Most people know it is important to save for retirement, but where to save can be confusing since there are so many different options. Saving in an employer-offered retirement account, like a 401(k) at for-profit companies or a 403(b) at a non-profit organization, can be an easy first step. If an investor is ready to save more or wants an account outside of work, a Roth IRA may be an option. These accounts have different tax treatment, contribution limits, and rules for contributing—but if an investor is eligible to contribute to both, they can be used together.

403(b) vs. Roth IRA

An investor can have both a 403(b) and a Roth IRA account. A 403(b) is only available through an employer, whereas a Roth IRA can be opened by an individual separate from an employer. However, not everyone is eligible to open a Roth IRA.   

• A 403(b) is an employer-sponsored retirement plan named after the tax section code that allows for it. Only tax-exempt employers, such as public schools, non-profit organizations, hospitals, and churches can offer their employees a 403(b) plan. An employee contributes to the plan with pretax dollars, which means the contributions reduce the employee’s taxable income in the year they make them. Then, the investor pays taxes when they withdraw the funds in retirement. 

• A Roth IRA is an Individual Retirement Account (IRA) available to those with earned income below certain limits. To be eligible to contribute, a single tax filer must have a modified adjusted gross income of no more than $144,000 in 2022. A person contributes to a Roth account with after-tax money. This does not provide the immediate tax advantage of reducing the person’s income, but means that no taxes are due upon withdrawal in retirement. In this way, investment gains on Roth IRA funds are viewed as “tax-free.” 

Non-profit employers may provide another option, a Roth 403(b).  This is different from the traditional 403(b) because an employee contributes after-tax dollars to this account so income taxes will not be due when withdrawing the money. 

How are 403(b) and Roth IRA plans taxed?

A 403(b) plan and a Roth IRA are taxed at different times, which is why some people like to have both types of accounts. When using both accounts, a person has a tax advantage both when they contribute and when they withdraw the money in the future. 

Pretax vs. post-tax contributions

A 403(b) is a tax-deferred account since a person contributes with pretax dollars. Contributions are deducted from a person’s income, which lowers the amount of income immediately subject to taxes, giving the person the tax advantage of paying less taxes when they contribute to the account. 

A Roth IRA is funded with post-tax contributions. When a person receives their income, taxes have already been withheld. The investor can then use that income with taxes already taken out to contribute to a Roth IRA.  

Taxed vs. tax-free distributions 

A 403(b) imposes taxes on the distribution taken out at retirement since taxes were not previously paid on the contribution. The withdrawal in retirement is taxed at the person’s current tax rate. People take advantage of deferring the taxes because they may be at a lower tax rate in retirement than when they contributed. 

A Roth IRA is tax-free when distributions are taken out at retirement, meaning no income taxes are due on withdrawal. This is because taxes were paid on the income before the money was deposited in the Roth IRA. Any growth generated by the funds in a Roth IRA are also not subject to taxes. 

403(b) vs. Roth IRA: similarities and differences 

While both a 403(b) and a Roth IRA are retirement planning accounts, their key differences allow a person to take advantage of different strategies.

Similarities between a 403(b) plan and a Roth IRA

• Both are retirement accounts.

  Both 403(b) and Roth IRA plans are tools used to build retirement savings. They have rules set in place to encourage long-term savings. 

• Possible tax penalty on early withdrawals.

  Early withdrawals from a 403(b) without meeting an exception, such as a disability, will incur a 10% tax penalty. But If a person wants to withdraw the earnings from the Roth IRA before age 59 ½, there will be a 10% tax penalty similar to the 403(b) early withdrawal penalty. Note, however, that withdrawals of contributions to a Roth IRA can be withdrawn at any time without taxes or penalties.

• Catch-up contributions.

  Both types of accounts allow for catch-up contributions for savers age 50 or older, but the amount differs. For 403(b) plans the catch-up contribution is $6,500 in 2022 versus $1,000 in 2022 for Roth IRAs. 

Differences between a 403(b) plan and a Roth IRA

• Contribution limits.

  An employee can contribute up to $20,500 to a 403(b) in 2022. If they are over age 50 they can currently contribute an additional $6,500 a year. A 403(b) has a unique catch-up contribution up to $3,000 for at least 15 years of service at the employer. Employers can also contribute to an employee’s 403(b) With employer contributions and both catch-up contributions the contribution limit for a 403(b) in 2022 is $67,500. The contribution limit for a Roth IRA in 2022 is $6,000.

• Access to accounts.

  A 403(b) is a retirement plan accessed through an employer. A Roth IRA can be opened by an individual outside of an employer as long as they have earned income below the limit. 

• Ability for loans.

  An individual may take a loan from their 403(b) if the employer’s plan allows for that. A Roth IRA does not allow loans. 

• Withdrawal rules.

  A person can withdraw contributions, but not earnings, from a Roth IRA at any time without taxes or penalties. To withdraw from a 403(b), an investor must follow the rules by meeting the age requirement (age 59 ½) or an exception, such as turning 55 and retiring from the employer sponsoring the plan, for an early withdrawal. Taking out money  from a 403(b) without meeting those requirements can result in taxes and a penalty. 

• Investment risks.

  A Roth IRA provides more investment options than a 403(b). A 403(b) is limited to investing in mutual funds and annuities. There can also be higher investment costs and fees with the limited options in a 403(b).  

Alternatives to 403(b) and Roth IRA plans

There are many options when trying to save for retirement, and it’s possible to have these alternative retirement accounts on their own or in conjunction with a 403(b) or Roth IRA. It’s important to remember the contribution limits apply to the investor and not each account. For example, if someone has two retirement plans that defer salary like a 403(b) and a Solo 401(k), the employee contribution limit of $20,500 in 2022 applies to the aggregate total across both accounts.

• Traditional IRA.

  Similar to the Roth IRA, a traditional IRA is a plan outside of an employer. Unlike a Roth IRA, it is a tax-deferred account. Income taxes are not paid on the contribution, but are owed on the money withdrawn. 

• SEP IRA.

  This is a retirement tool for a self-employed person or a small business owner. It works like a traditional IRA but is specifically for business owners. A SEP IRA has a higher contribution limit because the self-employed individual can contribute up to 25% of their net compensation or $61,000 in 2022, whichever is less.

• Solo 401(k).

  A Solo 401(k) is an alternative for self-employed individuals with no employees, allowing for contributions up to $61,000.  

The bottom line

A 403(b) and a Roth IRA provide investors with ways to save for retirement. Their major differences include their tax treatment and who can access them. The differences between the two allow an investor to enjoy different tax advantages when they use the two in conjunction with one another in retirement planning.

FYI: Try Titan’s free Roth IRA Calculator to project how much your Roth IRA will give you in retirement.