403(b) vs. Roth IRA: Which One is Better?

Saving for retirement can feel like a daunting task, but it’s important for your future. And the earlier you start, the longer you have to let your retirement savings grow. But it can be tough to know where to start. Does your employer offer a retirement plan? If so, how does that work? If you can’t get an employer-sponsored plan, what are your other options?

We’ll answer these questions and more about the ins and outs of retirement planning. Read on to learn about Roth IRA and 403(b) retirement plans, their pros and cons, and whether it’s smart to have both a Roth IRA and a 403(b).

403(b) vs. Roth IRA

There are compelling arguments for having either type of retirement account (or both). But first, let’s take a look at how each form of retirement savings is structured.

What is a 403(b)?

A 403(b) is a plan for retirement offered to employees by public schools, including state colleges and universities, non-profit or tax-exempt employers, and some churches. It’s very similar to 401(k) plans offered by private-sector employers in that your contributions are tax-deductible. This means contributing to your account lowers your effective income, giving you tax savings in the short term.

For example, if you make $4,000 a month before paying taxes and you’re in the 22% tax bracket, you would owe $880 in taxes. Instead, if you contributed $500 a month to your 403(b) retirement fund, that lowers your taxable income to $3,500 a month. As such, you would only owe $770 in taxes, a savings of $110.

The money you contribute is then invested, based on a few options of your employer’s choosing. This, unfortunately, won’t give you as many choices as other retirement investment plans. According to the Internal Revenue Service (IRS), assets in a 403(b) plan can be placed in any of the following investment types:

• An annuity contract provided through an insurance company
• A custodial account invested in mutual funds
• A retirement income account set up for church employees

Any earnings on that money will grow tax-free. However, as soon as you begin to withdraw money after age 59½ (the age for eligible distributions), you’ll have to pay taxes on those funds just like ordinary income. On the plus side, you’ll more than likely be in a lower tax bracket during your retirement years than when you were working full-time.

How Roth IRA funds work

A Roth individual retirement account (Roth IRA) is most commonly a personal account, although sometimes a Roth IRA is included with 403(b) plans. But, in general, you set up and fund a Roth IRA on your own through a bank or other financial institution.

A key difference between a Roth IRA and a 403(b) is the way it’s funded. As mentioned, both accounts have tax advantages, and the upside of 403(b) plans is tax-deferred contributions, but you’ll pay taxes on withdrawals.

By contrast, Roth IRA contributions are made with after-tax dollars, and the advantage of that method is tax-free withdrawals at retirement age. In addition, any earnings you make through your Roth IRA are also tax-free.

Another important difference is that, unlike a traditional IRA or a 403 (b), a Roth IRA doesn’t have annual required minimum distributions (RMDs). This means you only need to withdraw Roth IRA funds when you need them. So, if you want to continue to let that tax-free retirement income grow until you really need it, you’re allowed to do so.

You also have a lot more retirement investing options to choose from with a Roth IRA. A 403(b) plan is limited by what your employer offers, whereas you choose what you want to invest in with your Roth IRA. Ideally, you’ll invest in a diversified portfolio that might include a mix of individual stocks, bonds, CDs, mutual funds, exchange-traded funds, or other assets.

Contribution limits and income limits for Roth IRA and 403(b)

As you plan your retirement strategy, it’s important to be aware of how much money you can contribute to your Roth IRA or 403(b). Additionally, you’ll need to know what your income limits are for a Roth IRA, which a 403(b) doesn’t have.

Contribution limits for 403(b) plans

In 2023, the contribution limit (also known as your elective deferral limit) for a 403 (b) is $22,500 per year. If you’re 50 or older, you’re also eligible for “catch-up contributions,” which amount to an additional $7,500 per year.

In total, the maximum allowed in combined contributions from employees and employers is $66,000 for 2023.

Contribution limits for Roth IRAs

For the year 2023, individuals can contribute up to $6,500 annually to a Roth IRA. Like 403 (b) plans, those who are 50 and older can also take advantage of catch-up contributions. For IRAs, that comes to $1,000 more each year. That comes to a total limit of $7,500 in 2023 for the over-50 crowd.

Income limits for Roth IRAs

To be eligible to contribute to Roth IRAs, those who are married and filing jointly must have a combined modified adjusted gross income (MAGI) of $218,000 or less in 2023 to be eligible for the maximum contributions allowed.

If married and filing jointly, and your income is between $218,000 and $228,000, your contributions will start to phase out. However, if your income exceeds $228,000 for 2023, you’re not eligible to contribute to Roth IRAs that year.

If you’re single, the adjusted gross income limit is $138,00 for 2023. Those who make between $138,000 and $153,000 for 2023 can make reduced contributions. In the event that your income exceeds $153,000 for 2023, you’re no longer eligible to make Roth IRA contributions.

Pros and cons of a 403b vs. Roth IRA

As with all financial products, there are benefits and risks to both 403(b) plans and Roth IRAs. To get a better idea of how they compare to each other, let’s take a look at the pros and cons of each account.

Should you have both a Roth IRA and a 403(b)?

It’s important to remember that there are no rules that state you can’t have both types of retirement funds.

“Having a balance of both types of retirement accounts can be a smart move for your long-term savings strategy,” says Levon L. Galstyan, a Certified Public Accountant at Oak View Law Group. “Whether having both is right for you depends on your personal financial circumstances, such as your income, expenses, and retirement goals.”

Madison Sharick — CFA, CFP, and owner of MadiManagesMoney — says that many financial planners will ask you to consider whether or not you’ll be paying a higher tax rate when you retire and that should help inform your decision. But she disagrees, pointing out that it’s hard to predict what will happen decades down the road in regard to your income or the U.S. tax code.

FAQs

Is it better to do a 403(b) or Roth IRA?

This, of course, depends on your personal finance situation. If you have limited means and don’t feel you can contribute to both, it’s probably best to contribute to an employer-sponsored 403(b) over a Roth IRA. This is because you don’t have to pay taxes on your contributions, which lowers your taxable income for the year.

In addition, the contribution limits are much higher for a 403(b) than a Roth IRA, meaning you can save more for your retirement in a shorter period of time.

How much should I put in my 403(b) per paycheck?

Many financial advisors recommend that you allocate about 15% of your earnings to retirement savings. That said, your personal situation may not make that a reasonable possibility at all stages of your life. Basically, any money you save for retirement is a positive step, and contributing as much as you can is a smart move.

One important point to consider, however, is whether your workplace offers employer-matching contributions. For example, some institutions may require you to contribute a certain percentage of your salary, say 5%, before they will supply matching funds. If at all possible, try to take advantage of this option. Not only is it essentially free money, but it’s also tax-free income.

What’s the five-year rule for a Roth IRA?

One of the benefits of a Roth IRA is that you can withdraw your own contributions at any time without taxes or penalties. However, you’ll be taxed and/or penalized if you try to withdraw any of the earnings you’ve made before age 59½ unless your account has reached the five-year mark and one of the following applies:

• You withdraw account earnings.
• You convert a traditional IRA to a Roth IRA.
• A beneficiary inherits your Roth IRA.

There are a few exceptions to the five-year rule where you may also be able to withdraw funds penalty free (but not necessarily tax-free) in certain situations. These circumstances may include up to $10,000 to buy a first home, money used for higher education, or funds used to pay for unreimbursed medical expenses.