This is Part 2 in our Investing Q&A series. If you missed Part 1 from a few months ago, be sure to go back and catch up here! Otherwise, let’s dig back in — today we’re going to focus a little more on employer-sponsored retirement plans:
What is a 401k vs 403b vs 457b vs TSP?
A 401k is an employer-sponsored retirement savings plan by which employees direct a portion of their income/paycheck into their 401k account and often receive a matching contribution from the employer. Typically, any withdrawals made prior to age 59 ½ may are subject to a 10% early-withdrawal penalty (exceptions apply). Upon reaching age 59 ½, employees are able to make withdrawals penalty-free and dollars are taxed at ordinary income levels.
A 403b is quite similar to a 401k, but they are usually found in tax-exempt and nonprofit organizations. They have the same tax advantages, contribution limits, and early-withdrawal penalties as with a 401k.
A 457b is somewhat similar to a 401k & 403b but has a few important differences. You’ll often find them offered to state/local government employees and some non-profit organizations. They have the same pre-tax advantages as the 401k and 403b, but can differ in contribution limits and withdrawal rules. The 457b plan contribution limit is totally separate from the 401k/403b and their limits. As a result, you can maximize the 457b AND a 401k/403b. There are two primary types of 457b plans: governmental and non-governmental plans. Governmental plans are not subject to the company’s creditors and allow you to roll over proceeds to an IRA at termination of employment — whereas non-governmental 457b plans are subject to company creditors and have quite restrictive termination and withdrawal provisions. For instance, if you terminate employment, you cannot roll these over to an IRA and in many cases mudt begin taking taxable distributions immediately.
TSP – this is essentially the 401k plan run by the US Government for federal employees. It has the same tax advantages, contribution limits, and early-withdrawal penalties as with a 401k and 403b..
What is the Most I Can Contribute To All of These Plans?
If you have no self employed income, you’re limited to employee-only contributions. The combined 401k/403b/TSP maximum for employees is $19,000 for 2019 – with a few exceptions. In some cases, you can contribute beyond the $19,000 through catch up contributions (age 50 and older) or through after-tax contributions. Additionally, if your plan has mandatory employee contributions, those contributions may not count toward your maximum. And some plans that don’t meet compliance testing are required to set limits on contributions for highly compensated employees that are below the normal maximum. These numbers will depend on your specific plan.
457b plans have a separate limit and you can contribute an additional $19,000 even if you’ve already maxed out the other plans. You can read more about how these plans work together here.
How do I Decide Which Work Retirement Plan to Contribute to First?
If you have access to multiple retirement plans, odds are that one is better than the other(s). It’s important to consider and compare things such as:
- Employer matching
- Fund expense ratios (check out the plan “fee disclosure” document)
- Plan/administration fees
- Available fund options for proper asset allocation
- Combination of plans that provides the highest maximum tax-sheltering contribution
- Potential effects on your or your spouse’s public service loan forgiveness “PSLF”
Don’t just split your dollars up arbitrarily between plans – make sure you’re informed and choosing efficiently! You’d be AMAZED how drastically plan fees & fund expenses can impact future performance – we’re talking hundreds of thousands of dollars.
How Much Should I Contribute to my 401k?
At MINIMUM, you should be contributing what is required to get your full employer match. I’m sure you’ve heard it before – but this is FREE money. A 100% return on your investment.
If you’re going to max out your 401k (at the full $19,000), we encourage you to pick a % of income or flat dollar amount that will spread the contributions evenly throughout the year. For example, if you set your contributions to 10% and you’re making $500k annually, you’re going to max the plan out before the year is half over. Why does this matter? Two reasons: 1) if your plan does not have a “True Up” option, you could be missing out on your employer matching. And 2) it prevents you from having variable cash flow, which allows for irregular spending and inconsistent budgeting. So, if you’re making $500k, elect to contribute 3.8% or a flat dollar amount of $1,583.33/mo to spread it out.
How Do I Pick Funds in my 401k?
Start with your risk tolerance. How do you feel about investing overall? What are your objectives? How long is your time horizon to retirement? How much experience do you have with investing? The answers to these questions will put you somewhere along the Very Conservative → Very Aggressive risk tolerance spectrum. In very general terms, the higher the proportion of stocks in your portfolio, the more risk you’re taking.
If you’ve not taken one before, consider taking a Risk Tolerance Questionnaire. Vanguard has a free online tool to help point you in the right direction. Ultimately, your result is usually shown as a recommended ratio of stocks to bonds, which is your recommended asset allocation (ie. an 80:20 result means you should hold 80% stocks and 20% bonds based on your answers).
Next – evaluate your investment options. Your plan is required to provide you with a list of your investment options that discloses things like asset classes, fund fees/expenses, etc. Look for options with low expense ratios. If you don’t have a lot of experience, you might consider a Target Date fund. These options have pros and cons, but can be an acceptable option for those who would like to “set it and forget it”. Typically, simpler = better if you don’t have much experience. On the other hand, if you’re a little more familiar with investing, you might pick a handful of funds based on your desired asset allocation. In general, though, keep it simple. There’s no real need to own 15 different funds in your retirement plan.
What is Investment Rebalancing?
If you’re not in a “set it and forget it” fund that maintains its own balance, it’s likely your ratio of stocks:bonds will get off track over time based on market volatility. You’ll want to take a peek at your account at least annually to make sure your investments are in-line with your targets. If not, set your fund proportions back to the original percentages/amounts. Some plans even allow you to set this up to happen automatically.
And that’s going to do it for today! If you learned something new, great! If what you learned was that you don’t want to have to mess with any of this, give us a call! We’d love to help. Stay tuned for Q&A Part 3 where we dig further into the details of investing.
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