Many taxpayers find the Roth IRA attractive because of its tax-free feature – because you contribute to one with after-tax dollars , and the fact that required minimum distributions (RMDs) do not apply while the owner is alive. In addition, there is no maximum age for making contributions; you have to stop contributing to a traditional IRA in the year when you reach age 70½.
An IRA isn't the only way to get a Roth account; you can also get the advantages of a Roth in your 401(k). But what if the retirement vehicle you're eligible for is a 403(b) or 457(b) plan, two types of tax-advantaged plans available to certain categories of employees in the public sector or not-for-profit organizations (see 457 Plans and 403(b) Plans: A Comparison)? Can you get a Roth-type plan with these vehicles? The answer is yes.
In this article, we highlight a few of the major features of these accounts and some of the factors that you may consider when deciding whether to choose a Roth instead of a traditional retirement savings vehicle.
Tutorial: Retirement Planning
Traditional vs. Roth 401(k), 403(b) or 457(b)
Which retirement plan – Roth 401(k) ,403(b) and/or 457(b) account – you are offered will depend on what kind of company, government or organization you work for and whether your employer chooses to offer any of these plans. It's your employer that also will decide whether you can choose only the traditional version or also have the newer Roth option. Managing both versions can add administrative costs.
The "designated Roth account" (DRA) program, which went into effect in 2006, allows employees of participating organizations to designate salary deferral contributions to 401(k) ,403(b) or governmental 457(b) plans as Roth contributions.
With a Traditional 401(k) , 403(b) or 457(b) plan, salary deferral contributions are generally used to reduce the participant's taxable income (i.e. contributed on a pretax basis) from salary, and are taxed when withdrawn. With a DRA program, the contributions are made on an after-tax basis, but the money invested in the account grows tax-deferred, and distributions are tax-free – provided the distribution occurs after a five-taxable-year period and the participant is at least 59½ years old, disabled or deceased when the distribution occurs.
If your employer provides you with the opportunity to contribute to either, the following are some factors that are usually considered to favor the Roth option:
- You have quite a few years to save for retirement and plan to keep the money invested for a long time.
- You are in a low tax bracket today, or feel that your tax bracket will be higher when you retire.
- You want your heirs to keep as much of the money they inherit from you as possible.
- You can manage without the tax savings you would get from contributions to a Traditional account
It's best to consult a financial professional to ensure that a Roth is the right choice, as there are other factors that may make a Traditional IRA or 401(k) plan more favorable for you. (To find out more about 401(k) and 403(b) plans, read A Closer Look At The Roth 401(k), Introductory Tour Through Retirement Plans and 401(k) Plans: Roth or Regular?)
How Much Can You Contribute?
Contribution limits are the same for a traditional or Roth version of each type of account. However, there are differences among the accounts. Here are the figures for 2015 and 2016:
Traditional or Roth 401(k). $18,000 ($24,000 if you're 50 or over)
Traditional or Roth 403(b). $18,000 ($24,000 if you're 50 or over)
Traditional or Roth 457(b). $18,000 ($36,000 if you're 3 years away from your plan's normal retirement age)
Employers may limit the amount you can contribute to a percentage of your salary, which could result in lower contribution amounts. For instance, the plan may be designed to limit contributions to 10% of compensation, which would limit contributions (minus catch-cup amounts) to $5,000 for someone whose compensation is $50,000. Even if you cannot afford to contribute the maximum amount, try to contribute enough to receive the maximum amount of any matching contributions your employer may make to the plan. If your plan does include a matching contribution feature, bear in mind that matching contributions will be made to a traditional pretax account.
Income Limitations for Roths and Roth Conversions
One of the good things about Roth 401(k)s is that – unlike with a Roth IRA – there is no income limitation for participating in one. Click here to see the IRS chart comparing the requirements.
The Roth accounts have been so popular that many taxpayers have converted traditional IRAs and 401(k)s into Roth IRAs. There also used to be income limitations on which taxpayers were permitted to do these conversions. Effective in 2010 and beyond, the Tax Increase Prevention and Reconciliation Act (TIPRA) eliminated the $100,000 modified adjusted gross income (MAGI) cap for individuals looking to convert their non-Roth IRAs and other eligible retirement accounts to Roth IRAs. It also eliminated the requirement that married couples file a joint tax return to be eligible for a Roth IRA conversion. This allows more individuals to enjoy the benefits that Roth IRAs provide.
Does it make sense to forgo tax savings today in anticipation of the tax-free growth provided by Roth accounts? You'll only know for sure when the time comes for you to withdraw money from these accounts, at which point you will see whether tax rates have risen over the years and whether Roth distributions have remained completely tax-free as promised back in 1997. As mentioned earlier, there are other non-tax related factors to consider. A competent financial planner can help you make realistic projections and educated decisions.