403b and IRA
403b and IRA refer to retirement plans with similar tax benefits and a few marked differences.
In addition, each has its unique strengths and weaknesses, which we shall look at throughout this article.
Without further ado, let’s look at 403b vs IRA and which retirement plan is best for you.
403b Retirement Plans
A 403b retirement plan is an employer-facilitated tax-sheltered annuity (TSA) retirement program offered by public schools, churches, and other tax-exempt organizations.
The employees contribute part of their salary. Their employer can also match a portion of the contribution to their employees’ accounts. This is at the employer’s discretion and is not mandatory.
The participants of this retirement savings plan are mainly educators and public school administrators, public servants, certain ministers, and non-profit organization employees.
The savings in a typical 403b are deposited in the plan before any tax is deducted, which will be deducted when the funds are withdrawn from the account.
The tax levied is pegged on the contributor’s prevailing tax bracket at the point of withdrawal, which is usually after retirement.
This can be advantageous in two ways:
- The tax bracket is naturally expected to be lower upon retirement because the contributor’s compensation goes down. As a result, the amount of tax taken out will be less than what would have been taken out if the tax was levied when the contribution was made, assuming there won’t be any radical tax code fluctuations during the period.
- Funds in the 403b account are tax-deferred, allowing the account to grow faster because the IRS does not take its share during the investment period. As a result, you can compound the revenue from these tax savings, maximizing returns on your retirement savings.
The maximum amount an employee can contribute to a 403b is whichever is lesser, between 100% of their compensation that is included in this computation or $19,500 between 2020 and 2021. After that, the IRS adjusted the threshold subject to annual computations of rises in the cost of living.
A contributor who is 50 or older is allowed to contribute an extra $6,500 annually as a retirement catch-up contribution in 2020 and 2021, also subject to IRS cost of living adjustments.
An employee who has worked for the same 403b qualified organization for 15 years is also allowed to make an extra catch-up contribution of up to $3,000 annually, whether or not they have reached 50 years, provided they meet other criteria stipulated by their specific plan.
Again, they can do this for up to 5 years, which can pump an extra $15,000 into their retirement account.
403b plans are eligible for matching contributions depending on the employer’s flexibility.
Suppose the employer opts to match the employee’s contribution to any percentage. In that case, the maximum annual total of both their contributions is whichever is lower between $58,000 for 2021 (subject to cost of living adjustments) or the employee’s most recent annual compensation that can be included in the computation.
The employer can even keep making these contributions to the employee’s account for up to 5 years after severance of employment if their specific plan allows it.
Individual Retirement Account (IRA)
An IRA is also referred to as an individual retirement arrangement by the Internal Revenue Service (IRS). These are accounts that individuals open with financial institutions that they use to save for their retirement.
The accounts usually have tax advantages to encourage saving for retirement.
These accounts are used to deposit earnings from their current employer that will be used to support the contributor in the future. Individuals can easily set up their retirement accounts as long as they have an income. They do not need the employer’s input to start contributing towards retirement.
The maximum annual contribution to an IRA is $6,000 in 2021, subject to cost of living adjustments. If you are 50 years and above, you get an optional allowance of $1,000 as a retirement catch-up contribution, bringing the maximum possible contribution to $7,000.
If your taxable income is less than these amounts, it becomes the maximum, as you cannot contribute more than your income.
People of all ages can contribute to an IRA, and you only get to access the funds without penalties after reaching the age of 59.5 years.
Tax for a traditional IRA is also deferred up to the withdrawal time, which will be levied at the contributors prevailing tax bracket. Therefore, the tax savings and benefits are the same as the 403b.
403b vs. IRA
Several 403(b) plans are not protected by the Employee Retirement Income Security Act (ERISA). As much as it is not entirely foolproof, it has enforceable standards for retirement plans to safeguard your savings.
You will have more peace of mind if the retirement plan is regulated.
On the other hand, subjecting the plans to such rules can also mean higher administrative costs.
With the margins already struggling for 403b plans, one should be careful when balancing income against risk. Look for the ones offering passive investment options like exchange-traded funds (ETF) with the lowest costs. The expense ratio should not be more than 0.5% of your earnings from the fund.
Cost of Investment
Because a 403b retirement plan limits you to the vendors offered by the employer, you lose the ability to pick the best offer.
The smaller margins of limited investment options also raise the relative investment cost in these plans.
Any charges incurred directly affect your retirement savings, and the growth can be reduced substantially if not monitored.
IRAs are considerably cheaper than 403b’s because they are more competitive and require less administrative expenditure.
Employer Matching Contributions
This is a source of extra retirement money that employees can access, which is not available for regular IRAs but is accommodated in 403(b) plans.
It only becomes an advantage if the employer agrees to make their payment.
The extra income makes a significant contribution to the retirement kitty. Unfortunately, the IRA holder lacks a facility for the employer to chip in.
403b’s have much higher contribution limits and a larger retirement catch-up allowance which is more flexible. Therefore, you will build your retirement savings much faster if you maximize your 403b vs. IRA contributions.
These limits should be considered with other variables in mind, though. The limit might be higher, but the contributor lacks the resources to maximize them.
Investing in an IRA with higher returns in such a situation can be more beneficial.
Diversity of Investment Options
An IRA will generally have more and better investment choices than a 403b. A 403b retirement plan tends to shy away from complex investments like stocks, bonds, certificates of deposits (CDs), exchange-traded funds (ETFs), and other fixed-income avenues.
Often their own rules don’t allow them to venture into these fields. However, having an IRA on the side will let you balance your portfolio.
These accounts are mostly opened in financial institutions like mutual funds companies or stock brokerage firms specializing in such trades.
However, some employers will have access to some impressive mutual funds that you can’t invest in on your own with just an IRA. Therefore, you should weigh all available offers. Sometimes there will be viable opportunities for growth on both options.
Combination of 403b and IRA
Fortunately, you can contribute to both a 403b and an IRA to ensure you have accumulated enough savings to sustain yourself in retirement. The IRA will supplement the savings from the employer-sponsored retirement plan.
In so doing, you will have diversified your investment options and created additional opportunities to maximize tax relief on your earnings.
You can also roll over your 403b contributions to an IRA once you become eligible or retire from employment because the 403b benefits are not applicable when your income ceases.
Apply for a direct rollover, as it will allow you to retain your deferred tax status and avoid incurring early withdrawal penalties or prevailing taxes.
Which Retirement Plan Is Best Between 403b and IRA?
There is no overall winner. Instead, each plan has its unique applicability, and it can bog you down or buoy you towards a cozy retirement, depending on your circumstances.
Your risk aversion, age, employment status, when you expect to retire, and financial goals will influence the kind of plan that works for you.
Consider using both options in varying proportions to reap the best from both plans. The 403b contribution limit is isolated from the IRA limit so that you can maximize your contributions to both accounts in the same year.