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Choosing Between a Roth 403B and a Traditional 403B

Should you choose a Roth 403B or go the traditional route?

It might be a question you’ve asked yourself without knowing where to begin looking for the answer, so I will help you do just that with this post.

The Roth 403B and the Traditional 403B

With a Roth account, you give up an advantage now for a benefit in the future. Roth retirement accounts allow you to take qualified distributions that are free of income tax. The counter to this is that you cannot take a tax deduction when you contribute to the account, but the trade off for tax free-distributions may be worth it for many people.

Say you work a job making $100,000 per year. With a traditional 403B plan, a salary deferral of $15,000 means your taxable income is $85,000. Your contribution has the potential to grow tax- deferred and you would be able to start taking withdrawals at 59 1/2 years old. When you do begin taking those distributions, the money you take out would be taxed at whatever your income bracket for that year is. In thinking about the future, you have to think about whether or not tax brackets will be higher or lower than they are now.

It’s anyone’s guess what the answer would be, but when it comes to financial planning, we have to assume lower because you are no longer working. By putting your money into a Roth 403B, you would pay taxes on the full $100,000, but no taxes on the future qualified withdrawals.

So which one is best for you?

It’s hard to say just because you can never be sure of what will happen in the future. You never know what Congress or the IRS will do when it comes to the tax code, meaning that you should be cautious about passing up a tax deduction today just because you’ll potentially have lower income in the future. Back in the late 1970s, the highest marginal tax bracket was 70%. If you asked the question of whether a Roth 403B would have been better back then, you would have come across the same argument. Do you reduce taxable earnings now or wait until you’re 59 1/2 and hope things are better?

So Which One Is Better?

The answer to the question of which of the two is better depends on you. Most people earn more money as they go through their working years and then less once they retire. In those cases, I would almost always say the traditional 403B is best because of the current tax deductions it provides.

You also have to think about market performance. If you knew the market was going to go up double digits annually for 10 years, you’d want to go with a Roth 403B to avoid the tax hit that the growth will have to take. If the market was going to average 2% annually, avoiding Roth is better because taxes wouldn’t be as much of an issue.

One advantage that the Roth has is that while a regular 403B requires the owner to start taking distributions at age 70 1/2, with a Roth 403B, you can keep the money working tax-free until death. If you are in a position where you don’t need the distributions, this may add some value to your portfolio as a tax shelter.

Finally, you should know that Roth 403B plans are not always an option at organizations that offer the traditional accounts. It costs money to make these options available and companies don’t want to spend that money until they know for a fact that the tax code will support it. These plans were suppose to only be available until 2010 but the provisions making them possible were extended indefinitely thanks to the Pension Protection Act. However, I do think we’ll see a more tax-friendly government while Social Security and pension-related problems continue growing.

Fully understanding everything there is to understand about 403b plans can be tough because of constantly changing rules, but I’m here to help. Feel free to get in touch with me if you have any questions.

 

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted. Roth Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth accounts. Their tax treatment may change. This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation.

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