the equivalent of 3 to 6 months of living expenses. If one also has significant purchases or expenses planned for sometime in the future but before 59.5, you may want to save or invest for that, too, at least in part.

What comes first?

1. The way your message is worded, it isn't clear if the 7% employer contribution is to your 403(b) or to something separate. If it is to the 403(b) and contingent on you also contributing to the 403(b), then I would recommend contributing at least to the point where you get the maximum employer match, if feasable.

2. After that, I would generally recommend a Roth IRA. The money within a Roth IRA grows tax deferred and, if the withdrawals are qualified (e.g., one has had a Roth IRA for at least 5 years and is at least 59.5 years old before making withdrawals of the earnings), the growth is tax free. Plus:

- the regular contributions can be withdrawn at any time for any reason, tax free and penalty free. (The earnings, on the other hand, have to remain invested for at least 5 tax years and meet one of the qualifications before being penalty free.) Of course, for the best payout in retirement, it is better to keep both the contributions and earnings invested.

- The Roth IRA account can be established at just about any brokerage or fund family, so the choice of investments are much greater than typically available in a 403(b). This means you could potentially find less expensive good investments, or find investments that would help round out the offerings in your 403(b). (E.g., my 403(b) is with TIAA-CREF, which tends to be domestic large cap heavy in its stock offerings, so my Roth IRA is a little bit overweighted in small caps to help balance the equities portion of my retirement portfolio.)

- Unlike a 403(b), there is no Minimum Required Distribution.

- Beneficiaries can receive them potentially tax free.

- If you expect your retirement marginal tax rate to be higher than your current marginal tax rate (quite a possibility for someone investing early and for a long time), it may make sense to pay taxes now on money before it goes into a Roth IRA and allow it to grow tax free, instead of taking the tax deduction now by investing pre-tax money in a 403(b) and then having to pay your retirement marginal tax rate on money that you draw out of the 403(b).

- Even if your retirement marginal tax rate won't be higher than your current marginal tax rate, it could still be nice having tax free money available that you can draw out for a significant purchase in retirement without pushing you into a higher marginal tax rate. (I have talked to several people who have retired, wanted to get a 5th wheel, an RV, or a travel trailor, but their plans got delayed or they ended up taking out a loan because they didn't want 49% of their withdrawals going to state and federal taxes.)

I have seen a message from one person who really doesn't have enough money for both a Roth IRA and an emergency fund, so he decided to put $2K/yr in his Roth IRA and have that money placed in a money market fund. That way, if he needs that money, he can take it out; but if not, at a later date when he can build up a separate emergency fund he already has that $2K/yr in the Roth IRA so he could move that money from the MMF to a stock fund. (For long-term investments, stocks or stock funds, especially stock funds that have low expenses like an S&P500 index fund or a total stock market fund, are recommended.)

If the bulk of your retirement income will come from the 403(b) (and the for-profit equivalnet, 401(k)), it may make more sense to maximize the 403(b) before making Roth IRA contributions--get the tax deferral now at your marginal tax rate (e.g., 28%) and be taxed at your effective tax rate (e.g., 18-20%, depending on income levels) in retirement.

3. After the employer match in the 403(b) and contributing as much as you legally can to the Roth IRA, consider whether or not to contribute more to the 403(b). One must evaluate the investment choices and total expenses (both the investment advisory fees and the M&E expenses if this is in a Variable Annuity, sometimes called out in separate parts of the annuity contract, sigh) and see if the expenses are so high or investment choices so poor that you would really be better off in tax efficient investments in a taxable account instead of the tax deferral of a 403(b). A lot of the time 403(b) plans have such high fees that, unless one needs the added features that the higher expenses are costing you, it may end up not being worth it.

4. After contributing to the 403(b) up to the employer match (if any), the Roth IRA, and, if not prohibitively expensive, to the 403(b) up to your max, taxable investments in somewhat tax efficient investments could make excellent sense: individual stocks you can hold on for the long term, "tax managed" mutual funds, or other mutual funds with very low turnover such as a Total Stock Market fund or an S&P500 fund.

Some direct stock purchase plans and some dividend reinvestment plans (DRIP) can be set up as a Roth IRA or a regular (taxable) account, so if this is where you would like your Roth IRA, it would be worth while checking the Shareholders Relations department of the companies you are interested in.

A very common debate is whether it makes sense to invest in a taxable account before or after paying off one's first mortgage, but generally that is debated way down here at step 4, not up higher in my suggested priority list where one is investing in "tax favored" accounts.
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My general philosophy is to delay paying any tax as long as possible

You're brave and awfully non-paranoid. My paranoia tells me, "What if the government imposes a 100% tax on a 401(k) at time of withdrawal?"
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Thanks to everyone for the lively discussion regarding my original post.

I'm really glad establishing an Emergency Fund was mentioned. I would like it if someone would clarify something about that for me. I called TIAA-CREF (who also administers my 403b) and I believe they said that 911$ should be 10% of income seperate from any other investments??

Also, about my original post: I don't make much ( I work for a school). My 403b allows you to contrib. up to 20% or $10,500- whichever comes first. The 7% contrib. from my employer will begin this coming Sept. and is directed into whichever TIAA-CREF funds I indicate (existing or new ones). This money will be contributed as long as I am an employee of the school, regardless of whether I continue to fund money into the 403b or not.

So, again, what to do first? I am putting the 10% into a 911$. I probably should and could comfortably contrib. up to 10% into my 403b. Is this all I should do for now? No other IRA/Roth?
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So what if the 7% contribution from my employer is not contigent upon my also contributing money to the 403b? Should maxing out a Roth, first, be a priority and then continuing contributions to my 403b? I am in the process of grad school and am very secure my income later will far exceed my current income. Therefore, paying the taxes now may be a better way to go, si?

Thanks, again.
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I've never heard of the 10% rule, but it's like all other suggestions, a rule of thumb. I think more importantly you need to know what your living expenses are and then use that as your guide for the emergency fund. You might make 40k/year but only "need" or "live off" 25k, therefore, your emergency fund should contain about 6-12k.

As far as 403(b) vs IRA, if you can invest in an S&P index fund in the 403(b), I would max it out. That will reduce your taxable income and possibly put you in a lower income tax bracket, maybe. Then fund a Roth IRA, but don't do it at the expense of living like a "bag lady". If you don't have access to an S&P 500 index, I'd reverse the process, but that's my personal opinion.

JLC
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cacsc3, you asked:

<< I'm really glad establishing an Emergency Fund was mentioned. I would like it if someone would clarify something about that for me. I called TIAA-CREF (who also administers my 403b) and I believe they said that 911$ should be 10% of income seperate from any other investments??

Also, about my original post: I don't make much ( I work for a school). My 403b allows you to contrib. up to 20% or $10,500- whichever comes first. The 7% contrib. from my employer will begin this coming Sept. and is directed into whichever TIAA-CREF funds I indicate (existing or new ones). This money will be contributed as long as I am an employee of the school, regardless of whether I continue to fund money into the 403b or not.

So, again, what to do first? I am putting the 10% into a 911$. I probably should and could comfortably contrib. up to 10% into my 403b. Is this all I should do for now? No other IRA/Roth?
>>

After paying down all unsecured debt (as someone mentioned in an earlier post), YES . . . .establishing an Emergency Fund is the first thing you should do for now. Once you get that established, it's been my experienced and observation that people then tend to feel comfortable and confident where they tend to make much better investment decisions.

Typically an Emergency Fund should be much more than “10% of income”. It should either be 3 to 6 months of one's income . . . or, 3 to 6 months of one's total living expenses. Whatever this amount turns out to be, it should also represent that conservative element of one's investment asset allocation model.

It's important to take advantage of any employer matching too. So, while one would not to put the Emergency Fund at the top of the priority list and try to complete the funding of it as soon as possible, if one can afford to, one should also try and stretch themselves to try and also take advantage of what the employer is willing to give.
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cacsc3,you asked:

<< So what if the 7% contribution from my employer is not contigent upon my also contributing money to the 403b? >>

If this is so, then the Emergency Fund should come first.

<< Should maxing out a Roth, first, be a priority and then continuing contributions to my 403b? >>

After the Emergency Fund has been fully funded, then I feel funding the Roth IRA would an excellent next step.

<< I am in the process of grad school and am very secure my income later will far exceed my current income. Therefore, paying the taxes now may be a better way to go, si? >>

Paying taxes now would not be the ONLY advantage (assuming you're looking at the tax free withdrawals at retirement). For example, the Roth also allows you asses to the principle without tax or penalty should a situation occur where the Emergency Fund may not be enough. Also, there are tax advantages for your heirs over the traditional IRA's and qualified plans.


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Thanks again for everyone's input. I think I have a sketchy plan in mind now. I definitely need to divert more money to my emergency fund first and foremost. Then I will max out a Roth and then increase my contributions to my 403b. I really appreciate all the feedback.
lee
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So what if the 7% contribution from my employer is not contigent upon my also contributing money to the 403b? Should maxing out a Roth, first, be a priority and then continuing contributions to my 403b?

In that case, the recommendation I labeled #1 wouldn't apply.

I would recommend funding the Roth IRA fully.

However, if you decide to fund the 403(b) at this time instead of the Roth IRA, you will still be doing very well, especially since TIAA-CREF's various stock investment accounts are pretty good with large caps and, even with the M&E fees, have very low expenses. Plus, the 403(b) has the added advantage of payroll deduction so one doesn't forget to contribute.

Either will help your retirement, so either or both would be good, and both are far, far, exceedingly far better than doing nothing. (Alas, at my work too few people participate, even though they can start participating in TIAA-CREF's "Group SRA" (403(b)) for as low as $25/paycheck.)

And since either will be good, you could do some of both if you wish.
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