What Is a Roth 403(b) and How Does It Work?
Understand how a Roth 403(b) works, including its tax advantages, withdrawal rules, and how it compares to other retirement savings options.
A Roth 403(b) is a retirement savings option that blends features of traditional 403(b) plans and Roth IRAs. It allows employees of tax-exempt organizations, such as public schools and nonprofits, to contribute after-tax dollars. The primary benefit is that qualified withdrawals in retirement are tax-free, making it attractive for those expecting to be in a higher tax bracket later.
Eligibility and Enrollment Requirements
A Roth 403(b) is available to employees of certain organizations, including public schools, churches, and tax-exempt entities under Section 501(c)(3) of the Internal Revenue Code. Not all nonprofits or educational institutions offer this option, so employees should check with their HR department.
Enrollment is typically through payroll deductions. Some employers automatically enroll employees, who must opt out if they do not wish to participate. Others require active enrollment during hiring or an annual benefits period. Some plans impose waiting periods before new hires can contribute.
The IRS sets annual contribution limits for both traditional and Roth 403(b) accounts combined. In 2024, employees can contribute up to $23,000, with a $7,500 catch-up contribution for those 50 and older. A special provision allows employees with at least 15 years at the same employer to contribute an extra $3,000 annually, up to a $15,000 lifetime maximum.
How Contributions Work
Employees contribute to a Roth 403(b) through payroll deductions using after-tax dollars, ensuring qualified withdrawals in retirement are tax-free. Contributions are deducted automatically, simplifying consistent saving.
Employers may offer matching contributions, but these are usually placed in a traditional 403(b) account, meaning they will be taxed upon withdrawal. The availability and structure of employer contributions vary by plan.
Tax Treatment of Distributions
Qualified withdrawals from a Roth 403(b) are tax-free if the account holder is at least 59½ and has held the account for at least five years. The five-year period begins on January 1 of the year of the first contribution.
If a withdrawal occurs before meeting these conditions, contributions can be taken out tax-free, but earnings are subject to income tax and may incur a 10% penalty unless an exception applies. Exceptions include disability, certain medical expenses, or distributions to beneficiaries after the account holder’s death. Roth 403(b) plans do not allow tax-free earnings withdrawals before 59½ under the “five-year rule” exceptions that apply to Roth IRAs.
When Withdrawals Are Allowed
Withdrawals are generally restricted to ensure retirement use. Funds can typically be accessed upon leaving a job, whether due to retirement or a career change. Some plans allow partial withdrawals, while others may require a lump sum or rollover.
Hardship distributions are permitted for immediate financial needs such as medical expenses, funeral costs, or preventing eviction. These withdrawals must be verified by the plan administrator and are limited to the necessary amount.
Possible Rollovers
A Roth 403(b) can be rolled into another Roth account, such as a Roth IRA, Roth 401(k), or Roth 457(b), if the receiving plan accepts rollovers. A direct rollover is recommended to avoid tax consequences. If withdrawn funds are not deposited into a new account within 60 days, they may be treated as a taxable distribution, and earnings could incur penalties if the account holder is under 59½.
Unlike traditional 403(b) accounts, which can be rolled into a traditional IRA without immediate tax implications, a Roth 403(b) must be transferred into another Roth account to maintain its tax-free status. Rolling it into a traditional IRA would make the entire balance taxable.
Roth 403(b) accounts require minimum distributions, but Roth IRAs do not. Rolling a Roth 403(b) into a Roth IRA eliminates mandatory withdrawals, allowing retirees to keep their savings invested longer. Employees should check their plan’s rules, as some employers impose restrictions or waiting periods.
Required Distributions
Unlike Roth IRAs, Roth 403(b) accounts are subject to required minimum distributions (RMDs) starting at age 73 under IRS regulations. The first RMD must be taken by April 1 of the year following the account holder’s 73rd birthday, with subsequent withdrawals due annually by December 31. Failing to take an RMD results in a penalty of 25% of the required amount, though this drops to 10% if corrected within two years.
Rolling a Roth 403(b) into a Roth IRA eliminates RMDs, allowing funds to remain invested. However, if funds stay in a Roth 403(b), RMDs must be taken, even though withdrawals remain tax-free. Planning ahead ensures compliance while maintaining an investment strategy.