"Traditional" V. "Roth" — The 403(b) Decision

What is the difference between Traditional 403(b) Salary Deferrals and Roth 403(b) Salary Deferrals?
Under your employer’s retirement plan, you can elect to defer a portion of your compensation for contribution to the plan as a Salary Deferral. You can make Traditional 403(b) Salary Deferrals or Roth 403(b) Salary Deferrals. Traditional 403(b) Salary Deferrals are made on a pre-tax basis. This means you are not currently taxed on the portion of your compensation that is contributed to the plan as Traditional 403(b) Salary Deferrals. You will be taxed on any Traditional 403(b) Salary Deferral contributions you make to the plan, and any earnings on those contributions, when you receive a distribution from the plan. On the other hand, Roth 403(b) Salary Deferrals are made on an after-tax basis. This means you will pay taxes on your Roth 403(b) Salary Deferrals at the time of the contribution. Because you will have already paid tax on your Roth 403(b) Salary Deferrals, you will not pay tax when your Roth 403(b) Salary Deferrals are distributed to you. In addition, as explained below, if a distribution is a “qualified distribution,” you will not pay any tax on the earnings.

Am I eligible to make Roth 403(b) Salary Deferrals?
There are no special eligibility requirements to make Roth 403(b) Salary Deferrals. If you are eligible to make Traditional 403(b) Salary Deferrals, you are eligible to make Roth 403(b) Salary Deferrals.

How do I make Roth 403(b) Salary Deferrals?
You can elect to make Roth 403(b) Salary Deferrals online by logging into your account. When you elect to make Salary Deferrals, you must indicate whether you want to make Traditional 403(b) Salary Deferrals on a pre-tax basis, or Roth 403(b) Salary Deferrals on an after-tax basis. After a contribution, either Traditional or Roth, is received in the plan, it’s status cannot be changed. For example, if a Traditional contribution is made into the plan now, it can never be changed into a Roth contribution in the future.

What is the maximum amount of Roth 403(b) Salary Deferrals I can make?
The maximum amount of Salary Deferrals you can make in 2009 is $16,500, or $22,000 if you are more than 50-years-old. It does not matter whether you make Traditional 403(b) Salary Deferrals or Roth 403(b) Salary Deferrals. This limit is subject to cost-of-living adjustments

How is a Roth 403(b) Salary Deferral distribution taxed?
If you receive a “qualified distribution” of your Roth 403(b) Salary Deferral Account, the entire distribution (i.e., your Roth 403(b) Salary Deferrals AND the earnings on your Roth 403(b) Salary Deferrals) will not be taxed. A qualified distribution is a distribution that satisfies the “5-year” rule and is made after your attainment of age 59 ½, death, or disability. The 5-year rule is met if five calendar years have passed since you first made a contribution to your Roth 403(b) Salary Deferral Account.
Example: Robert terminates employment May 31, 2011, when he is 58-years-old. Robert made his first Roth 403(b) Salary Deferral contribution in 2006. At the time of his termination of employment, the balance of Robert’s Roth 403(b) Salary Deferral Account is $15,000, which consists of $12,000 of Roth 403(b) Salary Deferrals, and $3,000 in earnings on his Roth 403(b) Salary Deferrals. Under the terms of his employer’s plan, he is eligible to receive a distribution of his Roth 403(b) Salary Deferral Account. Although the distribution would satisfy the 5-year rule, the distribution is not a qualified distribution because the distribution was not made after Robert’s attainment of age 59-½, death, or disability. The portion of Robert’s Roth 403(b) Salary Deferral Account attributable to his Roth 403(b) Salary Deferrals will not be taxed (because the contributions were subject to tax at the time of contribution), but the portion of his Roth 403(b) Salary Deferral Account attributable to earnings will be subject to tax because the distribution was not a qualified distribution.
Example: Susan terminates employment in 2009 when she is 60-years-old. Susan made her first Roth 403(b) Salary Deferral contribution in 2006. Her employer’s plan permits her to receive a distribution because she has terminated employment. Although a distribution will be made to Susan after she has attained age 59-½, the distribution will not be a qualified distribution because the distribution has not satisfied the 5-year rule. The 5-year rule period begins January 1, 2006 (the January 1st of the year in which Susan made her first Roth 403(b) Salary Deferral contribution) and ends December 31, 2010 (the last day of the 5-year period). The portion of Susan’s Roth 403(b) Salary Deferral Account attributable to her Roth 403(b) Salary Deferrals will not be taxed (because the contributions were subject to tax at the time of contribution), but the portion of her Roth 403(b) Salary Deferral Account attributable to earnings will be subject to tax because the distribution was not a qualified distribution. If Susan waits until January 1, 2011, the distribution will satisfy the 5-year rule, and the distribution of her Roth 403(b) Salary Deferral earnings would not be subject to tax.

Can I rollover my Roth 403(b) Salary Deferral Account?
If you are entitled to receive a distribution of your Roth 403(b) Salary Deferral Account, then you may roll over your Roth 403(b) Salary Deferrals to a Roth IRA or to a 403(b) or 403(b) plan that permits Roth Salary Deferrals. You cannot roll over your Roth 403(b) Salary Deferrals to a Traditional IRA or to any other plan.

How do I determine whether to make Traditional 403(b) Salary Deferrals or Roth 403(b) Salary Deferrals?
            You should consider certain factors when deciding whether to make Traditional 403(b) Salary Deferrals or Roth 403(b) Salary Deferrals.
            ▪ Ability to Make Greater Contributions. If you made the same amount of Roth 403(b) Salary Deferrals as Traditional 403(b) Salary Deferrals, your paycheck would be less if you made Roth 403(b) Salary Deferrals. If you can make the same level of contribution to a Roth 403(b) Salary Deferral Account that you could make to a Traditional 403(b) Salary Deferral Account, you should consider making Roth 403(b) Salary Deferrals rather than Traditional 403(b) Salary Deferrals. If making Roth 403(b) Salary Deferrals instead of Traditional 403(b) Salary Deferrals means you will have to make a smaller contribution, you should make sure you are at least making enough Salary Deferrals to receive the maximum amount of matching contributions, if applicable. Similarly, if you cannot afford to take home a smaller paycheck, then you may want to consider making Traditional 403(b) Salary Deferrals.
            ▪ Comparison of Current and Future Tax Rates. Traditional 403(b) Salary Deferrals (and earnings thereon) are taxed when they are distributed from the plan. In contrast, Roth 403(b) Salary Deferrals are taxed when they are contributed to the plan. You should, therefore, consider your federal income tax rate when you receive distributions compared to your current federal income tax rate. For example, if you believe your federal income tax rate will be lower when you receive distributions from the plan, you should consider making Traditional 403(b) Salary Deferrals. On the other than, if you believe your federal income tax rate will be higher when you receive distributions from the plan, you should consider making Roth 403(b) Salary Deferrals. Of course, your income tax rate when you receive distributions from the plan will depend on your taxable income at that time, as well as any changes in the tax laws between now and then.
            ▪ Receiving a Qualified Distribution At the time you make Salary Deferrals, you should consider when you will probably withdraw those Salary Deferrals from the plan. If you believe you will need to receive a distribution before the 5-year rule is satisfied (or before your attainment of age 59-1/2, death, or disability), you should consider making Traditional 403(b) Salary Deferrals. The longer earnings can accumulate in your Roth 403(b) Salary Deferral Account, it is likely more advantageous to make Roth 403(b) Salary Deferrals rather than Traditional 403(b) Salary Deferrals. This, however, is not always the case. If you are unsure about whether to make Roth 403(b) Salary Deferrals or Traditional 403(b) Salary Deferrals, you should consult a tax professional. You should always keep in mind that when it comes to your retirement, it is usually best to save as much money as possible in your employer’s plan whether you make Traditional 403(b) Salary Deferrals or Roth 403(b) Salary Deferrals.