Cutting Back on Our 403b Plan for More High Paying Dividend Stocks



high paying dividend stocksThis 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.

high paying dividend stocks

403b Mutual Fund Example – S&P 500 Index Fund Returns

high paying dividend stocks, 403b plan

Vanguard Mutual Fund Example – S&P 500 Index Fund Returns

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?

  

Related Posts:

1) My Money Design for Achieving Financial Freedom – November 2012 Update

2) Will Dividend Stocks Help Me Retire Early?

3) Using the Dogs of the Dow to Buy the Best Dividend Paying Stocks

Photo credit: Out of Chicago / Foter / CC BY-NC-SA

Comments

  1. says

    I actually really like this plan.

    You have the same issue that I have in that you have plenty of years remaining prior to retirement and you want to have access to your money rather than have it locked away from you.

    That’s the problem with retirement schemes, it is designed for those of us less financially savvy than the average personal finance blogger.
    Glen @ Monster Piggy Bank recently posted..Buying Land and Building a House – Part 4My Profile

    • MMD says

      That has been a challenge I’ve been trying to solve for years – how to reasonably grow my money so I can access to it without locking it away. I’m thinking your blogging efforts might help you out here. Generate enough side cash and now we’re talking!

      Funny thing about retirement accounts – they assume you’ll be “poorer” during retirement. For example, with the exception of a Roth, most accounts cut taxes now and delay them until later when you’re supposedly in a “lower” tax bracket. But you qualify for being in a lower tax bracket by making less income. So by design, they assume we’ll be poor??

    • MMD says

      Good points John. In a pinch, I could liquidate this money very quickly. Hopefully if the tax cuts don’t expire, I will pay a lower percentage in taxes also!

  2. says

    If you need more pre traditional retirement age assets then a taxable account is definitely the way to go. I would still contribute to the 403b unless it is absolutely horrid but just not as much in the past. Good thinking, you don’t want to get ready to retire early then realize you have no assets to draw from without incurring a penalty.
    Lance @ Money Life and More recently posted..Massive Cash Back – Blue Cash Everyday® and Preferred® by American ExpressMy Profile

    • MMD says

      I realized a long time ago that saving for retirement was great but there was going to be a giant “do not go pass Go” sign until I got to age 59-1/2. We will definitely keep contributing to the 403b and get some tax advantage, but not quite as much as I was doing before. Between our 401k and other accounts, I think its time we merely shift some weight from the left foot to the right foot (i.e. post 59-1/2 accounts to pre 59-1/2 accounts).

  3. says

    I actually like that idea for you because you will invest the money. For the average person who doesn’t pay that much attention, the automatic plan might be the only way to get them to save. If I remember correctly, your wife is a teacher? My husband also teaches and we stopped his 403B contributions last year. He also has a PERA 401K that is better. Not sure why they have both, but the 403B had abysmal returns, fees, and choices. We are choosing to put more in real estate at this time, but for the same reason as you. We don’t want to work until retirement age and need some way to have income until then.
    Kim@Eyesonthdollar recently posted..Reasons to Love Your Used CarMy Profile

    • MMD says

      Thanks Kim. Yes, you remember correctly – my wife is a teacher. It seems we have made similar observations about the 403b performance (or rather lack thereof), and are building our “pre age 59-1/2″ options using different routes. What is a PERA 401K?

  4. says

    Honestly it depends on a great number of factors. Do you have a Roth IRA, does your 403B receive a match? ect… I am a big fan of only contributing up to a company match. If you do not receive a match then it might make sense to use a Roth IRA.
    Since you want to retire at a younger age it makes sense to have outside accounts. But it’s best to have more money than you think you need to retire.
    Justin@TheFrugalPath recently posted..Stockpile Smart: Hoarding Isn’t SavingMy Profile

    • MMD says

      We both have Roth IRA’s that are maxed each year. The 403b does not get a match, which is one of the reasons I don’t mind going with a strategy like this. I’m also a big believer in saving more than you think. All my retirement models assume lower return figures so that I purposely have to save more in order to compensate.

  5. says

    Certainly if you have goals that require access to a portion of your money prior to age 59 1/2 then it makes sense to fund those goals outside of the 403(b) plan. If I am understanding your example correctly your wife has an unbelievably expensive 403(b) plan, I’d guess that there is some sort of group annuity involved. While I like dividend paying stocks, I don’t look at them as a diversified portfolio unto themselves. As with any investment, I would be hesitant to ascribe any sort of past performance to the future. There is risk in taking that path exclusively just as with any other tightly concentrated strategy.
    Roger @ The Chicago Financial Planner recently posted..4 Retirement Savings Steps to Take NowMy Profile

    • MMD says

      Thanks for sharing Roger and welcome to the site. Yes, access to our savings early is going to be important to our overall plan. I don’t really want to liquidate our Roth IRA’s, nor do I want to take out a 72T from our 401K with such a low return rate. So if I must choose one place to look for diverting funds into taxable but accessible accounts, it’s the one with the high fees and non-stellar performance = the 403b (which is a group annuity).

      I agree with you that there is risk in any investment. A good portfolio would have a nice round collection of different assets and industries. However, I look to large cap dividend stocks with a just a little more trust than other stocks. My logic is that if you insist on picking stocks, why not go with the companies that have proven themselves to be winners and have enough cash on the books to pay you a cut.

    • MMD says

      P2P is on my 2013 list of things to investigate. It does seem to have some pretty lucrative benefits. And it would be an interesting diversification from the stock market.

      I once read that there are two types of people: Those who give their money away in payments and those who collect the money that the other ones are giving away. I know which side I want to be on!

  6. says

    I am also a fan of dividend stocks especially when enrolled in a DRIP. I like to buy them when the market dips to get the highest possible starting yield. The I just let dividends reinvesting and forget about it for the most part. I just read annual reports and quarterly reports when they are available to check out how the company is doing then I look at the price of the shares to see how the market is treating them.
    Luis Narvaez recently posted..Get Rich Investing: Strategic Asset Allocation for More MoneyMy Profile

    • MMD says

      The DRIP strategy is very appealing, and I would definitely use it if I was very committed to a certain group of stocks. What keeps me away from the DRIP is the notion that it could be a lot of work. For example, I noticed that in some instances you have to buy the stocks directly from the company. This involves a lot of paperwork, setup, and record-keeping. I also hear there are services that will do all this for you if you setup a brokerage account, but they charge fees that cut into the returns. My plan will be a “semi-drip” where I will collect the dividends and re-invest them at the end of each year. Since I plan to potentially change stocks each year, this strategy may work better for my needs.

      • says

        My broker which is TD Ameritrade has free DRIP programs that do not charge any fee besides the $9.99 that they charge when you make your initial investment or when you decide to sell and allow partial shares.

        I like your approach to dividend reinvesting, it is the Buffett approach. He collects dividends from Berkshire’s portfolios and reinvests them when he sees something attractive. Done well it should beat any automatic DRIP strategy out there. Personally I can’t follow this approach because my portfolio is not big enough and trading fees would cut deep into my earnings. That $9.99 buy or sell commission can hurt when my dividends are not big enough. This is why I use the automatic DRIP feature in my account. That way I can reinvest for free until I have a decent portfolio.

        -Luis
        Luis Narvaez recently posted..Investing for Retirement: Finding Reliable Stocks for Your PortfolioMy Profile

        • MMD says

          Ameritrade does this for free? Thanks for the advice. I use Fidelity, but I have never looked to deeply into whether they offer this service or not. I’m hoping my small account grows pretty large here over the next few years. Its just going to take some strong commitment on my part.

          • says

            They are one of the best brokers out there. I also like their commission free ETFs list. For an IRA account this could mean lots of retirement money. A person can do some index investing without paying commissions and DRIP for free. It is perfect for people that cannot save a lot each month and want to dollar cost average into index ETFs. I invested into IVV (S&P 500) for some months then started moved my money to individual dividend stocks.
            Luis Narvaez recently posted..Beat The Market With The Best Investment BooksMy Profile

    • MMD says

      Yes, they do well on the pension (except when they are cutting it), but not so much on the 403b. The real killer is the high fees. You may want to double check your funds to see if you’ve got the same problem. I think a little bit of transition will work well for this strategy and may have better long term implications.

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