How to Know If a Roth 403(b) Is Right for You

Updated: Dec. 15, 2020, 10:44 a.m.

Ministers, public education workers, and employees of 501(c)(3) organizations sometimes have the option of saving for retirement in a Roth 403(b) instead of a more traditional retirement account like a standard 403(b) or 401(k). These accounts all share many similarities, but there are also a few key differences you must understand to get the most out of your account.

Here's an in-depth look at how Roth 403(b) accounts work, including their advantages and disadvantages compared to other common types of retirement accounts.

How a Roth 403(b) works

A Roth 403(b) is a retirement account funded with after-tax dollars that combines the high contribution limits and employer matching of a traditional 403(b) or 401(k) with the tax-free retirement distributions of a Roth IRA. A Roth 403(b) is very similar to a Roth 401(k). A 403(b) account is available only to government workers, certain ministers, and employees who work in public education or for a tax-exempt organization.

You elect to defer a certain percentage of each paycheck to your Roth 403(b), just as you might with a 401(k), but your contributions don't reduce your taxable income for the year like pre-tax contributions to a traditional, non-Roth 401(k) or 403(b). You pay income taxes on them now, and in exchange you are allowed to withdraw your contributions and your earnings tax-free in retirement, assuming you've had the account for at least five years.

Pros and cons of a Roth 403(b)

Roth 403(b)s have their advantages and disadvantages, just like any other retirement account.

Advantages to a Roth 403(b)

Some of the key benefits of a Roth 403(b) are:

  • Tax-free withdrawals in retirement: You pay taxes on your Roth 403(b) contributions in the year you make them, and afterward the money grows tax-free. In this case, when you withdraw it in retirement, it doesn't count toward your taxable income. This makes a Roth 403(b) a smart option if you believe you're in the same or a lower tax bracket today than you will be in once you retire. If you think you're in a higher tax bracket today than you'll be in once you reach retirement, a traditional 403(b) might be a better fit.
  • High contribution limits: You may contribute up to $19,500 to a Roth 403(b) in 2020 and 2021, $26,000 if you're 50 or older. These are the same 401(k) contribution limits.
  • Extra catch-up contributions: Individuals who have worked for their employer for at least 15 years are eligible to make an extra catch-up contribution of $3,000 per year above the annual limit, up to a lifetime maximum of $15,000.
  • Employer matching: Some employers may choose to match some of their employees' contributions, just as companies offering a 401(k) often do. If your company allows matching, your employer's contribution is still subject to tax in retirement, unlike your personal contributions.
  • Shorter vesting schedule: Vesting schedules determine when you get to keep your employer-matched funds if you decide to leave the company. Vesting schedules for 403(b)s are often shorter than those for 401(k)s, and some offer immediate vesting. This lets you keep all employer-matched funds once you leave the company.
  • No income limitations: Any employee who is eligible to participate in the company's retirement plan may contribute to a Roth 403(b). This distinguishes them from Roth IRAs, which prohibit certain high earners from putting money in directly, though they may do so via a backdoor Roth IRA.
  • Easy way around required minimum distributions: Roth 403(b) accounts require you to take required minimum distributions (RMDs) when you turn 72 or when you retire, whichever is later. But if you don't want to do this, you can always rollover the funds into a Roth IRA, since these accounts don't require RMDs.

Limitations to a Roth 403(b)

Some of the main drawbacks of a Roth 403(b) account are:

  • Few investment options: 403(b) plans offer more options today than just the variable annuities they started with, but you probably won't have as many investment options as you would with an IRA or even a 401(k).
  • High fees: Some Roth 403(b) plans may charge higher fees than you could find with other types of Roth accounts, but this isn't true of all of them. Do some research into the administrative costs and the costs associated with your investments and aim to keep these as low as possible to maximize your profits.
  • Less common: Roth 403(b) accounts are growing in popularity, but they're not as common as the traditional 403(b), so your company may not offer one.

Roth 403(b) vs. other Roth accounts

Here's a brief overview of how a Roth 403(b) stacks up to two other popular Roth retirement accounts -- the Roth 401(k) and the Roth IRA.

Roth 401(k)

The Roth 401(k) and the Roth 403(b) are both employer-offered retirement plans. They share many features, including tax-free withdrawals in retirement, high annual contribution limits, and the opportunity for employers to match your contributions. Roth 401(k)s also have no income restrictions on who can contribute, so provided your employer offers this type of plan, you can contribute regardless of your income.

A Roth 401(k) does not offer the additional $3,000 in annual contributions to long-serving employees the way Roth 403(b)s do, but those 50 and older are still allowed to make catch-up contributions if they wish.

Finally, Roth 401(k)s may give you a greater variety of investment choices, which would enable you to find more affordable options better suited to your risk tolerance. That said, both 401(k)s and 403(b)s tend to offer fewer investment choices than IRAs.

Roth IRA

A Roth IRA is a type of retirement plan that anyone can set up for themselves and contribute to with any savings they have left over. Contribution limits are much lower than for a Roth 403(b). In 2020 and 2021 you're allowed to contribute only up to $6,000 to a Roth IRA, $7,000 if you're 50 or older.

Additionally, Roth IRAs place income restrictions on high earners. If your income is over a certain threshold, which depends on your tax filing status, you may not be able to contribute up to the annual limit, or you may not be able to contribute any money directly to the account. (You can still contribute money indirectly by placing it into a traditional IRA and doing a Roth conversion in the same year. Such an account is known as a backdoor Roth IRA.) Roth 403(b)s have no such income limitations, so they're more appealing to high earners.

The two key advantages of a Roth IRA over a Roth 403(b) are the lack of RMDs and a greater variety of investment options. You have much more freedom to invest your money how you choose, and you can leave your funds there as long as you'd like without fear of taxes or penalties.

A Roth 403(b) isn't right for everyone, but it could be a smart home for your money if you believe you'll be in the same or a higher tax bracket in retirement. As with all retirement plans, do some research into your employer's Roth 403(b), including its investment options and fees, to make sure it's the right place for your retirement savings.

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