This may be financial planning treason, but I’m going to suggest it anyways. We’re considering cutting back on the contributions to our 403b plan in favor of using the money to buy more high paying dividend stocks. Why would this move be controversial? Because it would mean contributing less money to a tax sheltered account and diverting it to one where we would pay taxes. Why in the world would I want to do that?
The Rationale for More High Paying Dividend Stocks:
While I was working on the latest update of my Money Design plan for financial freedom, I noticed a troublesome trend:
• The majority of my savings was going to accounts where I wouldn’t have access to them until after age 59-1/2.
• I was under-funding accounts that I would have access to before age 59-1/2 which would help me to achieve early retirement.
This situation posed a dilemma for me: Would it make sense to divert at least some of the money I was using for our 403b plan contributions to fund more high paying dividend stocks?
If I did so, that would definitely make more money available to me before age 59-1/2 because the dividend paying stocks would be in a taxable account that I could access anytime.
But that would also mean giving up the benefit of not having to pay taxes on the contributions to my wife’s 403b plan. So which is the better choice?
Unimpressed With Our 403b Plan Returns:
For anyone who doesn’t know, a 403b plan is U.S. employer retirement plan that is very similar to a 401k plan where you pick from a group of mutual funds to invest in for the long haul. The difference between a 403b plan and 401k is that a 403b plan is sanctioned for government employees (among a few other small differences).
Over the past 12 years that my wife has contributed to her 403b plan, the performance has been somewhat lackluster. Despite its tax sheltered benefits, there are a few major issues that could make other investment options more appealing:
1) The hidden and administrative fees are very high compared to other commercially available mutual funds such as Vanguard.
2) The long term returns from the non-index funds have made sub-par returns.
3) Her employer makes no contributions to the 403b plan.
However in fairness to the 403b plan, there would be quite a few benefits that should not be ignored:
• The 403b plan is tax sheltered until withdraw
• I’d really be sandbagging the golden years. Between the 401k, IRA’s, pension, and Social Security, the addition of the 403b funds would just be yet another bucket of money to draw from.
• The deductions into the 403b plan are automatic, so it would be hard to cheat the system or use the money for something else.
• The 403b plan does have the option to annuitize the balance, which may provide for a better effective rate over remainder of our lives as opposed to running out of money with a regular account.
Why Dividend Paying Stocks May Be Better:
In terms of an investment, there are a few things which make me think that high paying dividend stocks may be better suited to my needs:
• Whether you invest in stocks or mutual funds in your 403b plan, the market will go up and down, and that will dictate what your investment value will be. BUT with high paying dividend stocks, you are guaranteed at least some small rate of return (usually 3 to 4%). In the bad times, it would be nice to know that you at least get something rather than nothing!
• If you use a strategy like Dogs of the Dow to buy high paying dividend stocks, then you’ll be reducing your risk because you’ll be investing in some of the largest and best ran companies available.
• Expenses would be a lot lower. Say you build a portfolio of $100,000. To just trade up or buy more high paying dividend stocks would cost less than $100 (0.1%). The 403b plan is eating up between 1% and 3% of our returns with expenses would could cost between $1,000 and $3,000.
• For now (Fiscal Cliff pending), income and capital gain from high paying dividend stocks is taxed at a lower rate (about 15%). As has been shown in other posts, your money grows at the same rate no matter if you pay the taxes now or later. So all things considered the same, why not take the lower tax rate?
Stick to the 403b Plan or Buy More Dividend Stocks?
To the average investor, I would probably recommend to stick with the 403b plan on the principals of tax sheltering and trying to find the cheapest, best performing mutual funds.
But for me, my family’s motivation goes beyond financial means. Our desire to achieve financial freedom early and have money available to fund this endeavor makes me lean towards making the switch. Plus the fact that we already have so many other income sources available post age 59-1/2 makes me confident that this plan could work.
Shortly it will be a new year and new start. I believe I will start by lowering at least a portion of our contributions to our 403b plan and automatically having them transfer to our brokerage account for purchasing more dividend paying stocks. We’ll see how this strategy works out and evaluate changing course if need be.
So my financial savvy readers – Between these two options, which one would you choose? Do you define your needs simply in terms of financial, or do you also have goals that take priority in your decisions?