Advice for a high school teacher: open a 457 or a second Roth IRA?

[fundyswm]

Hello!

I suppose my situation isn't that complicated, but it is somewhat unique because of my future pension as a teacher. My question is whether I should open up a second Vanguard Roth IRA (for my wife) or open up a 457 account.

Relevant personal information:

- I am 27 and my wife is 26. We are both high school teachers in the Midwest.

- Our annual pre-tax income is currently around $100k.

- We file taxes jointly

- No kids (will probably have one in 2-3 years)

Relevant financial information:

- We are forced to pay into our state's teacher pension plan, which is known as one of the best in the Midwest. Our school district takes out 14.5% of our monthly pre-tax income and matches it and that goes into our state's teacher pension fund. The plan's eligibility requirements are basically set for teachers to be eligible for retirement between the ages of 52-54. If my wife and I have perfect lives and never quit teaching, we are on pace to retire at 53 and 52, respectively. Once we retire, our monthly benefit amount is roughly 80% of the average of our highest three paying years. For example, if I made $60k each of my last three years and those were my highest-paid years, my annual retirement benefit would be $48k per year. That would obviously also be taxed at income tax rates at that time. Remember, my wife and I are both in this system, so we would get an annual total of $96k pre-tax in the above example. A lot of retiring teachers don't realize this benefit will be subject to income tax, so many have to continue working after teacher retirement. This has led me to seek out supplemental investing options.

- We are currently renting an apartment and plan on doing so for another few years.

- We have $21k in ally savings accounts ($10k for emergency fund, $9k for future down payment on a house, $2k in general savings). We are currently contributing about $1,200 a month total towards these accounts.

- I currently have $5k in a Vanguard Roth IRA in my name that is all invested in the 2055 Target Retirement fund. I am contributing $400 a month to my Roth, so not exactly maxing it out just yet. I'll be able to start maxing out my contributions sometime next year.

- We are paying $1,000 a month towards our student loans. Thanks to teacher loan forgiveness, we should be student debt free in 2.5 years.

- We are forced to have the health insurance our district provides, which is very much not a HDHP, so an HSA is not possible. It's not great insurance, but the district pays our premiums and we're pretty healthy, so it's fine for our needs.

Back to the main issue:

I want another retirement/investing account additionally to my current Roth IRA. Because of our pension program, my wife and I will retire around the age of 53. Obviously I won't be able to withdraw anything from my Roth IRA without penalty until I'm 59 1/2. This makes me want to have another investment account that I will be able to pull from as soon as we retire.

The companies that our school district suggests for retirement accounts all have 403(b) options and some have 457 plans. I have done a lot of (internet) research and have come to the conclusion that 403(b) plans seem to be.... bad for the most part? This has caused me to focus in on a 457. Another advantage of 457 would be that it would lower my taxable income with pre-tax contributions, which would diversify my investing accounts with one being Traditional (457) and one being Roth (Vanguard Roth IRA). I have only received fund information for a few of the companies that offer 457's through the district. These companies I have information on tend to offer funds with expense ratios around 1.1-1.4% (not great). A couple of them offer a single Vanguard fund, Vanguard Windsor II Fund Investor Shares (VWNFX), which has an expense ratio of 0.33%.

So given my information and what I'm looking for, which of the following accounts would you guys suggest to supplement my teacher pension and Roth IRA?

- 457

- Open a second Roth IRA (under wife's name)

- Taxable investment account

- 403(b)

Thanks for any advice!!

[MDM]

fundyswm, welcome to the forum, and congratulations for thinking about these things while still in your 20s.

- Our annual pre-tax income is currently around $100k.
Our school district takes out 14.5% of our monthly pre-tax income....

I'll assume that means your combined W-2 box 1 amount is $85.5K.  With no other significant income, your marginal tax rate for traditional contributions is 12%.

Once we retire, our monthly benefit amount is roughly 80% of the average of our highest three paying years.

You do not get a higher monthly benefit amount if you delay pension start, correct?

Obviously I won't be able to withdraw anything from my Roth IRA without penalty until I'm 59 1/2.

Not true.  Your Roth contributions may be withdrawn tax and penalty free at any time.

...403(b) plans seem to be.... bad for the most part?

Unfortunately true.  They don't have to be bad, but too many school admins, boards, and unions are unwilling to provide good ones.

This has caused me to focus in on a 457.

A governmental 457 (which, assuming you work for a public school district, it would be) can be preferable to a 403b, due to no penalty on 457 withdrawals at any age (after your retire from the 457 employer).  But districts with poor 403b plans sometimes don't have any better 457 options.

You really need to look at all the fund options in the 403b and 457 plans.  Sometimes there are 1 or 2 good ones among a plethora of poor ones.

Is there a Roth option for either the 403b or 457?

Thanks for any advice!!

If your marginal rate in retirement will be 12% or higher, using 100% Roth while you are paying 12% now is good, particularly if you contribute the maximum to the Roth accounts.

If you find that your income rises (or tax law changes) such that you would have some income taxed at 22% or more, contributing enough to traditional to get you back to the 12% (or 15%, etc.) bracket might be good.

See Investment Order and the links therein for more.

[DavidAnnArbor]

MDM provided you with a wealth of information.

Feel free to post the mutual index funds that are available in the 403b and 457plan as well as the expense ratios.

Ideally you would be able to contribute to all 3 plans, the 403b, the 457, and the IRA's.

[JSMustachian]

I would ask yourself if you want to keep working until your early 50's? Since you found MMM and this board so early you could retire in your 40's if you wanted so I would not let the pensions chain you down. They will still provide some benefit with an early retirement.

I would start building up your pre-tax retirement accounts. One day you will eventually be able to max both a 403b and 457b as many do on this forum so I would start with whichever has the best funds and lowest fees.

Research a popular strategy called "Roth conversion ladder" which will fund an early retirement before 59.5 without penalties.


I also think it would be beneficial for you to check out Root of Goods blog on taxes. His family used the same options available to you to essentially pay no tax on his income. This will help you maximize the retirement accounts.

[beltim]

This looks to me to be one of the edge cases where the optimal decision rests on a few important factors.  In no particular order:

- Are you covered by Social Security?  Most teachers with that generous a pension plan aren't, but some are, and it's an important consideration.  If so, this would sway the decision towards Roth investment vehicles.
- Is your 100k income before or after the 14.5% pension contribution?  If before, you essentially have 85k income now and plan on 96k in retirement.  This would sway the decision towards Roth investment vehicles.
- As JSM indicated, if you don't want to keep working until your max pension, that would sway the decision towards traditional investments.  The 457 would be particularly valuable in this case because you can withdraw 457 money penalty-free when you retire before age 59.5.  Then there probably wouldn't even be a need for Roth conversions.
- What is the future of tax rates?  They're near historic lows now - it's hard to imagine they won't increase in the next 50-60 years.
- Will you have children in the coming years?  Some combination of tax credits, deductions, childcare expenses, or reduced income could push your family into lower marginal rates at that point, possibly temporarily.  This would move the needle towards a 457 now, and a Roth at that point.

In general, I would probably go for the Roth here, as MDM suggests - locking in a 12% tax rate is pretty attractive.