Many people are confused about 403b vs. Roth IRA. 403b is a retirement account you can contribute to through your employer. At the same time, Roth IRA is an investment vehicle for those who have more control over their investments and want to pay taxes now rather than later (although there are many other factors). Below we discuss which one might be right for you!
Roth IRA vs. 403(b)
|Owner Type||Individual||Public Employees & Non-Profits|
|Wealth Tax||Tax-Free Growth||Tax-Deferred Growth|
|Income Tax||Tax-Free Income||Taxable Income|
A Roth IRA is an individual retirement account that allows you to make money without paying taxes. It was named in honor of Delaware Senator William Roth, after who the term ‘Roth IRA’ was coined for his introduction of legislation authorizing IRAs on a conditional basis.
Roth IRAs are funded with after-tax income, so there is no upfront tax deduction. But the money can grow tax-free over time, and withdrawal will also be free from taxes.
If you work, you can put your earnings into a retirement account.
In 2023, the contribution limit is $6,500 a year. People who are 50 or older can deposit up to $7,500.
Who can not contribute to a Roth IRA?
If you make more than $144,000 a year as an individual or are married and make more than $214,000 a year together, you cannot contribute to a Roth IRA.
You can not contribute to a Roth IRA if you do not receive earned income.
Required Minimum Distributions (RMD)
There are no required minimum distributions (RMD) if you invest in a Roth.
How To Open A Roth IRA
A Roth IRA account must be created with a company that the IRS approves. This includes banks, brokerage companies, federally insured credit unions, insurance companies, and savings and loans.
You can open a Roth at any time. But you must do it before the owner’s tax filing deadline, usually April 15th. After that, you cannot get an extension.
What Type Of Money Can Be Contributed
Only earned income can be contributed to a Roth.
If you are a W-2 employee, the money you make from your job can pay for a Roth IRA. Things like wages, salaries, commissions, and bonuses can all count.
If you are self-employed, compensation is the individual’s net earnings from their business, less deduction allowed for contributions made to retirement plans on the individual’s behalf, and further reduced by 50% of the individual’s self-employment taxes.
Money related to divorce can also be contributed. This is called alimony. Child support or money from a settlement can also be put in the account.
What Type of Money Can Not Be Contributed
- The rent from your rental properties
- Profits from selling a property
- Dividends or interest earned from investments
- Income generated from retirement plans
Spousal Roth IRA
A married partner can fund their spouse’s Roth account. It doesn’t matter what their income is. Spousal Roth IRAs are the same as regular Roth IRAs, but they must be held separately from each other’s accounts.
- Married and file taxes jointly.
- The individual making contributions must use earned income.
- Make less than $228,000 as a household.
You can take your money from a Roth IRA without taxes or penalties. If you only take out what you put in, the money is not taxable, and there are no penalties. This is known as a qualified distribution.
If you have a Roth account and want to get the money out of it penalty-free when you are older, then it must happen at least five years after the first time you put money in. And the money has to come out under one of these conditions:
- Owners are at least 59½ when they take money out of their Roth IRA.
- The distributed assets must be used to buy, build, or rebuild a first home. This can only happen for $10,000 per lifetime.
- The distribution of a person’s Roth IRA can happen after they become disabled.
- The beneficiary of a Roth IRA owner’s account will get the money after that person dies.
When you withdraw money from your account, it may be taxed. The percentage that it will be taxed depends on how old you are. If you have met the 5-year rule, there is no tax or penalty when withdrawing your account.
You’ve waited at least five years:
- Younger than 59½: Earnings are taxed and penalized by 10% (Early Withdrawal Penalty). However, you can avoid taxes and penalties if you use the money to buy your first home. You can also avoid taxes if you have a disability or die.
- Age 59½ and older: No taxes. No penalties.
You have not waited for at least 5-years:
- Younger than 59½: Earnings are taxed and penalized by 10% (Early Withdrawal Penalty). However, you can avoid penalties if you use the money to buy your first home. You can also avoid penalties if you have a disability or die or use the withdrawal for qualified education expenses.
- Age 59½ and older: You are paying the taxes but avoiding the penalties.
If you take money from your Roth account too early, you may have to pay tax and a 10% penalty. The exceptions are:
- Unreimbursed medical expenses. It is okay if you use the money to pay for medical bills that are more than 10% of what you make in a year.
- If someone has lost their job, they might need to pay for their medical insurance.
- The withdrawal is used for qualified higher-education expenses. This includes tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible
- You can get up to $5,000 for your pregnancy or adoption if you withdraw within one year of giving birth or adopting.
A Roth IRA conversion allows owners to convert their traditional IRAs into Roth IRA accounts. This allows investors to:
- Pay the taxes on their tax-deferred savings, and earn interest tax-free.
- In addition, they receive tax-free income when they retire.
- Withdraw their contributions at any time, tax-free.
- Finally, avoid required minimum distributions (RMD) in the future.
A 403(b) plan is offered to organizations, non-profit employees, and public school employees. This retirement account allows participants to set aside money tax-deferred for retirement.
These plans were introduced in 1958, and they can only invest in annuity contracts known as tax-sheltered annuity (TSA) or tax-deferred annuity (TDA) plans.
Contribution and Elective Deferral Limit
The contribution limits for 403(b) plans are the same as those of 401(k) plans. However, employee deferrals to a 403b plan are made before taxes so that they will reduce your adjusted gross income.
For 2022, the annual contribution limit is $20,500, and $22,500 in 2023. The current special catch-up contribution for workers aged 50 and over is $7,500.
403(b) plans offer a special additional catch-up contribution provision known as the lifetime catch-up provision or 15-year rule. Employees who have at least 15 years of tenure are eligible for this provision, which allows for an extra $3,000 payment a year.
Employers can match additional contributions, but the total contributions from employer and employee cannot exceed $66,000 for 2022 or $58,000 for 2021.
Employers can opt for after-tax contributions and Roth contributions. Automatic contributions are one of the benefits that 403(b) plans provide, but employers may opt out at their discretion. Participants of eligible plan types may qualify for tax breaks as well.
For 403(b) contributions to an individual, the IRS applies them in a specific order:
- elective deferral
- service catch-up provision (15 years)
- age 50 catch-up contribution
Employees who leave their employers can take their plans to other employers. They may roll their balances over into another 403(b), a 401(k), an annuity, or in some cases, a self-directed IRA.
One significant benefit of a 403(b) plan is that it can be carried over from one job to the next rather than being left behind at a previous employer.
- You can take distributions from your 403b plan without tax penalties once you reach the age of 59½ years.
- The early withdrawal penalty for early withdrawal on an account before 59½ years old will be 10%.
- Distributions are taxed as ordinary income.
- Roth distributions are income-tax-free, but employees must either contribute to the plan or have a Roth IRA open for at least five years before taking tax-free distributions.
- RMDs are required when you reach age 73. Failure to take an RMD will result in a 50% excise tax on the amount that should have been withdrawn.
- You might be able to get a loan from your 403(b). The loan amount can not be more than $50,000 or half of your retirement plan’s balance. It becomes taxable income if you don’t pay the loan back in five years.
All distributions are reported to the IRS on Form 1099-R and mailed to plan participants.
Limited Investing Options
Depending on the investment provider, investment options in a 403(b) plan are limited. Funds can be invested into an annuity or mutual funds via custodial accounts.
How To Spend a Roth IRA in Retirement Efficiently
Once the Roth IRA requirements are met, an owner can transfer their account into a Roth annuity with a lifetime income rider. The annuity will then distribute a tax-free income for the rest of the retiree’s or married retirees’ lifetimes, even after the Roth IRA has run out of money.
Younger investors can contribute to a new Roth IRA annuity or convert their traditional IRAs into a Roth IRA annuity and guarantee their future tax-free income during retirement.
How To Spend a 403(b) plan efficiently in Retirement
Employees can’t touch their 403(b) plans without a tax penalty until they’ve reached the age of 59½ years. At that time, a 403(b) plan owner can roll over their retirement savings plans into a deferred annuity with a lifetime income rider. The annuity will then equally distribute a percentage of the retirement account for the rest of the retiree’s or married retirees’ lifetimes, even after the account has run out of money.
What Do My Beneficiaries Receive When I Die?
A Roth IRA and 403(b) will provide a straightforward death benefit that is the retirement plan’s account value in a lump sum.
Helpful tip: Life insurance might be a better option if you want to leave money to your beneficiaries. In some cases, you don’t need to take a medical examination. Instead, receive a free life insurance quote to determine if you can get affordable coverage. Coverage starts at $9.37 per month. Proceeds are tax-free too!
So, what’s the verdict? A Roth IRA and 403(b) have pros and cons, but an annuity can really sweeten the pot for retirees. If you’re looking for a way to make your retirement savings last longer, talk to your financial advisor about setting up an annuity distribution plan. Click below to get started!
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