| 403(b) and/or Roth IRA? |
| Ideally, eligible participants would contribute the maximum allowable to both a 403(b) and a Roth IRA. This isn’t always possible or desirable. It’s not possible to contribute to both plans if you don’t have enough income, and it’s potentially not desirable to contribute to a 403(b) plan devoid of quality choices. Let's look at these two plans in a little more detail. |
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403(b) |
Roth Ira |
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| Eligibility |
Employees of public schools and certain tax-exempt organizations — as determined by Section 501(c)(3) of the Internal Revenue Code. |
| Single workers earning up to $105,000. Phases out at $120,000. |
| Married couples (filing jointly) earning up to $166,000. Phases out at $176,000. |
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| Contribution Amounts |
| For 2010, workers are able to contribute the smaller of: |
| 1. | the new elective deferral limit of $16,500, or |
| 2. | up to 100% of includable compensation (must be less than the elective deferral limit), or |
| 3. | for those with employer matches or other employer contributions, limits are $49,000 or 100% of compensation (whichever is less). Note: the employee is still limited to the employee elective deferral limit ($16,500 for 2010). An employer can add up to another $32,500. |
| 4. | in addition, if you are 50 or older at any time during 2010, you may contribute an additional $5,500. |
| see related note at end |
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For 2010 the limit is $5,000. In addition if you are 50 or older at any time during 2010 you can contribute an additional $1,000. |
| Tax Advantages |
Contributions are pre-tax and come directly out of your paycheck. Meaning, in the eyes of the government you've actually earned less (your 403(b) contribution is deducted from your earnings) so you are taxed less. A $100 contribution to a 403(b) reduces federal income taxes by roughly $25 (assuming you are in the 25% marginal tax bracket). In effect, your $100 contribution costs you only $75. |
No pre-tax advantages, however, withdrawals of contributions are never taxed and are always available for withdrawal. Tax free withdrawal of earnings may begin at age 59-1/2 (account must be held at least five years). Tax free withdrawal of earnings prior to age 59-1/2 may be made in case of disability, first-time home purchase and death. |
| Pros |
| – | Larger contribution amount |
| – | Automatically comes out of pay check |
| – | Built-in dollar cost averaging (purchase of a fixed dollar amount at regular intervals) |
| – | Lowers taxable income |
| – | Some plans allow loans |
| – | Employer matching may be available |
| – | Earnings grow tax-deferred |
| – | Offers strong protection from creditors |
| – | Catch-up provision allows additional contributions |
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| – | Can invest money in any financial institution |
| – | Can invest in individual stocks |
| – | Withdrawal of contributions are never taxed |
| – | Earnings grow tax-deferred |
| – | Tax free withdrawal of earnings prior to age 59-1/2 may be made in case of disability, first-time home purchase and death |
| – | Job change doesn't affect account status or require changes |
| – | Easy to arrange dollar cost averaging (purchase of a fixed dollar amount at regular intervals) |
| – | No forced withdrawals at age 70 1/2 |
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| Cons |
| – | Limited to vendors offered by employer |
| – | Employers often do a poor job of educating employees about the 403(b) |
| – | If retired, must begin withdrawals at age 70-1/2 |
| – | Withdrawals taxed as regular income |
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| – | Smaller contribution limit |
| – | Does not lower taxable income |
| – | No matching funds |
| – | Not protected from creditors in all states |
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Other Things to Consider |
| – | As long as you don't exceed the income provisions you can contribute to both plans. |
| – | If you are stuck with lousy investment choices in your 403(b), or are enamored with a particular financial institution, funding a Roth IRA may make more sense. |
| – | If your employer provides matching funds, the 403(b) may be the way to go, at least up to the match. |
| – | Younger workers may be unable to contribute a significant amount to a 403(b), lessening the benefit of pre-tax savings. In this case the lower contribution total and vendor flexibility may make the Roth IRA the best choice. |
| – | One school of thought has investors splitting money between the two plans. |
| – | Uncertainty on future tax rates and policies further complicates the decision.
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So which plan is best for you? Only you can make that call. Much of it depends on what you believe your tax bracket will be in the future and whether the deduction is worth more to you today than tax-free income in the future. The real bottom line? Regardless of the plan you choose, get started. Now! |
Back to Investment Basics » |
| Note: There is a provision of the Internal Revenue Code that temporarily increases the elective deferral limit for those eligible employees. This increase is known as the 15-year-rule. This special provision increases your elective deferral limit by as much as $3,000 more than the current $16,500 limit (as of 2010). To qualify you must have completed at least 15 years of service with the same employer (years of service need not be consecutive), and you cannot have contributed more than an average of $5,000 to a 403(b) in previous years. The increase in your elective deferral limit cannot exceed $3,000 per year under this provision, up to a $15,000 lifetime maximum. If you have 15 or more years of service with your employer, it is highly recommended that you consult with a tax professional concerning the limits on your contributions. |
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