403(b) vs. Roth IRA: Key Differences You Should Know

Choosing the right retirement savings plan is crucial for financial stability in later years. Among the available options, 403(b) plans and Roth IRAs offer distinct benefits tailored to varying needs. Understanding their differences helps in determining which aligns best with your goals.

Eligibility and Sponsorship

A 403(b) plan is designed for employees of public schools, certain non-profits, and some religious organizations. These employer-sponsored plans depend on your employment with a qualifying organization. Employers may also contribute, boosting retirement savings.

A Roth IRA, on the other hand, is an individual retirement account independent of employers. Anyone with earned income below specific thresholds can contribute. For 2024, the income limit is $153,000 for single filers and $228,000 for married couples filing jointly. These limits adjust annually. Contributions are the individual’s responsibility, offering full control over investment decisions.

Contribution Limits

In 2024, the IRS allows 403(b) participants to contribute up to $23,000 annually, with an additional $7,500 for those aged 50 and older, for a total of $30,500. These higher limits accommodate the need for larger retirement savings to address longer lifespans and rising costs.

Roth IRA contribution limits are lower. For 2024, individuals can contribute up to $7,000 annually, with a $1,000 catch-up for those 50 and older, totaling $8,000. Contributions may phase out for higher earners based on IRS guidelines, reflecting the Roth IRA’s supplemental savings role.

Tax Features

The tax treatment of 403(b) plans and Roth IRAs is a key difference. Contributions to 403(b) plans are pre-tax, reducing taxable income for the year. However, withdrawals during retirement are taxed as ordinary income. The IRS requires distributions to begin by age 73 under Required Minimum Distribution (RMD) rules.

Roth IRAs use after-tax dollars for contributions, offering no immediate tax break. However, qualified withdrawals, including earnings, are tax-free if conditions are met. This benefits individuals expecting higher tax brackets in retirement. Roth IRAs are not subject to RMDs during the account holder’s lifetime, allowing greater flexibility in managing withdrawals.

Early Withdrawal Conditions

For 403(b) plans, early withdrawals before age 59½ typically incur a 10% penalty and income taxes. Exceptions include permanent disability, death, or qualifying medical expenses. The “Rule of 55” allows penalty-free withdrawals for those separating from service after age 55.

Roth IRAs are more flexible. Contributions can be withdrawn anytime without penalties or taxes. However, earnings withdrawn before age 59½ and before the account is five years old are subject to a 10% penalty and taxes, with exceptions for first-time home purchases, qualified education expenses, and certain medical costs.

Distribution Requirements

403(b) plans require distributions starting by April 1 of the year after turning 73 to ensure the IRS collects taxes on pre-tax contributions and earnings. Failure to meet RMD obligations can result in penalties, though recent legislative changes aim to ease these.

Roth IRAs have no RMDs during the account holder’s lifetime, enabling tax-free growth indefinitely. This makes them appealing for those planning to pass wealth to heirs. Beneficiaries must take distributions within 10 years under the SECURE Act, but account holders retain full control over withdrawals during their lifetime. This flexibility allows individuals to align distributions with their financial and tax planning needs.