My wife works for a governmental agency with a 403(b) plan, which has no match. Is it better to contribute to this plan or invest outside of the plan? She plans to retire at 56, and will not be eligible to access the 403(b) contributions for 3 1/2 years after retirement without incurring a tax penalty. We are in the top tax bracket now, but expect to be in a lower tax bracket by the time she retires.
So, should she invest in a 403(b) plan without a match?
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If you're going to be in a lower tax bracket in retirement -- and most people will be -- then it makes sense to take full advantage of any plan that gives you an upfront deduction, whether or not you're getting a match.
If you're in the top federal tax bracket, every dollar your wife contributes reduces your taxes by nearly 40 cents. When she pulls the money out in retirement, she'll pay taxes on the withdrawal at your future, lower rate. That's a pretty sweet deal. The steeper the drop between your current tax bracket and your future one, the better the deal.
Investing outside of a retirement account won't reduce your current taxes and could increase your bill if your investments produce interest or dividend income. At the same time, you could qualify for low capital gains tax rates for investments held longer than a year. So setting up a taxable brokerage account may be a good option if you want to save more after your wife maxes out her 403(b) contributions.
You shouldn't worry too much about penalties, either. Withdrawals from retirement accounts before age 59 1/2 typically incur a 10 percent federal penalty, but there are a few exceptions to that rule. One of them is if the withdrawals are made from a qualified retirement plan other than an IRA, the employee is "separated from service" (which means fired, quit, laid off or retired) and the separation occurred in or after the year the employee turned age 55, says Mark Luscombe, principal federal tax analyst for tax research firm CCH. Since the plan in question is a qualified plan and your wife will be retiring after age 55, she should be able to dodge the penalty if she needs to tap this money.
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