Financial Advice for my Son

Investing

Tax-Deferred Investments

TAX-DEFERRED INVESTMENTS ARE THE BEST OF ALL

If you are in a tax bracket b, and invest $1 in a taxable investment at a growth rate of i for N years, you will have

$ (1 + i(1-b))^N . (Eq. 7)

If you can defer taxes until the end of the N years, you will have

$ 1 + ( (1 + i)^N - 1 ) * (1-b) (Eq. 8)

The following tables show the ratio of the tax-deferred investment to the taxable investment for several cases:

Table 3 Ratio of tax-deferred investment to taxable investment after 10 years

b
i	.28	.35	.39
.05	1.02	1.02	1.02
.10	1.07	1.08	1.09
.15	1.14	1.18	1.19

Table 4 Ratio of tax-deferred investment to taxable investment after 20 years

b
i	.28	.35	.39
.05	1.08	1.09	1.10
.10	1.28	1.34	1.38
.15	1.55	1.71	1.80

Table 5 Ratio of tax-deferred investment to taxable investment after 30 years

b
i	.28	.35	.39
.05	1.17	1.21	1.23
.10	1.60	1.77	1.87
.15	2.21	2.66	2.95

It should now be clear that tax-deferred investments are highly prized creatures.

JPL/CIT has a tax-deferred plan called a "403-b tax-deferred annuity", or TDA, which does not have to be an annuity! You are allowed to put up to around $10,000 / year (minus other tax-deferred money) into such a plan. This is an even better deal than stated above, because your salary is reduced by your contributions, allowing your contributions themselves to be tax-deferred from both federal and state income tax!

In this case, equation 8 becomes

$ (1/(1-b)) * (1 + i)^N * (1-b) = $ (1 + i)^N (Eq. 9)

since for every $1 invested on an after-tax basis you can invest $1 / (1-b) on a before-tax basis.

This situation produces the following tables:

Table 6 Ratio of tax-deferred investment to taxable investment after 10 years where the contribution is tax-deferred

b
i	.28	.35	.39
.05	1.14	1.18	1.21
.10	1.29	1.38	1.43
.15	1.45	1.60	1.69

Table 7 Ratio of tax-deferred investment to taxable investment after 20 years where the contribution is tax-deferred

b
i	.28	.35	.39
.05	1.31	1.40	1.45
.10	1.67	1.91	2.06
.15	2.10	2.55	2.84

Table 8 Ratio of tax-deferred investment to taxable investment after 30 years where the contribution is tax-deferred

b
i	.28	.35	.39
.05	1.50	1.66	1.75
.10	2.17	2.64	2.95
.15	3.05	4.06	4.79

So this is even better than the highly prized plain old tax-deferred investments!

CONCLUSION - PUT ALL THE MONEY YOU CAN INTO THE JPL/CIT 403-B PLAN.

However, note that there are withdrawal restrictions on such money. The 403-b plan is meant as a means to save money toward your retirement. Therefore, withdrawals before your retirement are restricted, and there is a 10% penalty for any withdrawals, just like for an IRA. However, you can still come out ahead even if you have to withdraw your money earlier and pay the 10% penalty for withdrawal before age 59.5. In general, after about 5 years, you are ahead to put the money into the 403-b even if you have to pay the penalty. To get the exact number, multiply the values in Tables 6-8 by 0.90. However, Congress keeps playing with the rules for being able to withdraw your money before retirement. It is therefore probably best NOT to save toward buying a house or a college education through the 403-b.