Before EGTRRA (Economic Growth and Tax Relief Reconciliation Act), it was possible for me to fully fund both my Roth IRA and my 403(b). EGTRRA changed all that. With the higher contribution limits and expanded options, beginning in 2002 I must make a choice about which one should be the primary focus of my retirement investment dollars. Can you give me some guidelines as to which one is better?

--Shana N., Las Vegas

Bob: Well Shana, the Economic Growth and Tax Relief Reconciliation Act of 2001 makes it very important for educators in your boat to become familiar with the concept of marginal tax rate (MTR).

Brad: You must compute your current marginal tax rate and then forecast, as best as possible, your marginal tax rate in retirement. Why? Because the smart frog knows that the main difference between 403(b) plans (and 401 and 457 plans, too) and Roth IRAs is that contributions to the former are made with pre-tax dollars while the latter are funded by after-tax dollars.

Bob: So a prime consideration for educator investors is whether to pay the taxes now and then invest in the Roth IRA, where the eventual withdrawals will be tax free. The other choice is to defer the taxes by investing in the 403(b) and then pay them when the contributions and their earnings are withdrawn in retirement. The only way to make this decision is to consider your current and future MTR. If your future MTR will be lower, then the 403(b) is the plan for you. If your future MTR is going to be higher, then the Roth should be your primary retirement investment plan.

Brad: So what exactly is your MTR? It depends on what tax rate bracket you are in. There currently are six brackets for all taxpayers with taxable income. These brackets vary depending on your filing status. The predicted income brackets and their marginal tax rates for the two most common filing categories for 2002 are shown in the box below.

Bob: EGTRRA phases in reductions in these marginal tax rates so that the current 27 percent bracket eventually becomes 25 percent, the 30 percent becomes 28 percent, and the former 39.1 percent bracket becomes 35 percent. But this doesn't guarantee that you will be in a lower MTR in retirement as is so commonly assumed. In fact, we can envision several highly probable scenarios whereby today's educators could easily be in a higher MTR in their retirement years. For example, an educator just starting out may be in the lowest MTR of his or her life if there are lots of step increases between now and retirement. Retirement pay alone could be considerably more than an educator makes starting out.

Brad: It is also important to consider how much your investment is going to grow. The annual contributions to a 403(b) plan can be as high as $20,000 per year starting in 2006, if you are over age 50 ($15,000 if you are under 50). So when you go to withdraw those 403(b) plan dollars, they will be income added to your retirement pay, which could easily move you to a higher tax bracket rate. This is especially true if you need a big withdrawal to meet a financial emergency.

Bob: Many teachers wrongly assume they will be in a lower tax bracket in retirement simply because their retirement pay will be less than their working pay. But your tax bracket is not solely determined by the size of the check you receive. Remember, your taxes are determined by your adjusted gross income minus your tax deductions. And a lot of those deductions are gone by retirement. Mortgages are paid off; the dependents are, one hopes, no longer dependent; and those job-related deductible expenses no longer can be taken.

Brad: Under the above scenarios, it would be a whole lot better to be able to make withdrawals of whatever size is necessary from a Roth IRA and not have the withdrawal affect your tax situation by one cent, assuming current laws are maintained.