Roth 403(b) Plans: Rules, Tax Benefits and More
A Roth 403(b) plan is one type of tax-advantaged, employer-sponsored retirement savings account. While these plans share some similarities with 401(k) plans, they have certain characteristics that set them apart. If you have the option to save for retirement in a Roth 403(b) through your employer, this guide can help you understand how they work and what tax benefits they offer. For more hands-on guidance as you navigate the ins and outs of a Roth 403(b) plan, consider finding a financial advisor.
What Is a Roth 403(b) Plan?
A 403(b) plan is a retirement account that public school employees, employees of tax-exempt organizations and certain ministers can enroll in. Examples of public school and tax-exempt employees who may be eligible to contribute to a 403(b) plan include teachers, administrative staff, doctors, nurses, librarians and custodians.
A Roth 403(b) plan is a 403(b) that the IRS designates as a Roth designated account. This means that Roth 403(b) plans adhere to the same contribution and withdrawal rules as Roth 401(k) accounts. Unlike a Roth individual retirement account, there are no income restrictions on who can contribute to a Roth 403(b); employment alone determines eligibility.
How Roth 403(b) Plans Work
Both employees and employers can make contributions to a Roth 403(b) plan. For 2019, employees can make elective salary deferrals of up to $19,000. An additional catch-up contribution of $6,000 is allowed for employees aged 50 or older. Those are the same limits that apply to a traditional or Roth 401(k).
Employers can choose to make matching contributions to employee plans, but they’re not required to do so. The combined limit on annual contributions, which includes both employee and employer contributions, is $56,000 for 2019 or 100% of the employee’s compensation for the most recent year of service, whichever is less.
Something distinctive about 403(b) plans is that if the plan allows for it, employees who have at least 15 years of service with a public school system, hospital, home health service agency, health and welfare service agency, church or association of churches can make additional catch-up contributions. The amount they could contribute above the annual limit is the lesser of:
$3,000
$15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, OR
$5,000 times the number of the employee’s years of service, minus total elective deferrals made for earlier years
If an employee is eligible for this catch-up contribution limit, plus the regular $6,000 catch-up contribution limit, the IRS requires the employee to make the 15-year catch-up contribution first, up to the limit he or she is eligible for. Then, they can make catch-up contributions up to the $6,000 annual limit, up to the amount that total contributions don’t exceed the combined limit for employer and employee contributions.
It sounds complicated, but essentially 15-year employees can potentially get three bites at the apple: first with their regular elective salary deferrals, then with the 15-year catch-up contribution and finally, with the regular catch-up contribution.
403(b) Tax Considerations
Roth accounts — whether it’s a Roth 401(k), Roth IRA or Roth 403(b) — are funded with after-tax dollars by employees. Qualified withdrawals of employee contributions and earnings are tax-free in retirement.
Cliff Caplan, a certified financial planner at Neponset Valley Financial Partners in Norwood, Massachusetts, says a 403(b) plan can be particularly beneficial to younger workers who have years to grow their retirement savings. Someone who has yet to reach his or her peak income-earning years may see more value from contributing to a Roth 403(b) if the person is in a higher income tax bracket in retirement. That’s because qualified withdrawals wouldn’t increase the person’s tax liability.
The trade-off, of course, since employees fund contributions to a Roth 403(b) with after-tax dollars, is that those contributions are not tax-deductible the way they would be with a traditional 401(k) or 403(b) plan. A worker who’s earning a higher salary but expects to be in a lower income bracket at retirement might prefer to get the upfront deduction for 403(b) contributions. In that scenario, the person may be better off contributing to a traditional, rather than a Roth, account.
Employers make matching contributions on a pre-tax basis. If your employer makes a match to your plan, you must pay taxes on those matching contributions and their earnings when taking distributions in retirement.
403(b) Early Withdrawal Penalties
As mentioned, qualified distributions are tax-free. To count as a qualified distribution, you have to be at least 59.5 when withdrawing money from your account. In addition, your account has to have been open for a minimum of five years. If you don’t meet either of those conditions, a 10% early withdrawal penalty would apply to distributions.
You may qualify for an exception under certain circumstances. For instance, you could avoid the penalty on an early withdrawal if:
You separate from service during, or after, the year you turned 55
You separate from service before age 55 but take substantially equal payments for a minimum of five years or age 59.5, whichever is later
You become totally and permanently disabled
403(b) Required Minimum Distributions
One benefit associated with Roth IRAs is the lack of required minimum distributions. With a traditional IRA or 401(k), you’re required to begin taking minimum distributions from your account at age 70.5. These distributions are calculated based on your account value and estimated life expectancy.
Once you reach RMD age the you cannot make new contributions. Failing to meet the RMD schedule has consequences. The IRS could levy tax penalties of up to 50% of the amount you were required to withdraw.
You might assume that a Roth 403(b) plan wouldn’t be subject to the required minimum distribution rule since it’s a designated Roth account. But, that’s not the case. The IRS still requires RMDs from Roth 403(b) accounts. A potential work-around involves rolling your plan assets into a Roth IRA; you’d then be able to choose when you take distributions from the account.
Investment Options and Management Fees
If your plan administrator offers both a traditional 403(b) and a Roth 403(b) option, they may look identical in terms of cost and what you can invest in.
“The fees are essentially the investment management fees that pertain to each investment option and the fee compression that is continuous makes them very competitive,” Caplain says. “The same investments that are available in a traditional 403(b) account are available for Roth contributions as well.”
Specifically, that includes mutual funds and annuities. Mutual funds are a collection of stocks. Annuities are insurance products that pay out a consistent income stream to the account owner at retirement. A 403(b) plan can offer one or the other, or a mix of both.
A 401(k), by comparison, might offer a broader range of investments, such as exchange-traded funds (ETFs) or target-date funds. The former is a mutual fund that trades on an exchange like a stock. The latter is a mutual fund with an asset allocation that adjusts automatically as you get closer to your target retirement date.
The Takeaway
A Roth 403(b) plan could be an important part of your retirement planning strategy. But you need to be sure whether it’s right for you. As you weigh the merits of these accounts, consider your current retirement savings, your current income, future earning potential, tax bracket and expected retirement age. Together, these factors can help you decide if a Roth 403(b) is the best way to build your nest egg.
Retirement Planning Tips
Your retirement plan isn’t something you can set and forget. As you move through different life stages, such as a career change or starting a family, your needs and goals for retirement may shift. Try using a retirement calculator to estimate how much you may need to fund your retirement lifestyle. It can help you determine whether you’re saving enough.
Consider talking to a financial advisor to guide you through the decision-making process. SmartAsset’s financial advisor matching tool matches you with up to three advisors in your local area. We fully vet our advisors and they are free of disclosures.
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