Roth IRA or after-tax 403(b)

Forum|Forum|5 years ago
June 28, 2020
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Suppose that I am over age 50, and I am eligible to contribute to a 403(b) at work, and my income is such that I may contribute to a Roth IRA but not a traditional IRA. The 403(b) plan has a number of attractive mutual funds with low expense ratios, and, as I am already their customer, I may invest Roth IRA funds in the same group of funds. I have made the strategic decision that if I contribute to the 403(b), it will be after tax, i.e. a Roth 403(b).

Under those circumstances, is there any particular advantage or disadvantage to contributing to one or the other. If for example I have $8000 to contribute, is it better to contribute $8000 to the 403(b), or $7000 to the Roth IRA and $1000 to the 403(b). I am aware of the limitation of the 403(b) funds that I may not withdraw them until age 59-1/2 or I terminate employment, while I may withdraw Roth IRA principal at any time. Are there any other benefits or pitfalls to one or the other type of vehicle?

D

dmertz

Employee

If the investment options are the same, it's better to contribute to the Roth IRA up to the contribution limit mainly for the reason that you stated. However, if you presently have no funds in a Roth IRA, contributing at least something to a Roth IRA gets the 5-year clock for qualified distributions from your Roth IRAs started so that once you have satisfied the both that requirement and have reached age 59½ any regular distribution you take from a Roth IRA is entirely tax free. Each Roth 401(k) plan in which you participate instead has it's own 5-year clock for distributions from the Roth 401(k) to be qualified distributions and a rollover of a Roth 401(k) to open your first a Roth IRA does not carry the beginning date of the Roth 401(k)'s 5-year clock with it.

Also, once the 5-year clock for distributions for your Roth IRAs to be qualified distributions has been met, if you take any earnings up to $10,000 lifetime from the Roth IRA (after receiving distributions of all of your contribution basis) for a first-home purchase, the distribution of these earnings will be tax free.

Of course if you have sufficient compensation available to do so, nothing prevents you from contributing the separate maximums to both the Roth 401(k) and the Roth IRA. If your employer provides a matching contribution, you would want to contribute to the 401(k) at least enough to obtain the maximum match before switching to contributing to the Roth IRA; the employer's matching contribution goes into the traditional account in the 401(k), but you can perhaps do a taxable In-plan Roth Rollover to move that to the Roth account in the 401(k). Also, if you are age 50 or over you probably need to contribute the maximum permissible regular elective deferral or Roth contribution to the 401(k) to be able to make the additional catch-up contribution permitted to be made to the 401(k). Finally, money in the Roth IRA might not have the creditor protection that it would in the Roth 401(k), depending on your state of residence.