What Is a 403(b) Account?
A 403(b) is a tax-advantaged retirement savings account available to employees of public schools, certain types of nonprofits, and some ministers.
It operates similarly to a traditional IRA, but it is the only retirement savings option for some people.
In an employer-sponsored 403(b) plan, you can choose from several investment options offered by your organization or external providers.
You decide how to allocate money across those options based on your risk tolerance and future financial needs.
Contributions made to a 403(b) plan are tax-deferred, meaning you do not pay taxes on the money until you withdraw it during retirement.
If you need to leave the employer who provides your 403(b) plan, you will have the option to roll it over into another retirement account (IRA, Roth IRA, or 401(k)).
What Is a Roth IRA Account?
A Roth IRA is an individual retirement plan where investors save and invest after-tax dollars and all earnings and withdrawals are tax free once you reach age 59½.
Roth IRAs do not have required minimum distributions (RMDs), which means you have the freedom to save and invest for as long as you wish.
In the event that you need to leave your employer, rollovers are not needed as Roth IRAs are individual accounts.
Similarities of a 403(b) and Roth IRA
In order to take full advantage of both types of accounts, it is advisable that the money be invested for a minimum period of five years.
Both investments should be withdrawn when you reach the age of 59½. Within that time frame, there is no penalty for withdrawing any contributions made towards either account type.
If you withdraw money before you reach 59½ years old, you will be charged with a 10% penalty tax on your earnings in addition to any income taxes owed.
Differences Between a 403(b) and Roth IRA
The major difference between the two accounts is the tax benefits.
Contributions made to a 403(b) are deducted from taxable income, while contributions to a Roth IRA are not deductible.
Another important difference is that there can be a penalty for an early withdrawal of contributions from a 403(b), while with a Roth IRA you will not be charged any penalty tax if you withdraw your money before reaching 59½ years old.
Benefits of a 403(b)
Pre-tax Contributions
By contributing to a 403(b), you can reduce your taxable income. Withholdings from paychecks deposited into the 403(b) will lower your taxable income, saving you money on your taxes.
Matching Benefit
To encourage employees to save money towards their retirement, some employers will match contributions into the 403(b) up to a certain percentage of your salary.
This is essentially like free money and should be taken advantage of.
Contributions made to a 403(b) plan are not counted towards your annual contribution limit, so you can contribute beyond the standard if you have an employer match.
Benefits of a Roth IRA
Tax-free Withdrawals
Since contributions to a Roth IRA are after-tax dollars, qualified distributions (withdrawals) are not taxed when you reach the age of 59½.
Flexible Investment Options
Roth IRA plan holders are not limited to the investment choices offered by their employer. They can choose from thousands of options regarding where to invest their money.
Drawback of a 403(b)
Early Withdrawal Penalty
If you withdraw funds from a 403(b) before reaching the age of 59½, you will be charged with a 10% penalty tax on your earnings in addition to any income taxes owed. This can negate any savings that you received from your contributions.
Drawback of a Roth IRA
Lower Annual Contribution Limits
Roth IRAs have a lower contribution limit compared to a 403(b) plan.
More specifically, the limit is set at $6,500 in 2023.
Contribution Limits
Each account type has a maximum contribution limit that you can pay per year.
For a 403(b), the maximum allowable contribution for 2022 is $20,500, with a catch-up contribution amount of $6,500 for those who are 50 years old and above. In 2023, the limit increases to $22,500, with a catch-up contribution of $7,500 for those 50 and over.
For Roth IRAs, $6,000 is the maximum contribution that one can invest, plus a catch-up contribution of $1,000 for those aged 50 or older. In 2023, the contribution limit increases to $6,500 while the catch-up contribution remains the same.
Withdrawal Schedule
You will need to withdraw your money from either a 403(b) or Roth IRA when you reach the age of 59½ years old. Within that time frame, there is no penalty for withdrawing any contributions made towards either account type.
In terms of earnings, if you withdraw money before reaching the age of 59½, you will be charged with a 10% penalty tax on your earnings in addition to any income taxes owed. This can negate any savings that you previously received from your contributions.
Choosing Which One to Invest In
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If you are concerned about the future of your retirement savings, then you should opt to invest in a 403(b) because it can help save money on taxes today.
If you would like to withdraw your money before reaching the age of 59½, you should opt for a Roth IRA because withdrawals made from contributions will be completely tax-free as long as it has been at least five years since the contribution was made.
If you are concerned about paying taxes on your investment returns, you should opt for a 403(b) because it offers both tax-deductible contributions and possible tax savings through withholding amounts from your paycheck.
The bottom line is that a 403(b) can offer advantages over a Roth IRA in terms of tax deductions and possible tax savings from withholding amounts from your paycheck.
Conclusion
Both types of accounts offer their own unique benefits and drawbacks. It is up to the individual investor to figure out which one suits them best.
For most people, a 403(b) might be the better choice because the money contributed into this type of account will receive tax deductions and can help to boost savings today.
On the other hand, a Roth IRA offers you complete tax-free withdrawals when you reach age 59½, or after five years, because the contribution date provides an advantage over a 403(b).
Both accounts should be considered as important aids for investors in their retirement planning.
Make sure to take the time to compare all of the features and benefits of each account type to determine which one will best suit your needs.
FAQs
1. Which account type is better for retirement savings: a 403(b) or a Roth IRA?
A 403(b) or Roth IRA are equally beneficial in terms of taxes because they are both tax-deferred accounts.
2. How much can you contribute to each account type?
For a 403(b), the maximum allowable contribution is $20,500 in 2022 ($22,500 in 2023). For a Roth IRA, it is $6,000 in 2022 ($6,500 in 2023).
3. When do you need to withdraw money from either account? Can you withdraw your contributions without penalty?
You will need to withdraw money from both at age 59½ years old or before. Withdrawals from contributions made towards either account will be tax-free if it has been at least five years since the contribution was made and you are over 59½ years old.
4. What are the benefits of each account type?
A 403(b) offers a tax deduction on contributions and possible tax savings through withholding amounts from your paycheck. A Roth IRA can give you tax-free withdrawals from earnings if it has been at least five years since the contribution was made.
5. What is the difference between earnings and contributions?
Earnings refers to all returns accumulated in your investment account. Contributions refers to the money that you have deposited into your investment account.
