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Subject:  Re: What comes first? Date:  2/17/2001  9:41 PM
Author:  Mark0Young Number:  27967 of 74536

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- the regular contributions can be withdrawn at any time for any reason, tax free and penalty free.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.
