Roth 403(b) Plans Explained

I am fortunate to work with many individuals who work for non-profit organizations including universities and medical teaching hospitals.  Often someone has heard the names of a few account types thrown around - IRA, Roth IRA, 401(k), etc. But for some individuals working for non-profits, the employer may offer a Roth 403(b) plan. Before you start contributing, it’s important to understand where your money is going and the tax implications this type of account can have on you now and into retirement. Below I'll outline what a Roth 403(b) plan is and if it may be an option to consider. 

What Is a 403(b) Plan?

403(b) plans were introduced to public sector employees by Congress in 1958 to help those who were ineligible for 401(k) plans to better save for retirement.² This tax-deferred retirement account offering is only available to government workers and employees of public schools, nonprofits, charitable organizations and certain ministries or religious organizations. Any organization that falls under the IRS’s 501(3)(c) tax exemption code may offer a 403(b) plan to its employees.¹

How Does a Roth 403(b) Differ From a Roth 401(k) Plan?

An easy way to differentiate these plans is to think of 401(k) plans as options for private sector employees (those who work in for-profit business and corporations) and a 403(b) plan as being offered to public sector employees, as we’ve outlined above. Other than that, the specifics of these plans are fairly similar, although their vesting schedules and investment options may differ.

Traditional 403(b) Vs. Roth 403(b)

Just like its 401(k) counterpart, eligible participants can choose whether to partake in a traditional 403(b) plan or Roth 403(b) plan. While the main difference between the two are the tax advantages, there are a few other important variations to consider as well.

Traditional 403(b)

When using a traditional 403(b), you are funding your retirement account with pre-tax contributions. This lowers your taxable income amount, meaning you pay fewer taxes the year the contributions are made. In return, you pay taxes on the money in the account as well as the accrued interest when the money is withdrawn (ideally once you enter retirement). With a traditional 403(b) plan, you are required to stop contributing and start withdrawing at age 70½.³ 

Roth 403(b)

Alternatively, a Roth 403(b) is funded using after-tax contributions. That means this type of account does not reduce your income level for the year, and the money added to this account is taxed alongside the rest of your earned income. However, once you are ready to begin withdrawing from your Roth 403(b) you will not have to pay taxes on the contributions or any earned income within the account.  

Is a Roth 403(b) Plan Right For You?

If you’re an employee of a qualified organization and are offered a 403(b) plan, it’s important to decide whether a traditional or Roth account will be best for you. Generally speaking, those who believe they will retire in a higher tax bracket than they’re earning in today find that a Roth account may be beneficial. Or, if retirement is still quite far away, the investment earned on a Roth account over several decades may make it worth passing over tax breaks now. Another approach is to diversify your tax planning and split your contributions between the traditional and Roth 403(b) accounts. In any case, take a look at your specific earnings and projected future path to best decide which type of 403(b) plan may be best for you now and into retirement.

Taking advantage of an employer-sponsored retirement plan can be an easy and effective way to save money for retirement. Remember to weigh all of your options and take advantage of incentives such as employer matching contributions, as these can be a great way to boost your retirement income in either type of account.

^{1 https://www.irs.gov/retirement-plans/maintaining-eligibility-to-sponsor-a-403b-plan}

^{2 https://www.irs.gov/pub/irs-tege/eotopici95.pdf}

^{3 https://www.congress.gov/bill/115th-congress/house-bill/4524/text?format=txt}

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