A 403(b) plan is a retirement plan offered by an employer. It is very similar to a 401(k) plan: like a 401(k), a 403(b) plan is a defined contribution plan. That means the amount of money ultimately accumulated for retirement is a function of the contributions made by the employee, the employer (if any) and how those contributions are invested.
Unlike a 401(k), 403(b) plans can only be offered by nonprofit organizations, public school systems as well as some churches and hospitals. Examples of the types of employees who might be eligible might include teachers, ministers, doctors and other healthcare workers, among other employees of nonprofit entities.
Many 403(b) plans offer mutual fund options for investment, but many still offer annuities with various sub-accounts on their investment menu.
A Roth 403(b) is an option offered by some employers who offer a 403(b).
How does a Roth 403(b) plan work?
As with a 401(k) plan, a 403(b) can offer a Roth option within the plan. Officially this is known as a designated Roth account. Employees can contribute to either or both the traditional and Roth accounts. For employers who offer a matching contribution for employees, these contributions must be made into a traditional 403(b) account based on the rules governing this.
One advantage of a Roth 403(b) compared to a Roth IRA is that unlike a Roth IRA, there are no income caps limiting an employee’s ability to contribute. Plan participants can contribute up to the annual contribution limits in place for 403(b) plans in a given year. For those participants who want to build up the portion of their retirement savings in a Roth account, the 403(b) plan offers this opportunity.
Balances in a Roth 403(b) can be withdrawn tax-free as long as certain requirements are met. As with other types of Roth accounts, the amount of your contributions can always be withdrawn tax and penalty free. Any issues of tax and/or penalties come into play surrounding the earnings in the account.
- Qualified withdrawals occur after the account holder has reached age 59 ½ and has had the Roth 403(b) account for at least five years, known as the five-year rule. There are certain exceptions to this including the death or disability of the account holder.
- Required minimum distributions (RMDs) must be taken from Roth 403(b)s for those reaching age 72. While these are not taxed, they do serve to deplete the account. The Roth 403(b) can be rolled over to a Roth IRA once the participant has left their employer in order to avoid taking RMDs.
Does a Roth 403(b) make sense for you? The answer, of course, depends upon your own personal situation and circumstances. Like any Roth account you are forgoing a current year tax break on the contributions in order to allow the contributions in the Roth account to grow tax-free and to be withdrawn tax-free in retirement. Some things to consider:
- Contributing to Roth can help diversify your retirement account holdings between traditional and Roth accounts if your retirement account balances are primarily in traditional accounts. We certainly don’t know what the future holds as far as changes in the tax laws, having assets in both types of retirement accounts provides a level of tax planning flexibility in retirement.
- Contributing to Roth 403(b) allows the ability to roll these assets to a Roth IRA account once you’ve left the employer. This can offer the ability to reduce your level of RMDs in the future.
- With the more restrictive rules on inherited IRAs for most non-spousal beneficiaries, contributing to a Roth 403(b) and then rolling the money over to a Roth IRA offers greater estate planning flexibility. Inherited Roth IRAs can be withdrawn tax-free by beneficiaries as long as certain requirements are met. This can negate the issue of having to withdraw and pay taxes on inherited traditional IRAs within a ten-year window for this group of beneficiaries.
Contribution limits for a Roth 403(b)
For 2022, the annual contribution limits for a Roth 403(b) are $20,500 with an additional $6,500 catch-up contribution for those who are age 50 or older. The combined limit for employee and employer contributions for 2022 is $61,000, this increases to $67,500 for participants who are age 50 or older.
Note these are aggregate qualified retirement plan contribution limits across all employer plans. This means that if you have a second job you don’t get two $20,500 contribution limits. Likewise if you have a side business and decide to contribute to a Solo 401(k) or SEP-IRA.
A unique feature of 403(b) plans is an IRS rule that allows an extra $3,000 in annual catch-up contributions for employees meeting certain criteria. Specifically you must have worked for the same employer for at least 15 years. This extra contribution can be made even if you are under age 50. There is a lifetime cap on these extra contributions of $15,000.
Roth 403(b) vs traditional 403(b) vs Roth IRA
Roth 403(b)s and traditional 403(b)s are often used in tandem with each other. Perhaps a participant wants to allocate a portion of their annual contributions to both types of accounts. As mentioned above, if the employer makes matching contributions those contributions by law must be made into a traditional 403(b) account. Here is a comparison of some of the features of both a Roth 403(b) and traditional 403(b):
| Roth 403(b) | Traditional 403(b) | |
|---|---|---|
Tax treatment of contributions | Made on an after-tax basis | Made on a pre-tax basis |
Taxes on distributions | Not taxable if certain requirements are met including being at least 59 ½ and having satisfied the five-year rule. | Fully taxable at the account holder’s ordinary income tax rate. |
Penalties on withdrawals | Prior to age 59 ½ if certain requirements are not met. | Prior to age 59 ½ except in a few instances. |
Subject to required minimum distributions | Yes | Yes |
Generally a Roth 403(b) might be considered if the participant feels that their tax rate in retirement will be equal to or higher than their tax rate during their working years. If they anticipate that their tax rate will be lower than during their working years, a traditional 403(b) might be the better option.
That said, it can often be a good idea to allocate some of your annual contributions to both types of 403(b) options to diversify the nature of your qualified retirement accounts and to provide a degree of planning flexibility in retirement.
In comparing a Roth 403(b) with Roth IRA, there are some similarities and differences to consider.
| Roth 403(b) | Roth IRA | |
|---|---|---|
Tax treatment of contributions | Made on an after-tax basis | Made on an after-tax basis |
Taxes on distributions | Not taxable if certain requirements are met. | Not taxable if certain requirements are met. |
Penalties on withdrawals | Prior to age 59 ½ if certain requirements are not met. | Prior to age 59 ½ if certain requirements are not met. |
Eligibility to contribute limited by your income | No | Yes |
Annual contribution limits | $20,500 and $27,000 (for those 50 or older) in 2022 | $6,000 and $7,000 (for those 50 or older) in 2022 |
Subject to required minimum distributions | Yes | No |
Investment options | Limited to what is offered by the plan | The full range of investments offered by the IRA custodian |
The Roth 403(b) might be the only option for a direct contribution for participants who earn too much to contribute to a Roth IRA under the IRS rules. Many participants who use a Roth 403(b) will likely have both options in place at some point in time. A Roth IRA is a logical destination for rollovers from a Roth 403(b) when a participant leaves that employer. Depending upon their career path it is possible they could also have a Roth 401(k) at some point and the same rollover advantages would apply there as far as using a Roth IRA.
For those whose employer offers a 403(b) plan, utilizing the Roth 403(b) option if available can make a lot of sense if having a Roth account fits into their retirement planning strategy.