Ask the grumpies: 403(b) vs. Roth

Leah asks:

If I don’t get a match with my employer 403(b) yet, is it better to just max out my Roth IRA? I haven’t been able to do that yet, but now I have enough of a paycheck to do so.

Is it advantageous to contribute to a 403(b) if I don’t think I’ll be at a job for more than a few years? Are those easy or hard to roll over?

Also, is it better to max out my Roth this year or pay off my student loans ASAP? I have enough in the bank to do one or the other. My student loans come due soon at the shocking 6.8%! (Shocking because, uh, aren’t interest rates super low? I’m amazed that my student loan rate is higher than advertised mortgage rates right now.) I’ll be draining my efund to pay off the student loans in full; they’re subsidized, so this would mean I won’t pay any interest at all on them and essentially just floated that money for two years. I figure it’s worth draining the efund because my spouse also has an efund that is sufficient for us, and I am also in a job with earnings that will pay the efund back this year. And it is both penny and pound foolish to save money at 0.8% APR to create 6.8% interest on my loan.

If you get a match with your employer account, that’s generally the way to go.  It is very difficult to beat a 100% immediate return on investment.  (Or even a 50% return if they only match at that rate.)  However, if the employer doesn’t match, there are a number of things you should be thinking about when deciding whether to go with the 403(b) or an IRA.  (Note, below I am assuming you don’t want to do anything crazy like putting rental properties in your retirement account– something you can do with an IRA, but not with a 403(b).)

1.  Do I qualify for an IRA?  If you’re not making a decently large amount of money then chances are you qualify both for the Roth and to get the maximum deduction on the traditional IRA.  Now, this is a bit less important because for the time being you can contribute to a traditional IRA and immediately roll it over into a ROTH, but that’s a little bit of a pain when you have a work retirement option already.

2.  Do I want to take the deduction now (as with a traditional plan, so your tax bill is lower this year) or do I want the deduction in the future when I’m old and drawing from the Roth (as with the Roth option)?  If you want the deduction in the future, does your 403(b) plan come with a Roth option?  If not, then the IRA Roth is the thing to do.  Otherwise the two are equivalent– you could either do a traditional 403(b) or a traditional IRA.

3.  How sucky are the investment plans in my 403(b)?  If Vanguard is one of your choices, then it doesn’t matter which you choose (after going through 1 and 2).  If you’re stuck with a high cost annuity or Ing is your only retirement option… then go with the IRA.  How do you know if your investment plan options are sucky?  The main things you look for are Fees and Choice.  It is hard to beat the fees at Vanguard.  Even Fidelity and TIAA-Cref are a bit higher, although those are reasonable options.  In terms of choice– you want to be able to buy low costs index funds and/or ETFs without having to pay a huge fee to do so.  Even better is being able to buy a cheap Target Date fund that you can just set and forget.
As for how hard is it to roll over a 403(b)– it is pretty easy.  You call up Vanguard, or whatever company you want to use, they ask you some questions, they fill out the forms, contact the company, and basically do everything for you.  However, there is a problem that sometimes people forget to do anything with their 403(b) before a window has passed with them leaving employment and they end up taking a penalty and getting sent a check for the balance of their account.  If you think that’s likely to happen to you, just go with the IRA.

Re: your loans.  That interest rate is high enough that paying them off seems beneficial over saving for retirement (but save what you can anyway!)  If they were 2% like #2’s loans are, we’d say to hold on to them because you can’t even get a mortgage at that rate.  But they’re not.  It also sounds like you’re covered in the event of a true emergency.  (If you weren’t, we’d have to talk about what to do about float, and how much you can really afford to pay off.)  So go for it!

12 Responses to “Ask the grumpies: 403(b) vs. Roth”

  1. Leah Says:

    I’m not sure of the exact 403(b) options. The companies we can go with are all geared toward working with teachers. I need to look into more details but have been a bit busy. I currently have a Roth IRA through Charles Schwab, and I’ve just bought index funds and one or two random stocks through them. I can buy Schwab’s index funds for free with a pretty low cost (at least, it was when I did the comparison shopping and opened a Roth IRA with them).

    If I don’t itemize deductions, then it’s not worth doing a traditional IRA, right? And I am pretty sure that, even now, our combined earnings are lower than they will be in the future.

    I won’t get the match until I’m in for three years. I have talked to other teachers, and some of them just the minimum amount in to get the yearly match. If I’m reading the paperwork right, the yearly match is just matching up to $350. If that’s the case, should I just put in $350 each year (once I can get the match) and then shuttle the rest to a Roth IRA? Maybe I’ll come back in the future and ask you once I know more details.

    RE: the loan, I have set a date to transfer my savings into my bank account so I can pay everything off. And I already have allocated my budget for how I will pay my efund back in full by next summer. I feel fortunate that I married someone with similar money views, and we both had funded efunds prior to marriage that were sufficient for a year+ of living. I’ll probably blog about all this once I make the payment. I’m set to get this done middle of this month before the interest would start in November.

    • nicoleandmaggie Says:

      TIAA-Cref is a pretty good choice in terms of fees (and customer service). Schwab is also relatively cheap (though I recently rolled over my old Schwab IRA to Vanguard)..

      You can deduct a traditional IRA without itemizing.

      If $5700 is putting away enough of a percentage of your income for retirement, then yes, you could do that. Presumably with a step schedule your income will increase over the years. You could increase your retirement contributions along with that.

  2. Dr. Koshary Says:

    You know, N&M, I’m a little surprised that you suggested the ‘set and forget’ target date fund option. My understanding is that those are fine for conservative investors (and people who hate dealing with this stuff more than necessary), but not ideal for most others. They’re not fine-tuned for an individual’s needs and preferences, and I would have guessed that you two are all about tweaking your own 403(b) and maintaining more active control of the investments. I’m not critiquing the suggestion, you understand: more like I’m asking if you think it’s ultimately not worth the trouble to fiddle personally with the investment portfolio.

    • nicoleandmaggie Says:

      It is not worth it. People who fiddle do worse than the market on average (as in, less than 50% of them beat the market). The economists who study retirement investing do Vanguard target-date funds if they have that option available. The best thing to do (unless you actually have the power to change markets, a la Gordon Gecko) is to find the lowest fee option that matches the market and adjusts for the amount of risk that is appropriate for your risk tolerance and expected retirement/death dates.

      For more on the topic, O’Dean is one of the earlier researchers, Choi and Madrian are more recent.

      Here’s our Target-date funds primer:

      • nicoleandmaggie Says:

        Also: hating to deal is not the same as conservative. You can put 100% of your portfolio in nasdaq and you’re not dealing with anything, but you have a somewhat risky portfolio. You can chase the highest earning CD and money market rates and you’re dealing with things but you’re way conservative.

      • bogart Says:

        Where I get hung up on the target funds idea is the fact that they are based on an individual, whereas I am part of a household, and not the stereotypical one (I may be toward one end of a spectrum on that, but I’m far from unique). Factoring in my DH’s pension (in which I have 100% survivorship), I figure I should basically be at close to 100% in stocks. Not forever — but for a good while longer. For DH to buy an annuity that would pay just what his pension pays him monthly in cash, ignoring the survivorship, ignoring the health insurance, ignoring the fact that the pension is (a tiny bit) tax protected (state, not federal) today would cost about 120% of the total value of all my retirement accounts. So I figure I am already (in effect) at least about 60% in cash equivalents, and invest as if I were the Evel Kneivel of investing risk on my side as a result. Of course over time, that will change, but only slowly (unless the bull market comes back, and even then).

        I don’t, however, trade. My 403b is in a few low-cost stock funds (TIAA-CREF; some are indexes, some aren’t, but all are basically buy-and-hold management perspectives) and I just keep adding to those. So what I’m doing may or may not be sensible, but it’s not market timing (or trading) that’s going to do me in.

      • nicoleandmaggie Says:

        Yeah, one thing you can do with target-date funds if your situation is different is think about what you want your path to look like, then pick the target date based on that path rather than the date you actually expect to retire. I want more risk in my portfolio than the retirement date I assume would be the most likely, so I just picked a later retirement date for my target-date fund. (But for any readers who don’t want to think about how they’re different from normal– just pick the retirement date– this here is more advanced than what you need… you’ll be fine if you satisfice.)

  3. hush Says:

    Pay off the loans. Then (as long as there’s no employer match), Roth it to the hilt every year you can possibly still qualify.

  4. femmefrugality Says:

    I had a few of the same questions. Thanks for asking, Leah! And thanks, guys, for the comprehensive response!

    • Leah Says:

      you’re welcome! And I appreciate the responses too. Definitely some good food for thought.

      A follow-up question: when “they” say you need to save 10-20% of your income for retirement, is that pre- or post-taxes?

      • nicoleandmaggie Says:

        There’s not really a good answer to that question! A lot depends on things we can’t predict about future taxes, future earnings, future health etc. etc. Something you may be able to predict is whether you envision your retirement spending to be higher or lower than your current spending. But even then a flat percent doesn’t make perfect sense when you have diminishing marginal utility of wealth. So, basically, if you’re risk averse, make that percent after taxes, but if you want more spending money now, make it before taxes. (And generally, whether you choose before or after tax, if you pick 15%, it’ll still be in the range of 10-20% of your income regardless of if it is net or gross)

  5. Carnival of Personal Finance #382 – The Leaves Are Changing | Walking To Wealth Says:

    […] from Nicole and Maggie: Grumpy Rumblings of the Half Tenured presents Ask the Grumpies: 403(b) vs. Roth, and says, “The Grumpies discuss the pros and cons of an employer account that doesn’t […]

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