Employer funded 403b vs Roth IRA
April 2, 2010 9:37 AM   Subscribe

I’m confused about whether to put money into my employer funded 403b or a Roth IRA.

I work at a university, and my employer funds my 403b account at a rate of 5% of my salary. This is not a match, however, and it’s up to me to decide if I want to deposit some of my own funds into it or not.

The prevailing online consensus seems to be that it is always better to fund one’s 403b (or 401k) if one’s employer offers a match, and only after the full match has been obtained start a Roth IRA. In cases where there is no employer match, the advice seems to be to go for the Roth IRA. But what about my situation where my employer funds my 403b, but *not* as a match? Should I prioritize funding the 403b or use my savings for a Roth IRA instead?

I guess my question is to what extent the tax benefit of funding the 403b outweighs the tax free goodness of the Roth IRA.

And/or is there something else I should be doing?

Thanks in advance.
posted by anonymous to Work & Money (11 answers total) 1 user marked this as a favorite
 
The fact that your employer's funding a bunch of money into the 403(b) makes the whole thing moot; it's "free" money unaffected by your actions.

So the question is, do you anticipate that when you retire, you'll pay the same, more, or less in taxes than you do now?

If you expect to pay less, because you're in a high bracket now, fund the 403b.
If you exepct to pay more, because you think taxes will be going up in general over time, or any other reason, you want to pay your taxes now, and fund the Roth.
posted by Tomorrowful at 9:40 AM on April 2, 2010


The prevailing online consensus seems to be that it is always better to fund one’s 403b (or 401k) if one’s employer offers a match, and only after the full match has been obtained start a Roth IRA. In cases where there is no employer match, the advice seems to be to go for the Roth IRA. But what about my situation where my employer funds my 403b, but *not* as a match? Should I prioritize funding the 403b or use my savings for a Roth IRA instead?

The "online consensus" simply means: if your employer is offering you free money, TAKE IT RUN AWAY TO THE BANK AND DO NOT TURN BACK. It doesn't matter whether it's classified as a "match" or not. It's free money. Take it, contribute whatever you must to get the free money, then fund your Roth.
posted by jckll at 9:51 AM on April 2, 2010


Also check where you are on the tax brackets (similar to what Tomorrowful said). If contributing a little more to the 403(b) on your own bumps you down a tax bracket, do it.
posted by getawaysticks at 10:11 AM on April 2, 2010


The "online consensus" simply means: if your employer is offering you free money, TAKE IT RUN AWAY TO THE BANK AND DO NOT TURN BACK. It doesn't matter whether it's classified as a "match" or not. It's free money. Take it, contribute whatever you must to get the free money, then fund your Roth.

Yes, the thinking behind this is that even if your employer's pre-tax investment plan is not the greatest (such as offering relatively expensive mutual fund options) a 1:1 match starts you off with a 100% gain that is nearly impossible to beat with any other investment option.

So the question is, do you anticipate that when you retire, you'll pay the same, more, or less in taxes than you do now?

Although that's the main consideration, another key one is that a Roth IRA allows you to take back your contributions at any time without penalty, and in certain circumstances (such as buying your first house) allows you to take out the earnings without penalty. This means that, if you contribute $5,000 to your Roth IRA over the next 3 years, and at that point your investments are worth $18,000, you'll have $15,000 that you can treat as a last resort emergency fund and $3,000 that you can use when you reach retirement age (or few other special circumstances before that). With 401(k)/403b, you may be able to borrow from it while you are still employed, but in general taking any money out for any reason before you reach retirement age hits you with a significant early withdrawal penalty.

Another thing to consider is your investment options and fees. With an employer plan, you generally have less options for how your money is invested, but less fees. With a Roth IRA that you open yourself, you can invest in whatever your broker provides, but you will also be subject to whatever fees your broker charges. There are a lot of cheap brokers out there (I use TradeKing for my Roth IRA, because they have cheap trades and don't charge an annual maintenance fee) and low cost funds (like Vangaurd's) so you can usually get something better than your employer's plan.
posted by burnmp3s at 10:15 AM on April 2, 2010


Another big advantage of the Roth is that earnings can be withdrawn tax and penalty free when you qualify for retirement. So the investments you make that are likely to result in more capital gains (such as stocks) you want to load into the Roth IRA.

You can only put $5,000 a year into the Roth anyway (and you can put $5,000 in for 2009 until tax day if you still haven't done that yet). Unless you are in a very high tax bracket now, you will probably want to max out the Roth IRA and then contribute more to the 403(b).

If contributing a little more to the 403(b) on your own bumps you down a tax bracket, do it.

People may read this statement and then suffer a common misunderstanding of how tax brackets work. The higher tax rate is only applied to your income above the tax bracket threshold. For example, the 10% tax bracket for a single filer goes from $0 to $8,375, and 15% starts at $8,376. If you make $8,376, you do not pay 15% on that amount. You pay 10% of $8,375 and then 15% of $1 (which is $8,376 - $8,375). Reducing your income by $1 will not, therefore, reduce your tax by a large amount.
posted by grouse at 10:26 AM on April 2, 2010 [2 favorites]


As mentioned above, comparing your current tax bracket to your estimated future bracket is the correct answer. One other point though: You should probably determine what kind of fees are associated with the 403b. Annuities in a 403b can have very high fees, but even mutual fund companies will charge custodial/administrative fees (note that this is different than the fund's expense ratio which you would pay in a 403b or the Roth IRA). The custodial fee in my university-provided 403b is on the low end at 0.22%
posted by Durin's Bane at 10:29 AM on April 2, 2010


You may also want to look into any vesting issues with the match (er, "not" match) with the money from the employer. May not be an issue but I didn't see it mentioned.
posted by Big_B at 10:53 AM on April 2, 2010 [1 favorite]


As others have said, all other things equal, it comes down to whether you think your tax rate will be higher when you retire or lower. There are two factors to this -- future tax laws and your future spending/withdrawal rate. If you think they will be higher, then the Roth comes out ahead. If you think lower, then the 403(b) comes out ahead. Since predictions are hard, especially about the future, as Yogi Berra would say, you can hedge your bet (or diversify your tax risk as the planners would say) so that you have some of your money in the Roth and some in the 403(b).

The advice above is predicated on all other things being equal, but of course they aren't. You should find out more information about the fees and expenses charged by your 403(b). If they are more than 1% total, you may be better off in a self-directed Roth. You can get a no-fee IRA at Vanguard and mutual funds that have less than 0.20% in expenses.
posted by JackFlash at 11:50 AM on April 2, 2010 [1 favorite]


If you can find a way to afford it...

I'd take advantage of both:
a) the tax-defered savings in the 403b ($16,500 + catchup contributions if you're >=50)
b) and, the Roth IRA ($5,000).

Maxing out both the 403b and the IRA adds and additional $21,500/annum towards your retirement.

That said, I wouldn't contribute to retirement vehicles to the point of illiquidity. For example, if you don't have an emergency savings account you might want to establish that prior to considering fully funding retirement.

That said a Roth stand in for an emergency savings account if you don't have one. As burnmp3s pointed out, because Roths are funded with after-tax money you can withdraw your initial contribution at any time without penalty. You can also perform the same type of operation on your 403b as well, but in those cases it would be a loan (or you pay taxes and penalties on the withdrawal).
posted by cheez-it at 1:08 PM on April 2, 2010


Just so I understand: they pay you $10,000 a year, and then they put another $500 into the 403b? Or your salary is $10,000, and they divert $500 into the 403b, leaving your actual pay at $9500?

I think the conventional wisdom is to always maximize the free money, for the reasons mentioned above. Even if the 403b fees are outrageous, you are still "up" because you wouldn't have *any* of it otherwise.

But a Roth is (purported to be, based on my research) a great way to structure long term savings too. The downside is that it is funded after taxes, so you are paying tax now on money you won't use until later. But the upside is that you (probably) won't have to pay tax on it later.

As for the brackets thing. What grouse says is true. But it is still meaningful. I'd still rather send that last dollar straight to savings as a whole $1, rather than take it as income and only get 85 cents. So if one is on the edge of a bracket, it makes it easier to decide to save the amount above the threshold into a tax-advantaged account knowing that they are getting more utility out of their earnings.

Lets say my income is $1000 over the 25% bracket. So, I decide to save that for retirement. I can send the $1000 to my 401k, which might not give me the best return in the world; or I can send it to a Roth where I can get a better return. But since I'm taking it as income, I'm only getting $750. So if my 401k breaks even at the end of the year, I would have to get a 33% return for that to be the right decision.
posted by gjc at 5:14 PM on April 2, 2010


What gjc says is true, but is missing a critical consideration, the taxes you pay on the withdrawals from your retirement account. Once you take this into account you get the results most people have been saying, which is to invest in roth if you think your taxes will be higher later in life, and not in roth if you think they will be lower. (Most estimates point towards higher unless there are dramatic changes to the way the government deals with taxes and the deficit).

With a roth you might only be investing $750 for every $1000 of your pretax income, but you'll never have to pay taxes on it later once you withdraw (except perhaps if the government breaks its promise). With a non-roth account invested with $1000, if you have to pay the same 25% tax on the holdings once you withdraw at retirement, you'll end up with the exact same amount after tax as you would with your roth account that started at $750. If the taxes at retirement are higher, then the roth would come out ahead.


GJC is correct about the fact that the marginal benefit of investing in a roth account decreases as your income increases, since your tax rate will be higher now (so it is less likely that your retirement tax rate will be much higher than your current tax rate.)
posted by vegetableagony at 11:56 AM on April 16, 2010


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