Which type of retirement account is right for you? Money Girl answers a voicemail question about using a FICA Alternative Plan, choosing the right retirement plan, and reaching your financial goals. Plus, you'll get an explainer about all those payroll taxes deducted from your paychecks.
Differences Between a Traditional and Roth Retirement Plan
Jamie mentioned that she has the option to set up her FICA Alternative Plan as a traditional or a Roth retirement account, using either a 403(b) or a 457(b) plan. But she needs clarification on their differences to know which one would be best for her.
In general, these plans work the same whether you fund them for a FICA Alternative Plan or not. Traditional plans are tax-deferred, which means amounts contributed are not included in your taxable income for the current year. Instead, you pay income tax on distributions taken out in retirement.
Roth plans have the opposite taxation because you don’t get a tax break on contributions in the year you make them. However, any type of Roth account allows you to take withdrawals in retirement that are completely tax-free.
Roth plans have the opposite taxation because you don’t get a tax break on contributions in the year you make them. However, any type of Roth account allows you to take withdrawals in retirement that are completely tax-free. That can add up to massive tax savings!
Unlike a Roth IRA, which isn’t available if your income exceeds certain limits, Roth accounts at work have no income limits or restrictions. You can participate in a Roth 401(k), a Roth 403(b), or a Roth 457(b) no matter how much you earn.
Using a Roth makes sense if any of these apply to you:
- You believe that your income tax rate will be higher in retirement than it is now.
- You don’t need a deduction to reduce your taxes in the current year.
- You have many years to go before retirement.
- You want tax-free withdrawals to diversify your retirement income.
What Is a 403(b) Retirement Plan?
Now, let’s talk about the account types that Jamie can use for her FICA alternative plan, starting with a 403(b). It’s offered by many non-profits, public schools, churches, hospitals, and government agencies. They’re similar to the more well-known 401(k) retirement plan offered by many for-profit companies.
For 2019 (just like with a 401(k), you can contribute up to $19,000, or up to $25,000 if you’re over age 50, to a 403(b). One of the main benefits of having a 403(b) is that if you stay in your job for 15 years, your plan may allow you to save more than these limits, even if you’re younger than 50.
What Is a 457(b) Retirement Plan?
The other type of retirement account available to Jamie is a 457(b). There’s a version offered by state and local government agencies and one with slightly different rules offered by tax-exempt organizations.
For 2019 (just like with a 401(k) and a 403(b)), you can contribute up to $19,000, or up to $25,000 if you’re over age 50, to a 457(b).
One of the main benefits of a 457(b) is that you can make aggressive catch-up contributions starting when you’re three years away from retirement. For example, if your plan specifies 65 as your retirement age, once you reach 62 you can contribute a total of $38,000 for 2019 as long as you earn that much.
Additionally, if an employer offers both a 403(b) and a 457(b), workers may be eligible to max out both plans in the same year. So, my recommendation for Jamie is to split her contributions between both a Roth 403(b) and a Roth 457(b). That will allow her to get the best of both types of retirement accounts available in her FICA Alternative Plan.
For a summary of rules for using different retirement accounts, download the free Retirement Account Comparison Chart. This handy resource spells out everything you need to know on a one-page PDF.
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