Early withdrawal penalties may have scared people off from investing in the right place! If you’re investing in a non-retirement account and your retirement accounts aren’t completely maxed out, you’re probably throwing away thousands of dollars!
All we need is 403(b)!
If you’re a minister, you can invest in a retirement account through a 403(b). A 403(b) is a tax-sheltered annuity, which means you put money in before it gets taxed and it’s sheltered from taxes while it grows. Clergy members also have a benefit of being able to withdraw from a 403(b) tax-free for housing expenses after retirement!
A 403(b) does an amazing job of lowering your taxable income (therefore lowering your taxes) and helping you save for retirement. In 2015 and 2016, you can put up to $18,000/yr into your 403(b). Pastors over 50 may also contribute an extra $6,000/yr as a catch-up contribution!
How much should I put away for retirement?
Retirement and finance gurus like Dave Ramsey tell us to invest 15% for retirement.
If you’re a pastor, it’s likely 15% of your income won’t come anywhere close to maxing out your 403(b). And don’t forget, you can also use an IRA to reduce your taxable income and save up to $5,500/yr per spouse.
Let’s pretend you’re under 50, married, and make $100,000/yr as a pastor (Hah!). If you put away 15% ($15,000) toward retirement, you still have $14,000 in potential 403(b) and IRA limits that you could be sheltering.
After I’ve funded my retirement, where do I invest?
After you’re done putting 15% of your income into retirement accounts, where should you invest?
Most people will open up a non-retirement investment account at Charles Schwab, Vanguard, T. Rowe Price, or Fidelity (BTW, these are the ONLY four places I would consider).
But why? Why would you invest in a non-retirement investment account when there’s plenty more room to invest in your retirement accounts? Three little words: Early Withdrawal Penalties.
Everyone will tell you that you need to invest in non-retirement investment accounts because:
- Non-retirement account withdrawals are taxed at only 15% (capital gains taxes)!
- Retirement account withdrawals are taxed at your marginal tax rate (25% for most pastors)!
- Retirement accounts are additionally subject to 10% early withdrawal penalties!
So it seems like it would make sense. If you want to grow your investments, withdraw them, and not have them subject to higher taxes and penalties, you should invest in a non-retirement investment account. Right? Wrong.
When I did the math, it blew my mind!
It turns out that the benefit of being able to put more money into a retirement account (remember, it’s pre-tax) completely outweighs the benefits of investing in a non-retirement account.
NOTE: I AM NOT suggesting that you pillage your retirement account! I’m simply saying that if you have more room in your retirement account, it can make you thousands of extra dollars over investing in non-retirement accounts. AND it can lower your taxes!
Look at the comparison chart I put together. This chart assumes a one-time investment and marginal tax rate of 25%. It also assumes a 10% return on investment each year for math convenience.
The same money will buy you $10,000 of investments in a 403(b) OR $7,500 in a non-retirement account. This is because you have to pay $2,500 in taxes on the $10,000 before you invest in a non-sheltered account.
Being able to invest a higher dollar figure into your 403(b) makes the higher tax and early withdrawal penalties completely irrelevant. Even if you take an early withdrawal again and again and again, it still makes more sense to start with the higher initial investment that can be made pre-tax.
What I’m saying is this: If you have not maxed out your 403(b) AND your IRA limits, you’re throwing money away by investing in a non-retirement account.