Roth 401(k), 403(b): Which is Right for You?

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? 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. 

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 Roth option. Managing both versions can add administrative costs.

The "designated Roth account" (DRA) program, which went into effect in 2006, "allows employees of each participating organization to defer their salary [contributions] into a tax-exempt Roth bucket," says Jillian C. Nel, CFP®, CDFA, director of financial planning, at Legacy Asset Management, Inc. in Houston.

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used to reduce the participant's taxable income (i.e. contributed on a pre-tax basis) from salary and are taxed when withdrawn.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 you have access to both a 401(k) and a 403(b), you can contribute $18,500 total into these two accounts [for 2018; the limit rises to $19,000 in 2019] – so you can contribute $18,500 into one or the other, or split it between both, but you can't contribute more than $18,500 into both accounts combined," says Derek Hagen, CFP®, CFA, of Hagen Financial in Minnetonka, Minn..

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 don't want to ever have to pay taxes on the money your investments earn while they are in your account.
• 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. 

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 2019:

Traditional or Roth 401(k): $19,000 [up by $500 from 2018 ($25,000 if you're 50 or over)]

Traditional or Roth 403(b): $19,000 [up by $500 from 2018 ($25,000 if you're 50 or over)]

Traditional or Roth 457(b): $19,000 [$38,000 if you're three years away from your plan's normal retirement age (up from $17,000 in 2018)]

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-up 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.

"There are very few absolutes in the world of finance. However, there is one that we can all agree on: Don’t take a pass on the free money. Anytime your employer provides you with a match on your 401(k), 403(b), or 457(b), this is an offer of free money. Take it," says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Mass.

If your plan does include a matching contribution feature, bear in mind that matching contributions will be made to a traditional pretax account.

One of the good things about a Roth 401(k) is that – unlike a Roth IRA – there is no income limitation for participating in one. It can really pay to be aware of the difference between such retirement savings vehicles. 

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 2005 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, when the Roth IRA was established. 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.