Which Account Is Best for Retirement Savings?

Q: Which is better for a 45-year-old: a 403(b) retirement account or a Roth IRA? — Marie

A: You might think about doing a little bit of both, say Gretchen Cliburn, a certified financial planner with BKD Wealth Advisors headquartered in Springfield, Mo.

The key difference between 403(b) accounts, which are retirement plans for public-sector and non-profit employees, and Roth IRAs is taxes.

Your contributions to a 403(b), as with 401(k) plans, are made before taxes, which super-charges your savings on the front end. But you’ll owe taxes on the income when you start withdrawing funds for retirement.

It’s just the opposite with a Roth. Here you pay taxes before you make your contributions, but then you can rest easy knowing that you won’t owe Uncle Sam when you withdraw funds for retirement down the road.

Generally, it makes sense to focus on making contributions to a 403(b) if you think your tax rate will be higher now than when you retire, says Cliburn. A Roth typically works best for people who are just starting out and expect to be subject to a higher tax rate in retirement.

If you have no idea what your tax situation will be a decade or three from now, you can split the difference.

“If your employer matches contributions you always want to take advantage of that,” she says. Once you hit that limit, however, you may want to look to a Roth IRA.

In fact, many experts, including Cliburn, advocate “tax diversification.” Just as you want to make sure you don’t take too much risk in any one spot in your portfolio, there’s some wisdom for spreading your tax risk.

Beyond tax treatment, there are some other pros and cons of each. With a 403(b), you can sock away up to $18,000 a year, plus another $6,000 after you turn 50. Traditionally, the knock against 403(b) plans has been high fees and, for smaller plans, limited investment options; most were based on annuities. Things have improved over the last decade, but as with any retirement plan, consider the investment options available.

One of the big selling points of Roth IRAs, conversely, is control and choice of investment options. You can set up a Roth with banks, brokerages, or fund companies, and in most cases you can pick from an extensive menu of mutual funds and other investments.

The tradeoff: The maximum you can contribute to a Roth is $5,500 annually ($6,500 for those 50 or older) — and that’s if you qualify. If you’re single, contribution limits kick in when your adjusted gross income reaches $116,000 and phase out completely at $131,000. (If you’re married, those numbers are $183,000 and $193,000 respectively.)

With all of this in mind — taxes, investment options, and contribution limits — here’s a simple strategy for getting the biggest bang for your buck:

Step #1: Contribute to your 403(b) plan in as much as you take full advantage of any match offered by your employer. No doubt you’ve heard it before, but this is free money that you do not want to leave on the table, even if you think your tax rate will be higher in retirement.

Step #2: Once you’ve maxed out on your match, turn your attention to saving in a Roth. Doing so will not only help you hedge your tax bets, it may give you access to a better menu of investments than are offered in your employer plan.

Step #3: After you snag the match from your employer and max out on the Roth, go back to saving in your employer plan for the remainder of the year.

When a new year begins, repeat.

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