A few weeks back, in response to my How Much Does a Teacher Need to Retire post, reader Matt asked a question on Facebook: “What would be your order of operations for teachers/educators?”
It’s a great question. My initial response was that options and fees vary so much for everyone that it’s impossible to create a general order. That’s mostly true – and why I outline process thinking like 403b vs 457b: Which Should I Choose?
Yet, it’s ultimately an unsatisfying answer – and not all that helpful. I strive to do better for you. So, today I’ll share my investing order and why I make each choice. Don’t use this as a straightforward rule for all educators, but hopefully my thinking helps inform yours.
When choosing how to invest available cash, it’s important to look at several factors. Let’s quickly outline these because they will impact your own choices.
The first, and most obvious is whether the option is even available to you. Educators do not have universally common investing options. It’s a strange landscape out there.
We all have access to Individual Retirement Accounts (IRA.)
Most educators have a 403b. Most have a pension – but the benefits may vary.
Some have a 457b plan. Some have access to a Health Savings Account (HSA.) Many don’t.
Obviously, you can only factor something into your planning if you actually have access to it. Review your contract or check with your district HR as first steps.
Fees / Investing Choices
Even if you have an investing option available, you may not want to use it. Sometimes there are no good investing options and/or the fees are way too high.
I’m primarily an index fund investor. I prefer to have a broad market index option available.
I am also very fee conscious. There is no hard and fast rule, but you have to pay attention to fees to make your best investing decision.
As one example – if you only have annuity products with 3% plus fees, you may choose to invest in a taxable account over a tax advantage account. I certainly would.
How accessible is the money once you’ve invested it? Depending on your goals, circumstances, and timelines you may be willing to lock your money up for longer periods of time. Or, you may prioritize investing in something that is more easily accessible. This matters, too.
All of these factors play off each other in different ways based on your options. I’ll refer to each in my example below.
For the examples below, I’m assuming the fees and investment options in each are all relatively comparable. I’m fortunate that in my case, that is true. I have index fund options in both my 403b and 457b. The fees are close enough that I don’t need to factor them into my decision making.
I am fortunate that all of these options are available to both my wife and I, with the exception of an HSA. I have access to an HSA, and she does not.
We are within three years of our FI target date, but more than 10 years from being able to access our pensions. Flexibility matters some in our choices.
Your assumptions will be different and may lead you to different conclusions.
Educator Investing Order of Operations
As you grow the gap between what you earn and what you spend, you’ll have extra money available. At first, this may be a small amount. It’s okay to start small and build over time!
Don’t forget to check the 2020 contribution limits for 403b, 457b, HSA, and IRA.
Here is how I prioritize my own savings / investing.
– Emergency Fund
The first thing I prioritize is my emergency fund. It’s important to have enough money set aside that an unexpected event won’t derail all your financial progress. I keep six months critical expenses (those that I need to survive) in an emergency fund.
I’d recently been planning to draw this back to three months. The pandemic has taught me that six is the right amount for us. I recently heard Paula Pant of Afford Anything add “and your total out-of-pocket healthcare costs for one year” to this. That’s a good recommendation.
If you want to build your emergency fund while starting to invest a small amount at the same time, go for it. But, prioritize the emergency fund. Trust me, you’ll thank yourself later when something does happen.
– Employer Match
In investing advice for non-educators you’ll often see “get that 401k match!” as the first step. The 403b is the educator version of the 401k. Not many school districts provide a match to the 403b. I’ve always discounted it as an option.
Yet, I asked on Twitter and it turns out some educators do have a matching investment for their 403b! For example, if they put away 5% of their salary into a 403b, the district will match that amount. This is great!
If your employer offers a 403b match, invest enough to get the full match. That’s an instant return that you can’t pass up. It’s not common, but take advantage if you can.
I don’t have a 403b match, so my first priority (after my emergency fund) is the HSA, for several reasons:
Healthcare in the United States is one of our major financial drivers. We are virtually forced to prioritize it in our savings. If a qualifying plan works for your situation, an HSA is a great option.
The HSA has triple-tax-advantaged status. This makes it the most tax-efficient investment possible and allows a fair amount of flexibility.
The annual cap for the HSA is relatively small and it’s easy to “fill” this bucket and move on to the next.
After I cap my annual HSA contributions, I move on to my 457b plan. If you have access to a governmental 457b plan AND it has reasonable options and fees it is the most flexible retirement account for educators.
Contributions to a 457b are pre-tax. This lowers your initial tax burden. Your investments grow tax free. You’ll pay tax when you withdraw the money as if it were ordinary income. These things are all true for 401k, 403b, and traditional IRA.
457b has one advantage over these – you can withdraw money from your 457b, without penalty, upon separation from an employer. This is great for potential early retirees. Also, if you ever switch employers you can bridge the time or move your money to a better product.
That ease of potential early access makes it my first choice among retirement accounts.
3. IRA (Individualized Retirement Account)
After my 457b, I prioritize annual IRA contributions. This is only a slight preference over a 403b. I could see choosing a 403b here because of the ease of setting up a payroll withdrawal and letting it take care of itself.
However, I slightly prefer the IRA because it is not employer dependent. You can choose your brokerage and product. Your options are not limited by whatever your employer or plan provider offers. I hold REITs in my IRA because they are not available in my 457b or 403b.
If I had horrible fees in my 457/403b I’d choose the IRA first. I hold my IRA with Vanguard. It’s an easy set-up. The same is true for Fidelity.
With an IRA you have two options:
I choose to invest in a Roth IRA. In this option, you pay taxes on the money before it goes in, but not upon withdrawal. With a Roth you can also withdraw your contributions tax free at any time.
I chose to contribute to a Roth IRA to give me flexibility later. I can access the contributions if desperately needed, or use the Roth later to help maximize my withdrawal tax strategy in retirement.
If you prefer to take your tax advantages on the front end, you can contribute to a traditional IRA. Like the 457b and 403b you contribute tax free and pay taxes only upon withdrawal.
You can’t go wrong with either option. I prefer the flexibility of Roth.
The 403b is a perfectly fine option. It may even be your first choice and you wouldn’t be wrong (assuming you have something besides fee bloated annuity options).
It falls lower on my investment order simply because I get the same tax benefits, with more flexibility, from my 457b. I fund the Roth IRA first because of the wider variety of options.
5. Taxable Brokerage Account
After I’ve filled all my tax-advantaged buckets above, then I invest in my taxable brokerage account. This is just an account with a brokerage (again, I prefer Vanguard or Fidelity) and you can choose whatever investments are available.
The advantage of investments in a taxable brokerage is the ability to withdraw your money whenever you want AND you’ll pay a lower capital gains tax rate. Of course, you’ve already paid tax on the income before you invest into the brokerage.
Unlike the 457b and 403b which have limited investing options based on employer selection, you can invest in virtually anything in your brokerage account.
If I didn’t have a solid 457b option, I’d have slightly more preference for the taxable account to ensure I had some accessible investments should I choose to retire early. In my case, the 457b gives me that option with additional tax advantages.
I’m fortunate to be in a place now where we can fill up our tax advantaged buckets and still have some for a taxable account. That wasn’t the case for most of our careers, so our taxable accounts are still relatively small – but growing.
Summary – Educator Investing Order of Operations
There you have it – a quick summary of my educator investing order of operations. Your circumstances differ, so your order may be different. I’ve shared my thinking only to help inform yours. Feel free to comment, question, or argue with my reasoning in the comments below or by emailing me.
In summary, my educator investing order is:
|*||403b Match||Instant return|
|1.||HSA||Triple tax advantaged|
Health care is a priority
Accessible upon separation from employer
|3.||Roth IRA||Tax advantaged|
Flexible withdrawal options
|5.||Brokerage Account||Flexible access|
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