A reader was thinking about her retirement income planning and needed to decide between contributing to a 403b versus an IRA.
First, what is a 403b?
These are retirement accounts available to certain employees. Basically, if you work for an educational institution, civil government or certain nonprofit organizations, your employer probably offers a 403b plan. These plans are pretty similar to 401k plans. You can put money aside for your retirement on a pretax basis and the money grows tax-deferred. When you take money out of the account, you’ll have to pay your income tax.
Early withdrawals (generally speaking, prior to age 59 ½) are subject to the 10% penalty, but there are a number of ways you can withdraw money penalty-free:
· You reach the age of 59½.
· You retire from service at the age of 55 or older.
· You become disabled.
· You die.
What are the benefits of a 403b over an IRA?
1. If you participate in a 403b, you can defer up to $16,500 (2010). If you are over age 50, you can contribute an additional $5,500 (2010). Some employers will make matching contributions to a 403b. IRA contribution limits are much lower: $5,000 for those under 50 and $6,000 for those over 50; and nobody matches your IRA contributions no matter what your age is.
2. You can borrow money from a 403b plan but not from an IRA. If you do take a loan you must pay it back with interest. Having said that, sometimes being able to borrow money from your retirement plan isn’t such a blessing.
3. If you retire at 55 or older, you can access your 403b money penalty-free. If you have an IRA, you have to wait until you are 59 ½ to access the money penalty free.
What are the disadvantages of a 403b plan?
1. Investment choices in 403b are limited and they are often expensive. It’s also very difficult to even know what the real costs are of the choices provided. To make matters worse, many plans only offer fixed and variable annuities. This is a very expensive proposition because on top of the plan expenses, the annuities have their own costs. Also, annuities often have ridiculously long surrender periods. It almost never makes sense to buy annuities within any retirement account but the 403b plans often leave you no choice.
2. IRAs offer a lot more investment flexibility. You can invest your IRA just about any way you want and usually much less expensively. You can change your investments whenever you like and you can even hire a financial adviser to manage your IRA for you. The 403b plans are limited in the choices you have and the frequency with which you can make changes.
3. IRAs offer a lot more flexibility with respect to beneficiary planning. For example, if Mary dies and she names a non-spouse beneficiary, that person could take advantage of Inherited IRA rules that provide much greater deferral than the 403b offers.
Now that I’ve convinced you that the IRA is a better choice, I have some bad news. None of this may matter.
Why? There are a number of IRA restrictions and you may not have any choice.
If your joint income exceeds $89,000, your ability to make deductible contributions to an IRA is phased out since you have the option to participate in a 403b plan. That’s right…even if you chose not to participate in the 403b, your deductible contributions to an IRA are restricted.
If you have limited resources and are interested in getting the best immediate tax break, you should first maximize your contributions to the 403b if your joint income is over $89,000.
(If you go this route, you should call the administrator and ask for the booklet that describes ALL the investment options. I know from firsthand experience how difficult it is to get information from employers and there are many reasons for this. Without going into a very long story, suffice it to say that the investments that teachers and other participants in the 403b plan are approached with are rarely the best deals. In fact, they usually stink.)
If your joint income is below $89,000, you will have the option of putting your money into the 403b or a deductible IRA. If that’s the case, go with the IRA. This will give you the most flexibility and lowest cost.
What advice would you give? Do you think the 403b is better? Should you skip both the 403b and IRA and opt for a ROTH?
Carol Whelan says
I have a 403B with Russell. Also have 403B with Security Benefit Life which is still connected to the town I worked in. The Russell has been doing well with equities. The SBL has a guarantee of 4%. My financial advisor wants to change them both to an IRA. I will keep the same equities and 4% guarantee. I am told that funds will be easier to access in an IRA. I am not sure why or if I should roll over. I took my first RMD this year and I am no longer making contributions as I retired 13 years ago.
Neal Frankle, CFP ® says
I’d have to know more. Make sure your advisor isn’t just interested in the commission they could generate.
Caroline Ehrlich says
I just spoke with my 403b representative(Fidelity administers the account) and since I am 70 1/2 this year, I must beging taking out a MRD for this calendar year. I also asked whether my beneficiaries could roll over their inheritance into an inherited IRA, and he said yes. A 403b could be rolled over into an inherited IRA. Is he correct? Caroline Ehrlich
Christian says
I contribute to both the 403(b) plan my agency has set up, AND a ROTH IRA. I max out my ROTH and put as much as I’m comfortable living without into the 403(b). As bad as it sounds, there’s no real strategy behind this other than I want to save more for retirement than the $5000/year allowed by the ROTH limits.
Neal@Wealth Pilgrim says
Hey Christian,
I don’t about anyone else…but this doesn’t sound bad at all. I’d rather you save too much than otherwise. But you can even run yourself a free financial projection at a number of sites to see if you are overdoing it.
I only bring this up because it’s important to enjoy too! Not sure if you’re going without….but I like having a plan because it puts it all in perspective.
Bern says
Hey Christian,
I commend you for taking action on saving. It’s rare these days.
However, I hope I don’t overstep my boundaries by bringing up a concern with your strategy. With one plan, you enter pre-tax money – 403(b). With the other plan, you enter post-tax money – Roth IRA. Tax savings is going from one pocket into the other. Thus, it’s splitting strategies.
What I tell people is to take a step back and look at all of their strategies. It’s hard for us to compartmentalize each financial action…but all are related and affected by one another.
How you pay off your mortgage will affect your retirement. How you plan for retirement will affect your liquidity. How high or low your credit score is will affect your credit card payment. And so on…
For me, I think it’s best to take a macro view of our finances to make sure that everything is firing on all cylinders. Just something to consider…
Spokane Al says
Just one small clarification – you stated in part, “If you have an IRA, you have to wait until you are 59 ½ to access the money penalty free.”
One can access IRA money penalty free via the 72t provision of the IRA code which states that in order to avoid penalties one must take substantially equal payments over five years or until one reaches 59.5, whichever is longer.
This must be done very carefully and I would recommend that one do his/her research to avoid conflict with the IRS.
Neal says
Spokane Al..
You are correct. Thanks for pointing this out.
Bern says
In my opinion, neither. These “qualified” retirement plans come with too many strings attached.
They’re easy to get money in but no one really considers how the funds will be accessed when it is needed.
In the end, the government wins. We don’t invest in these plans anymore. We use our money to create our own personal bank and control our money on our terms.
Neal says
I’ll have to admit you bring up an interesting point.
I need to really think about this.
What “could never happen” only a few short years ago seems to happen every day now.
Can anyone guarantee what the government is going to do with our money 10, 20 years down the road?
Hmmmmmm