403(b) vs. Roth IRA: What’s the Difference?

403(b) vs. Roth IRA: An Overview

Both 403(b) plans and Roth individual retirement accounts (IRAs) are vehicles designated for use in retirement planning. A Roth IRA is a personal retirement planning vehicle that can be used by anyone. Notably, 403(b) plans are similar to 401(k) plans in that they are offered by employers, but which plan is offered depends on the type of employer.

A 403(b) plan is a retirement account that can be offered only by public school systems, nonprofit organizations, and some churches and hospitals. If you fall into this category of employment, you may be wondering about the differences between the two vehicles and how to optimize their use.

403(b)

Both 401(k) plans and 403(b) plans are offered through employers. When these plans are available to you, they offer a great opportunity to both save and potentially receive extra pay in the form of matching benefits. Matching benefits match the amount that you contribute to the plan, often dollar for dollar, up to a specified limit.

A 403(b) plan’s investment options are decided by your employer. An employee who invests in a 403(b) plan must choose among the investments available within the plan. As such, each individual employer’s 403(b) plan may be different, so it’s important to read the fine print and understand the options. In general, in addition to matching benefits, plans may offer special plan account options, loans, and other provisions that can allow for accessible cash.

Notably, 403(b) plans have maximum contribution limits, which are important to identify annually, as they increase with annual cost-of-living adjustments. In 2022, you can contribute $20,500 ($22,500 for 2023).

Employees over the age of 50 have the option to contribute an extra $6,500 in catch-up contributions for a total of $27,000 in 2022 (a $7,500 catch-up contribution in 2023 for a total of $30,000). Comprehensively, employees and employers can contribute a combined total of $61,000 in 2022 ($66,000 in 2023).

How 403(b) Plans Are Taxed

In a 403(b) plan, scheduled contributions are deducted from your paycheck before taxes are calculated. This is called a pretax contribution, and it is considered a type of tax deduction, as it lowers the taxable income.

For example, an individual who earns $3,000 in a pay period and falls into a 15% tax bracket pays $450 in income tax. If that same individual contributes $500 to a 403(b) plan, the tax is calculated on an income of $2,500, bringing the tax bill to $375.

Using these calculations, the 403(b) participant makes a significant retirement account contribution and saves $75 in taxes at the time of the contribution; however, any contributions that you make to a Roth IRA are always available for withdrawal, tax- and penalty-free.

Because 403(b) contributions are made pretax, you must pay taxes on the withdrawals that you make in retirement. Distributions can begin without penalty at age 59½. The tax rate on those withdrawals is based on the tax bracket into which you fall when the withdrawals are made.

Another tax advantage for 403(b) plans is that growth in plan assets is tax deferred. This means that all dividends, interest, and capital gains received in the plan are accumulated tax-free until they are withdrawn as income.

Roth IRA

A Roth IRA is usually invested through a separate personal account unless it is offered within a 403(b) plan. Regardless, the rules for Roth IRAs are all the same.

Individual Roth IRAs can be opened through just about any large brokerage in the United States. Charles Schwab, Vanguard, E-Trade, and TD Ameritrade all offer Roth IRAs. One of the main differences between a 403(b) and a Roth IRA is that a Roth IRA is usually a separate personal account that does not need to be adjusted through employment changes.

A 403(b) plan will be held with an employer, while an individual Roth IRA is held at a brokerage, with no need for management adjustments if you change jobs. If you leave an employer, a 403(b) account typically still remains open, but many investors will often transfer the funds for consolidation purposes.

A Roth IRA does not have the advantage of matching benefits, therefore, all of the money that you contribute to the Roth IRA is your own. In 2022, you can contribute a maximum of $6,000 to a Roth IRA ($6,500 in 2023). If you are age 50 or older, you can contribute an additional $1,000 in catch-up contributions, for a total of $7,000 in 2022 and $7,500 in 2023.

There are income limits for being allowed to contribute to a Roth IRA. In 2022, if you are married filing jointly, you can contribute the maximum amount if your modified adjusted gross income (MAGI) is less than $204,000 ($218,000 for 2023). If your income falls in the $204,000 to $214,000 range ($218,000 to $228,000 for 2023), you can contribute a reduced amount. If it’s $214,000 or more ($228,000 for 2023), you cannot contribute to a Roth IRA for the year.

If you file single, these amounts for 2022 are $129,000 ($138,000 for 2023), $129,000 to $144,000 ($138,000 to $153,000 for 2023), and $144,000 or more ($153,000 for 2023).

If you are married filing separately and lived with your spouse at any time during the year, you cannot contribute if your MAGI is $10,000 or higher. There are no income limits for a 403(b). These rules apply in both 2022 and 2023.

How Roth IRAs Are Taxed

Some of the other big differences between 403(b) and Roth IRA vehicles have to do with taxes. Roth IRA contributions are considered after-tax contributions. Essentially, you are making a contribution from your own pocket, which is believed to already be taxed with standard income tax regulations. There are no tax deductions with a Roth IRA.

Earnings in a Roth IRA are tax-free, and withdrawals of funds from a Roth IRA are tax-free in retirement. Roth IRAs also allow for tax-free withdrawals after the account’s five-year anniversary if all other qualifications are met.

Choosing the Right Tool

When considering a 403(b) vs. a Roth IRA, you are not limited to opening one or the other. It can be beneficial to have both types of accounts when planning your retirement savings; however, if you have both, you may want to choose which to prioritize when allocating your funds. Note that there are special rules concerning contribution limits when contributing to both plans.

A 403(b) account is generally the most optimal choice if there is employee matching, as this is money given to you in addition to your salary. You will have to pay taxes on these funds in retirement, though, so keep in mind your expected tax rate then and subtract accordingly for future projections.

If you’re interested in a Roth IRA, it’s good to open an account as soon as possible to take advantage of the withdrawal benefits after the five-year anniversary. Once your Roth IRA is open, you can contribute as much or as little annually as you would like, in line with the maximum restrictions. Generally, it can be optimal to max out your 403(b) contributions first, then contribute to your Roth IRA.

The Bottom Line

Roth IRAs and 403(b) plans are complementary tools for your retirement. While Roth IRAs allow your contributions to grow tax-free, you can contribute a much larger amount to your 403(b) plan. In addition to higher limits, 403(b) plans also offer the option for employer matches, which is essentially free money toward your retirement. Using both tools is a wise strategy for your retirement.