Roth or Traditional 403(b) or 457 Plan?

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Perhaps you're familiar with two types of individual retirement accounts (IRAs) – traditional and Roth. Now Roth 403(b) and Roth 457 plans may be available in addition to traditional 403(b) and 457 plans in California school districts that choose to offer them. This change provides more choices to help educators meet their retirement saving goals.

After the Roth 403(b) was first introduced in 2006, many districts across the state began adding it to their retirement plan lineups. Effective Jan. 1, 2011, districts are allowed (but not required) to also offer Roth 457 plans. Knowing the difference between Roth and traditional retirement plans can help you make informed choices about what's right for you.

What's the Difference?

With a traditional 403(b) or 457 plan, your contributions are made before taxes, so you save on your current tax bill. Contributions and earnings grow tax-deferred, and withdrawals at retirement are taxed at ordinary income tax rates.* Benefit = upfront tax savings and tax-deferred growth.

With a Roth 403(b) or Roth 457 plan, your contributions are made on an after-tax basis; taxes on the contributed amount are paid up front and there is no current tax break. Contributions and earnings grow tax-free and can be withdrawn tax-free at retirement if certain conditions are met.** Benefit = tax-free growth and distributions when you retire.

Like traditional 403(b)s, Roth 403(b)s impose required minimum distributions (RMDs) during the account holder’s lifetime. However, you may choose to roll over the 403(b) account balance into a Roth IRA [link to IRA article] to avoid RMDs when you retire or after you leave your employer. It's also important to note that opening and contributing to a Roth 403(b) does not affect your eligibility to open and contribute to a traditional or Roth IRA.

Is Roth Right for You?

If your district offers a Roth 403(b) or Roth 457, you have a decision to make. Your decision boils down to whether you want to contribute pretax or after-tax dollars, and that may depend on your goals and financial circumstances. If you expect your tax bracket to be lower in retirement than it is now, it may make sense to contribute to a traditional plan and take advantage of the tax break now. However, if you expect your tax bracket to be the same or higher in retirement, it may make sense to contribute to a Roth 403(b) and benefit from tax-free withdrawals later.

It is nearly impossible to accurately predict your tax bracket due to uncertain future tax rates. Other unknown factors such as inflation, personal income and expenses may also affect your decision. Keep in mind that you don't have to choose one or the other; you can have multiple 403(b), 457, traditional and/or Roth accounts through your district, if offered, and make contributions to all in the same year – as long as the total contributions don't exceed the limits for the plan year. Doing so may provide flexibility to draw from either type of account depending on your changing circumstances in retirement.

A financial or tax advisor can help you look at the options to determine what may work best for you.

** Withdrawals from a Roth 403(b) or 457 plan are tax-free if the account has been held at least five years and the account holder is at least age 59½. Nonqualified withdrawals are subject to ordinary income tax rates and a 10% tax penalty. (Tax penalty does not apply to 457 plans.)

CTA does not give tax advice. Consult a tax advisor for information specific to your situation. * Withdrawals made prior to age 59½ (age 55 if leaving your job) may be subject to a 10% federal tax penalty (does not apply to 457 plans).