Why You Might Not Contribute to a 403(b)/401(k) When Nearing Retirement

BY Paul Solman  November 28, 2012 at 10:38 AM EST


Photo by Peter Gridley via Getty Images.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Wednesday’s query:

Jim Narloch: If close to retirement age (65), which is better? I Bond or 403(b)?

Paul Solman: Oh, Jim, questions like yours are both deeply worrisome and deeply gratifying. Why worrisome? Because asking about the choice between investing in an I (Savings) Bond as opposed to a 403(b) [or 401(k) is like asking which I prefer: Tom Brady or professional football? To put it in terms of the clichéd fruit analogy: one apple versus an orange orchard.

Why gratifying? Because questions like yours keep retirement at bay for compulsive explainers like me. And in this case, your question allows me to make two points.

An I Bond is a specific investment, a loan to the U.S. government that you can take back at any time after six months, though there's a slight interest penalty if you redeem it within five years.

A 403(b), by contrast, is simply a way to invest in which taxes on any earnings are deferred until you cash in the investment.

First point: As Boston University finance professor Zvi Bodie explained here not long ago, I Bonds are an attractive investment if you're willing to hold them for six months.

The second point concerns whether or not to put more money into a 403(b) or 401(k) account as your near retirement. The answer is that it all depends on your tax bracket today compared to what it will be when you withdraw money from the account. Taxes on a such accounts are deferred, not forgotten. You must pay money on the income, including its tax-deferred growth, eventually. Typically, investors put money into tax-deferred accounts in order to shelter the returns when they are in a higher tax bracket, assuming their tax bracket will be lower when they retire, stop earning and begin to withdraw the money.

But suppose tax rates go up? Suppose you will be paying a higher tax rate when you retire? Suppose you saved enough, tax-deferred, so that you earn as much in retirement from these investments (plus Social Security, let's say) as you earned when you were working? Something to think about.

This entry is cross-posted on the Rundown -- NewsHour's blog of news and insight.