Reshuffle Your Retirement, Part Deux

Not long ago, I wrote about rethinking your retirement contributions. In short, I suggested that you might want to consider sending excess contributions (those that go beyond what is necessary to get your employer’s match) to a Roth IRA rather than sending them to your 401(k) or 403(b). When I first started my current job, I opted to contribute 5% to get my employer’s dollar-for-dollar match, as well as an additional (unmatched) 5%. Each year since then I’ve increase my unmatched contribution by 1%. As of this year, this worked out to an extra 8% of my income going to my tax-deferred retirement account. During this time, however, I was neglecting my Roth IRA.

I’ve now adjusted my payroll paperwork to reduce my retirement contributions to just the 5% necessary to get my employer’s match. When I first suggested this strategy, I noted that you’ll be increasing your immediate tax burden. Thus, although the size of your paycheck will increase, it won’t increase in lockstep with your reduced retirement contributions – rather, your tax withholding will increase, thereby taking a bite out of what you need to be sending to your Roth. The point here is that, for this plan to work, you need to be sure that you can continue contributing the same amount to your Roth as you were contributing to your tax deferred employer plan. At the very least, factor any possible decrease in your contributions into your calculations when deciding whether or not this sort of a switch is in your best interest.

Anyway, to make a long story short, I’ve received my first payroll advisement following the changes that I made, and I’m pleased to report that this strategy will have almost no net effect on my monthly takehome pay. I’m realizing an additional 8% of my income, yet my withholding has increased only slightly (< $10/month). Thus, it will be very easy for me to simply slide that extra 8% from my bank account over to Vanguard (my Roth IRA custodian) each month with barely a hiccup in my take home pay. Of course, the increased tax burden won't really come home to roost until taxes come due. However, for a variety of reasons that I won't go into right now, I usually end up with a fairly substantial tax return. Thus, I don't anticipate feeling the pain when my 2005 taxes come due, although my return will end up being somewhat smaller than usual.

3 Responses to “Reshuffle Your Retirement, Part Deux”

  1. Anonymous

    Again and again, I see the advantage of the Roth IRA. However, if IRA is for your retirement funding, the best place is to put money in tax advantaged savings of IRA. For most people it only makes sense to contribute to 401 k or tradional IRA. The argument fiancial people give is that your tax bracket will be high at the retirement. I would be happy to pay more taxes in retirement, if I have that type of money. But what this does is that it stops individual to save more currently. For every $4000 in your 401k or traditional IRA, you are puting only $3850 or $3350 for federal tax rates of 15 and 25%, respectively and state tax rate of ~8%. On the other hand you will be investing $6494 and $7462 for that $4000 in Roth IRA for these tax rates.

  2. Nickel

    I agree completely. But for some people this just isn’t possible. I’m working toward maxing both, as well as my wife’s Roth. However, that would be >$30k this year, and we just can’t swing it (yet). But we’re getting there. As I noted, I increase the amount of salary that I am putting into retirement by 1% per year. Thus, the amount we’re saving grows not just due to raises, but also due to an increased savings rate.

  3. Anonymous

    I prefer the idea of maxing out both (401k AND Roth), even if I need to be conservative on my day to day life.

    Why wait for latter to build the egg nest?

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