The best approach is to do both ... use what you dig out of the lower slope as fill behind the retaining wall.

Before you start, look into the zoning and building codes.

A retaining wall that is poorly built can take out your house in a mudslide.

Thanks for the reply. That's an interesting point. I am feeling like my projects are a lot more feasible (once I diagnose my drainage issue).

Before you dig ANYTHING, make sure you call 811, a free service, that will help you ensure that you do not accidentally cut into service lines. This is not only a safety issue, but it could cost you big money if you accidentally cut a line (not to mention saving you from the angry neighbors that just lost a utility because you cut the line)!
There's more info about 811 here, and some additional retaining wall info that might be helpful to you: http://info.basalite.com/blog/
Best of luck, Happy Building!
Terrie

Here is a link that might be useful: Basalite Concrete Products blog

Seriously make sure you call b4udig or whatever it is called in your state, and also most states I think have a website for it. Where I live they will mark it in a day or two.

AT&T told me that if I were to cut my fibre line it would be a $1500 charge. That is the line in my yard, the one near the ditch is even more.