In the index funds vs target date funds choice, Green State Credit Union usually favors a few index funds for teachers who hold both a 403(b) and a Roth IRA. Many teachers assume a fund switch inside a 403(b) or 457(b) triggers tax. It doesn't, because exchanges inside the plan aren't taxable.
The real gains come from lower fund costs and from holding bonds in pretax accounts and stocks in Roth accounts. Most teachers start asking about this in late fall, when open enrollment materials arrive, or in January, when the year-end statement shows what the fund actually cost.
Green State Credit Union wrote this for teachers and public-school employees with a state pension. It walks through six steps, with a cost table on a hypothetical balance, and says plainly when a single target date fund is the better tool.
By Michael Donovan, AIF — Chief Investment Officer | Reviewed by David Okonkwo, ChFCMichael leads the investment committee, setting strategic asset allocation guidelines and reviewing manager performance quarterly.
Teachers often judge a 2035 fund by its name. Read the glide path; the stock share at 2035 can differ a lot between providers.
Senior Financial Planner, Green State Credit Union
Moving bonds into the pretax account and stocks into the Roth is the one fund change that saves tax rather than shifting it.
CPA and Tax Director, Green State Credit Union
Step 1: pull the six numbers that settle this
Six items decide most of this choice, and each sits in a document you already have. Pull the fund fact sheet from your plan website, your enrollment confirmation or a quarterly statement, year-end statements for every Roth and pretax account, the beneficiary page, and your state retirement system's pension estimate.
Two rows decide most of the answer: Roth accounts and the pension estimate. The expense ratio is easy to see, but those two tell you where stocks and bonds can sit and how much risk the portfolio must carry. The slip at this step is judging the fund by the year in its name. A 2035 label says nothing about the stock share at 2035; read the glide path in the prospectus.
| Item | Why it matters | Where to find it |
|---|---|---|
| Current expense ratio | $405 per year at 0.45% | Fund fact sheet |
| Stock share at target year | Sets risk during withdrawals | Fund prospectus glide path |
| Default or chosen fund | Defaults ignore your pension | Enrollment confirmation, statement |
| Roth and pretax accounts | Lets bonds and stocks split | Year-end statements |
| Beneficiary on file | Heirs face ten-year window | Plan website beneficiary page |
| Monthly pension estimate | Decides stock share | State retirement system estimate |
Step 2: what does the cost gap mean on a $90,000 457(b)?
On a $90,000 457(b), a 2035 target date fund at 0.45 percent costs $405 per year, while three index funds at 0.08 percent cost $72. The gap is $333 per year, or $3,330 over ten years before any growth. A modest balance still shows the rule.
Agnieszka (hypothetical), 58, is a district payroll specialist with exactly that account, roughly half in bonds. Her husband Kenji, 61, is a high-school band director with a state pension. The math: $90,000 × 0.45% = $405. $90,000 × 0.08% = $72. $405 − $72 = $333. The exchange inside the 457(b) creates no tax. To run your own numbers, enter your balance and both expense ratios in our calculator.
Kenji's pension covers their basic bills, so the couple can hold a bond index fund in the 457(b) and keep stocks in their $40,000 of Roth IRAs, where qualified withdrawals are tax-free. A target date fund can't do that split.
The rule of thumb: if the cost gap is at least 0.25 percentage points and the balance tops $50,000 (a gap of $125 per year or more), or you also own a Roth account, compare the index mix. Below that, with one account, the target date fund's simplicity usually wins.
Take a second household. A hypothetical 58-year-old colleague has $70,000 in one 403(b), no Roth and no wish to rebalance once a year. Her gap is $259 per year ($70,000 × 0.37 percent). She's reasonably served by the target date fund, because there's nothing to place in a different account.
Before Green State Credit Union suggests moving a 457(b) out of a target date fund, it lists every account the couple owns and decides which one should carry the bonds. Fund choice follows long-term research on cost and diversification, not a guess about next year's market. Any of these funds can lose value, including money you put in.
The arithmetic
Two households, two answers
Rule: if the fund costs at least 0.25 points more and your balance is above $50,000, or you own a Roth account, compare an index mix. Otherwise keep the target date fund.
| Option | Expense ratio | Cost per year | Ten years, no growth | Accounts it can split |
|---|---|---|---|---|
| Target date fund 2035 | 0.45% | $405 | $4,050 | No, same mix everywhere |
| Three index funds | 0.08% | $72 | $720 | Yes, bonds and stocks apart |
| Gap | 0.37% | $333 | $3,330 | Index mix only |
| Colleague, $70,000 gap | 0.37% | $259 | $2,590 | Not needed with one account |
Step 3: how much stock can a pension household carry?
Target date funds often hold somewhere near half in stocks at the target year, though paths vary, so check the fund sheet. If Kenji's pension covers about two-thirds of the couple's spending, the portfolio carries less of the load and a higher stock share can fit.
If the pension covers under a third, the fund's own glide path is closer to right. Place yourself by age: withdrawals without the 10 percent penalty start at 59½ (or at separation for a governmental 457(b)), and RMDs start at 73, or 75 for anyone born in 1960 or later.
Step 4: put bonds in the 457(b) and stocks in the Roth
An exchange inside a 403(b) or 457(b) creates no taxable income. The only limit is plan trading rules, which may block buying back into a fund you sold for a set number of days. Ask the plan before a round trip.
A target date fund holds the same stock and bond mix in every account. Separate index funds let you hold a bond index in the pretax 457(b) and stocks in the Roth IRA, where qualified withdrawals are tax-free. That placement is a real saving. The lower fee is a saving too: every dollar not paid in fees stays invested. Keep in mind that a larger pretax balance also means larger taxable withdrawals later.
Every 403(b) or 457(b) withdrawal counts as ordinary income. Medicare sets IRMAA using MAGI from two years earlier. If RMDs at 73 or 75 push joint MAGI past $218,000, the Part B premium rises two years later. Under the IRMAA brackets for 2026, the step is from $202.90 to $284.10 per month, based on 2024 MAGI.
Held in a taxable brokerage account, a target date fund can also pay out capital gains when it rebalances internally, reported on Form 1099-DIV. Broad index funds usually pay out fewer.
What saves tax and what only moves it
Thresholds a bigger pretax balance can touch
Step 5: the exchange form, the beneficiary page and Agnieszka's side
A change that redirects only future contributions leaves the existing $90,000 in the target date fund, still costing $333 per year more. Undoing it takes a separate exchange request for the current balance, and possibly a waiting period under the plan's trading rules.
If Kenji picks a pension option without a survivor benefit, his pension stops at his death and Agnieszka leans harder on these accounts. That argues for a steadier bond share. Most non-spouse heirs, such as adult children, must empty an inherited 457(b) or IRA within ten years, so the pretax balance arrives as taxable income in their working years.
Bring these questions to the plan administrator, your CPA or an advisor:
The paperwork slip
Spouse and heirs
- Does the plan limit buying back into a fund I just sold?
- Which index funds cover US stocks, international stocks and bonds?
- Was my target date fund the plan default?
- Who is the contingent beneficiary on file?
- CPA: would Roth contributions now change our bracket later?
Questions about index funds vs target date funds
Isn't a target date fund already diversified enough that three index funds are just extra work?
A target date fund is diversified, and for one account it's often the right call. Index funds add value only when you hold several accounts, since they let you place bonds in pretax and stocks in Roth. With one account and no yearly rebalancing, the extra work isn't worth it.
If my husband dies first, will I be left managing index funds I never picked?
Possibly, which is why simplicity matters. Check whether his pension option has a survivor benefit, since that decides how much the accounts must carry. A written one-page plan listing each fund and its purpose helps, and you can always consolidate into a target date fund later.
What happens if I switch my 457(b) to index funds and later want a target date fund back after a bad market year?
You can exchange back, and the exchange itself isn't taxable inside the plan. The plan's trading rules may block buying a fund you recently sold for a set number of days. Selling after a drop locks in the loss, so ask the plan about waiting periods first.
Does a target date fund in my taxable brokerage account cost me more in taxes than the same fund in my 403(b)?
Often yes. Inside a 403(b), internal rebalancing creates no tax. In a taxable account, the fund can distribute capital gains that appear on Form 1099-DIV and are taxed that year. Broad index funds usually distribute fewer gains, so they tend to suit taxable accounts better.
Step 6: test your fund menu with Green State Credit Union
Green State Credit Union advisors look at the 403(b), the 457(b), the Roth IRAs and the pension estimate side by side before suggesting any fund change. Before we start, we put the cost in writing so you can see it. The request form is the way to set up an intro call. If your menu lacks low-cost index funds or you won't rebalance yearly, a target date fund is usually the better tool. This page doesn't cover surrender charges on 403(b) annuity contracts.
A lower fee alone only shifts tax; placing bonds in the pretax account and stocks in the Roth is what actually saves it.
Where the rules come from
This is general information, not personalized investment, tax, or legal advice. Investing involves risk, including loss of principal. Before making decisions about your retirement or investments, consult a qualified professional about your own circumstances.