How to Prioritize Your Retirement Accounts

I just received the following comment from NCN of NoCreditNeeded, and I thought it was worthy of a post of its own:

Suppose you could invest in any and all types of retirement accounts, and there were no income limits, etc… How would you “rank” the different types of accounts? In other words, if you could invest in a 401(k), 403(b), Roth IRA, etc., how would you decide which to invest in FIRST, SECOND, THIRD…

Off the top of my head, here’s my answer…

I would start by making any contributions that come with matching funds. Once I maxed out the matching funds (= free money), I would move on to the Roth IRA. After that, I would go back to making deductible contributions. In some cases, there’s no choice left to be made at this point… Many people have a 401(k) and that’s it.

Assuming that I had more than one choice, such a a 403(b) and a 457(b), I would rank these by the available investments. If one has great, low-cost funds, then that’s the one I would go with first. After that’s maxed out, then I would move on to the other one.

In fact, this is exactly what I’ve done. My employer compels me to contribute 5% (no more, no less) to a defined contribution plan, to which they add a little better than 8%. In the past, my top priority after that has been maxing our Roth IRAs, although that’s no longer an option for us as we’re bumping up against the income limits.

After that, I turned to an optional 403(b) (and I later increased our contributions to take full advantage of it). This year I opened the 457(b) in order to maximize our retirement savings.

The reason that I opted for the 403(b) ahead of the 457(b) is that Vanguard is available through the former, and I’m a total Vanguard junky. The best option in the 457(b) is TIAA-CREF which is a bit more costly.

Of course, I’ve also been able to take advantage of a SEP-IRA to make additional deductible contributions above and beyond what’s available through the more ‘standard’ options. And in my case, I would rank the SEP-IRA ahead of the 457(b) for the same reason that I prefer the 403(b) — the ability to invest through Vanguard.

With all of that being said, I’d love to hear what you guys think…

12 Responses to “How to Prioritize Your Retirement Accounts”

  1. Anonymous

    When you get to around age 50 and your self-employement income tops $150K an Individual Defined Benefit plan can allow putting away 100% of income up to $150K/year. The amount varies with age and prior hig income. You can also add a 401(k) (100% of income to %15,500) and profit-sharing-plan (6% of income) good for another $25K+. Over 10 years you could sock away $2MM. One downside is expensive account management. Annual paperwork costs $1000 to $2000. Setup and shutodown costs are about the same.

  2. Anonymous

    Tammy, I’m not on expert on the subject, but as i understand it, some of the key points about the way the Roth vs. Traditional 401k works are:

    First of all, your employer must actually offer the Roth through their plan. If they do not offer it, you can not contribute to one. The Roth 401k is new as of 2006, so a lot of employers don’t offer it yet.

    Secondly, you can choose to contribute to one or the other or to both, but your total contributions cannot go over the limit. (I believe in 2007 it’s $15,500 for those under 50 and $20,500 for those over.)

    Thirdly, you prioritize based on your own personal situation. Unlike the Roth IRA, there is not an income ceiliing for the Roth 401k, so that’s not an issue. Most of it boils down to tax considerations, as with IRAs, and how much take home pay you need. The general rule of thumb is that if you believe you will be in the same or higher tax bracket when you retire, you opt for the Roth. Also, the Roth 401k, like the Roth IRA, is funded with after-tax money. This means that your take home pay is lower if you contribute to the Roth. If you want a tax break now and more current income, contribute to the Traditional 401k. If you want a tax break in the future, opt for the Roth. My plan offers a calculator that shows the growth of each based on taxes. For me, the Roth wins out in the long run.

    Some people hedge their bets and contribute partially to each kind. I’m not sure every plan allows for this, so you’d have to verify you can do this. My employer lets us split contributions any which way we like. I contribute 100% to a Roth 401k (and to a Roth IRA because my income is low enough.) Roth’s also have the advantage of not having a required minimum distribution (RMD.) Meaning, if you don’t need the money at 70-1/2, you don’t have to withdraw it. There are other advantages you can read about elsewhere.

    Finally, you need to understand how your employer matches your contribution. Mine doesn’t match, so i haven’t really studied this, but i believe that if you’re contributing to a Roth 401k, you’re employer match will always be held in a Traditional manner, meaning you will owe income tax on the employer contribution when you eventually withdraw funds, even though you won’t have to pay it on your own Roth funds. I don’t know what happens when you roll over your 401k when you leave–I guess you’d have to roll the respective amounts into two separate accounts–a Roth IRA and a traditional IRA? Can someone advise?

    Hope this helps. There’s a lot of info online, so surf around for additional perspective.

  3. Anonymous

    I am having some trouble understanding the 403 and 457 plans. Are they things that are only available through some empolyers or can anyone participate?

    Also, when you can contribute to a Roth 401K as well as a traditional 401K, how do you prioritize the two?

  4. Anonymous

    This is not exactly on-post, ie. it’s not a ranking of what I would do, but it’s a ranking of how we priortize based on the plans we are eligible to contribute to.

    Our plan is similar to Jesse’s:

    1. We max out my Roth 401k ($15,500 this year?), which has no match from employer. The fund choices in the plan are performing well so far (firm only started offering 401k last year), paycheck deductions are the easiest way to save, and i think 401k plans offer creditor protection, so this vehicle is our priority even without a match. And, as Debbie stated, taxes are bound to go up, so Roth options are our current favorite.

    2. We then max out our Roth IRAs. Not sure we’ll be eligible this yr thanks to my large January bonus and fact that DH’s self-employment income flucutates–makes it hard to know if we’ll be in that bubble thing (Nice to read about this stuff here, as we’ll likely be smack in that range for the first time.) We will wait until December to figure out whether to fund Roth v. Traditional. May be able to defer some of DH’s Dec. income to 2008.

    3. Finally, fund DH’s SEP. The percent we contribute changes each year depending on our cash flow and tax situation at time of filing. We set aside some money for the SEP throughout the year, but not enough to fully fund it (we save a lot in taxable accounts instead.) Last year we had a huge tax bill so decided to take cash out of a taxable account to fully fund the SEP and reduce taxable income. Pay ourselves rather than the tax man. Since my goal is to sock away 20% of income in retirement accounts and our pay has gone up this year, we will likely need to fully fund the SEP again to get to 20%.

  5. Anonymous

    Mine priorities almost match yours:

    1) defined contribution plan (not a choice–must do it–both I and my employer contribute about 6%)

    2) Roth IRA – has the most flexibility both for what to invest in and how to get the money out later. Also, I feel my taxes are going nowhere but up because I think taxes are going to have to rise when the boomers start retiring en masse and because I’m still at the 15% marginal income tax rate.

    3) After that, I was going to start just investing outside a plan because capital gains are taxed at a low rate. But then my company started offering Roth 403b’s, so I’m doing that. There’s no Vanguard, so I’m going with TIAA-CREF.

    I once the decided the 457b would make a good unemployment insurance tool because as Arc says, you can get the money as soon as you leave that company. However, a) I’m not planning on leaving this company until I retire and b) the fees and choices I have are very sucky. So I’d prefer investing outside a plan.

    I can barely afford to max out my IRA. It would take more than my entire take-home pay to max out everything! But I have found an additional $100/month for my 403b, and I am evaluating my spending right now to see if I can squeeze out some more.

  6. Anonymous

    I think as long as you do something, you are ahead of a lot of people. Thanks for your thoughts Nickel, I am sure a lot of people could use that advice.

    Oh, and by the way, love the new header.

  7. Anonymous

    Part of it also depends on what investment choices are offered. Often a company 401k or 403b is limited and it might be a better option to roll over to a IRA.

    Also another thing to consider if you want to get into the nitty gritty is to minimize your tax liabilities. Some investments are more tax efficient than others and so investment choices should be planned accordingly to the investment vehicle.

    BTW, nice new logo nickel!

  8. Anonymous

    My priorities:

    Company Roth 401k
    -contribute 15%, company contributes 75% up to the first 5%. The income limit on this is nada, and the max contribution is 15,000, which I don’t reach at only 15% of gross.

    Roth IRA for Me and Wife
    -Max them out with other income besides that of employee wages

    -Max it out at 20% of SE income from side businesses

    I figure I get good tax diversification this way, since my SEP IRA contribution is just a little bit under what my Roth contributions are.

    And everything except my employer’s Roth 401k, I do through Vanguard.

  9. Anonymous

    I have similar options/dilemma that you do (in that Vanguard is not available for my 457b plan), but I decided to fully fund the 457 first because there is no early withdrawal penalty. In other words, as soon as I leave my current employment, I can withdraw the money (no need to wait until 59 1/2). It is a significant benefit because if you’re really maxing out all these plans, it’s very unlikely that you will need to work until 60.

    For me, the priority order is:

    Pension (mandatory w/ employer match)
    SEP IRA for self employment
    Regular non-tax-deferred investments

    In fact, if I fully fund the ROTH, in addition to the pension, I may not need to fund the SEP IRA too much–there should be more than sufficient money to spend after 60.

    Just my 2 cents…

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