401K vs roth IRA

4 Steps to Balance Investments in your 403b (or 401K) and your Roth IRA

 
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Last year, I prioritized contributing to my 403b. Nowadays, I use the income from some of my side gigs and other jobs to contribute to a Roth IRA as well. If you are considering doing the same thing (by contributing to your employer-sponsored retirement plan and your own Roth IRA), here are a few steps you can follow:

Step 1: Have a plan for all your retirement investing. My investment portfolio is overwhelmingly filled with stocks. As someone who is [relatively] young with plenty of work years ahead of me, I’m decades away from retirement. Since I won’t retire for a while, I can include a high percentage of stocks and take more risks with my investments. By taking more risk, I increase my chances of making a profit on my money. Even if I “lose” money intermittently by taking so much risk, I have plenty of years to make up the losses, if they occur.

The percentage of stocks you have in your investment portfolio may be different. There are various investment allocations for people of all ages and stages of life with various risk tolerances. Some younger people choose to only invest in stocks, some choose to invest in stocks and bonds, and others like to have some real estate, commodities, or other alternative options. I’ve decided on a retirement investment allocation that fits me best: 75% in stocks, 15% in real estate, and 10% in bonds.

Step 2: Determine the type and percentage of investments to add to the Roth IRA. Now that I know what percentage of my retirement portfolio I want to allocate to each category, my next step is to determine which investments and how much of each investment I need to add to my Roth. Because I already have some of my investments in my main job’s retirement plan, I now need to add the remaining investments to my Roth IRA. When adding the remaining investments to my Roth IRA, I must make sure that the total value of all of my retirement investments remains at my desired allocation of 75% stocks, 15% real estate, and 10% bonds.

In my main job’s retirement account, I am invested in a target retirement index fund that invests my money in 90% stocks and 10% bonds. This means I need to add real estate index funds to my Roth IRA and also invest in some stocks and bonds in my Roth IRA to maintain my desired investment percentage. (Side note, although I plan to invest in actual real estate through the purchase of apartment buildings and multifamily homes, I like my retirement real estate investments to be in REITs aka Real Estate Investment Trusts - which are like giant real estate index funds that invest in many different properties). Also, keep in mind that since Roth IRA investments are made with money you already paid taxes on and never have to pay taxes on again, it’s often wise to make sure that you use this Roth account to make investments in things that pay dividends so you can avoid paying taxes on the money you make from those investments.

Step 3: Have the money automatically withdrawn from your account each month. Once I know how much of each investment I want to have in my Roth IRA, I just need to make sure I actually place the money into my Roth account. Although some people like to contribute the max allotment of $6,000 per year at one time to get their money invested sooner rather than later, I invest it in small pieces each month. Doing it in small pieces instead of all at once has two benefits for me.

First, it gives me more flexibility so that I can decrease the allotment one month and make up for it the next month if I need to. Secondly, contributing periodically each month gives me a greater chance of buying stocks at a “discount.” (The prices of stocks and index funds fluctuates. If I buy all of them at one time with by investing one large sum of money in my Roth IRA at once, then I buy all the stocks (or index funds) at the same price. However, if I invest a little each month then I increase my chances of buying stocks (or index funds) when they may be a lower price. Although there is also a chance I could buy the stocks (or index funds) at a higher price, doing it a little bit at a time has been shown to save people more money overall. This is known as “dollar cost averaging”. Each person is different, but I prefer to have the money automatically withdrawn from my account each month and invested into my Roth IRA. (When my salary increases, I’ll likely have the $6,000 taken out over 3 months instead of over the entire year)

Step 4: Adjust the investment percentages periodically. The prices of stocks, bonds, and REITs can fluctuate. Sometimes the prices change by only a small amount and thus stay at around the same price. Other times the prices of the investments can change by a lot and remain at this new level for a few months or even years. For example, when the coronavirus pandemic hit, the price of many stocks decreased and stayed low for a couple months before they started to come back up. When these fluctuations occur, they can change the balance of my retirement investments.

If stocks (or index funds) decrease then that means the value of the stocks in my portfolio have decreased, which means that instead of having 75% of my money in stocks this percentage may decrease to around 70%. In order to get back to my target of 75% I will need to buy even more stocks in the future (increase the percentage of new money I have going towards stocks) to make up this difference. Although different people have different preferences for how often they plan to adjust their investments, I plan to do it once a year.

Tell me, do you have a Roth IRA? If so, how are you investing it?

 

I invest in a 403b AND a Roth IRA, here's why:

 
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As a young professional who is trying to build wealth, I invest money. Although there are a myriad of different investment accounts and strategies, I invest in index mutual funds through my employer-sponsored retirement plan and through my own Roth IRA. Yes, I have both types of accounts. Let me tell you why.

I invest in my employer-sponsored retirement plan (which is a 403b, that is very similar to a 401K) because:

1. I get a match from my employer to invest in their plan. Back in the day, many jobs offered their employees a “pension” when they retired. This pension would guarantee an employee a certain percentage of their salary even after they retired and stopped working. Although these pension plans were great for the employees, they were extremely expensive for many companies. Thus, most jobs today no longer offer pensions. They instead, want to encourage their employees to save for their own retirement and give them an incentive (in the form of a retirement match) to do so. Through this retirement match, your employer will match what you contribute to your retirement plan. My employer, similar to many other employers, offers a retirement match if I contribute to my work-sponsored retirement account (aka a 403b). Since I don’t want to forgo free money, I contribute to my work retirement plan to get their “match.”

2. It saves me money in taxes. As an unmarried physician with no children, I pay quite a bit in taxes. Although I don’t mind contributing money to ensure that our government can run smoothly and fund things like education, infrastructure, and national defense, there are certain incentives in the tax code that can help reduce the amount of taxes I’m expected to pay. One of the incentives is contributing to a retirement plan. By contributing money to my employer-sponsored retirement plan, I am able to defer paying taxes on the money I contribute which decreases my tax rate. I also have the option of contributing to my work retirement plan via a 403b Roth, in which I can choose to pay taxes now and shield the income and profits from taxes when I withdraw the money later. So, whether I choose the pre-tax 403b (to help me save money in taxes now) or the 403b Roth (to help me save money in taxes later), either way I get to save money in taxes. Thus, either option is a win-win.

3. It decreases my student loan payments. Like many college graduates, I have student loans. In fact, the amount of student loans I acquired from medical school is so high that I had to consolidate my loans and enroll into an income-based repayment plan to make the payments more affordable. This plan, called REPAYE (revised-pay-as-you-earn), caps my student loan payments at 10% of my discretionary income which makes my monthly student loan payments much more affordable. As a resident physician who works for a non-profit hospital, I am also considered a “public servant.” Through a program called Public Service Loan Forgiveness (PSLF), after making 10 years of student loan payments, public servants who work for non-profit companies can get the remaining balance of their student loans forgiven, tax-free. Since the student loan payments I need to make are based on my taxable income, the more I lower my taxable income, the less money I have to pay in my student loans. One way I lower my taxable income, and thus lower my monthly student payment, is by contributing to my work-sponsored retirement account.

In addition to my work 403b, I also invest in a Roth IRA because:

1. I can make other types of investments that I can’t make in my employer retirement plan. Unlike my 403b or 401K, a Roth IRA is not set up through my employer. Because it is not connected to my employer, I have more options in the way I want to invest my money. Instead of being limited to certain mutual funds or index funds, I can expand my options. Through my Roth IRA, I invest in REITs (real estate investment trusts). By investing in REITs, I am able to make money via real estate, since these REITs invest in a variety of real estate deals and syndications. Adding real estate to my investments helps diversify my portfolio in a way that can make me even more money overall.

2. It gives me more flexibility whenever I want to withdraw the money One of the things I really like about the Roth IRA, is that because I contribute to it with “after-tax” dollars, there are fewer restrictions on when I can take the money out of the account. Although it is supposed to stay in the account until I retire, I can withdraw my contributions at any time, with no penalty (as long as I keep all the earnings/profits in the account). Thus, if I contributed $5,000 and made $500 in profits, I can take out the $5,000 I contributed at any time as long as the $500 I made in profit stays in the account. This means that if I ever run in to an emergency or decide to use some of the money to pay off student loans or purchase a home, I can withdraw some of the money from this account when I need. A Roth IRA is like a retirement account that I can technically use as a back-up emergency fund if I absolutely needed to.

3. I don’t have to pay taxes on the money in retirement when I take it out. Unlike my employer-sponsored retirement plan, I contributed to this Roth account with after-tax dollars. This means, when I withdraw the money in retirement, I don’t have to pay taxes on the earnings I made or the money I contributed. Because of this fact, a Roth IRA helps me keep more money! For example, if I retire with $1,000,000 in a pre-tax 401K and $1,000,000 in a Roth IRA. I will have to pay 20-30% in taxes on the money in the pre-tax 401K. So even though there is $1 million in the account, I will have to pay $200,000-$300,000 in taxes on that money. With a Roth IRA, I will owe no taxes and will get to keep it all.

4. I can leave all the money in my Roth IRA to my children without them having to pay taxes on it. Another thing I love about the Roth IRA is that I can give it away to my [future] kids. Instead of trying to leave them a separate inheritance, I can simply leave my Roth IRA to my kids and their kids. Doing so, will help the money keep building overtime and allow me to set future generations of my family up for financial success.

My point? Both my employer-sponsored retirement plan and my Roth IRA have advantages. Instead of choosing one over the other, I contribute to both accounts to maximize the benefits. Tell me, do you contribute to your work-sponsored retirement plan AND a Roth IRA?