Roth IRA versus 403b Plan

If you've been wondering whether or not to fund a Roth IRA or your 403b plan, we're going to lay out some of the things you might want to consider before making that decision.  They are both great retirement planning tools, but there may be reasons for choosing to fund one type of plan versus the other.

We're going to tell you right at the start, that if you've got enough disposable income, then the decision of funding a Roth IRA versus a 403b plan shouldn't even enter your mind - fund both.  But for those of you that can only afford to fund a Roth IRA or a 403b, keep on reading.

Benefits of Roth IRA Plans

The biggest benefit of a Roth IRA plan is the fact that the money withdrawn from the account at retirement is free from federal income taxes.  For example, if you decide to place $5,000 into your Roth IRA in 2008 and that grows to $15,000 at retirement, you can withdraw all $15,000 and not have to pay any federal income taxes.

Another benefit you get with Roth IRAs is greater access to your money.  While the Roth IRA withdrawal rules may be restrictive with respect to withdrawals that can be made without incurring a penalty, you still have the right to remove the money from the account at any time.  Just keep in mind that you might have to pay an early withdrawal penalty.

With 403b plans, you will need to consult with your plan administrator concerning the early withdrawal rules.  Money can be loaned from a 403b, but it is paid back with interest.  (Although some people might consider the fact that it's harder to get to your retirement money as a benefit.)  And you may not be able to contribute to your 403b until the loan is repaid.

Benefits of 403b Plans

Perhaps the biggest advantage of a 403b plan has versus a Roth IRA is the fact that employers often match employee contributions.  These matching contributions can quickly and greatly enhance the overall value of your 403b account.

Another benefit of employer plans such as a 403b is that the money that goes into the account is done so on a before-tax basis.  With a Roth IRA, the money used to fund the account is on an after-tax basis.  Let's look at a quick example to see the difference this can make:

Roth IRA versus 403b Plan Example

In this example, let's assume that you are planning on contributing $5,500 to your 403b plan and your employer matches your contribution at a rate of $0.50 for every dollar you contribute.  Alternatively, you could use this $5,500 in income to fund a Roth IRA.  Let's also assume that you are in the 28% federal income tax bracket.

Roth IRA versus 403b Account Value

Do you see how much more money you'd have in your 403b plan versus a Roth IRA?  Now some of you might be quick to point out that when you withdraw money from the 403b plan you'll have to pay federal income taxes.  Well, let's continue with this example.

Let's say you won't need this money for 15 years and it's going to grow at 7% per year.  At the end of the 15th year, you'll have $10,926 of tax-free money in your Roth IRA account.  The money you put in your 403b plan will be worth $22,762.  After paying taxes of $6,373 you will still have $16,389 or $5,463 more after-tax money to spend from the 403b investment.

This is the reason why so many financial consultants recommend that their clients first fund their employer sponsored retirement savings plans up to the point that employer matching stops.

Retirement Investment Options

It used to be that 401k plans and 403b accounts offered investors limited flexibility when it comes to investment options.  For example, participants might be limited to three to five mutual fund type offerings.  And although these funds usually provided relatively low returns, they were often very safe investments thereby preserving capital during a bear market.

Most plan administrators now offer more flexibility to the employee such as Schwab's Personal Choice Retirement Account, or PCRA.  These types of accounts can be used by 403b plan participants to greatly expand their investment options and are nearly identical to other investment accounts used for retirement.

Bankruptcy Protection of 403b Plans

Finally, federal laws are pretty strong when it comes to protecting your retirement plans such as 403b accounts from creditors in the event of bankruptcy.  But the money placed into an IRA account is a completely different matter.

The exact amount of protection provided to IRA account owners depends on state law.  Sometimes states provide no protection at all for IRAs, while others might provide limited protection.  If you think that you might file for bankruptcy, you might want to research your state's protection policies before choosing between a Roth IRA and a 403b.

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