by Starla Ross

Created on: December 15, 2010

When saving for retirement, employees of non-profit organizations now have an additional option - the Roth 403(b) retirement plan.  The 403(b) has been the staple of employees of non-profit 501(c)(3) organizations, public schools, and civil governments for many years, but in 2006 the option of contributing to a Roth 403(b) plan became available.

What is a 403(b) plan?  In short, the 403(b) retirement plan has the same tax rules and contribution limits as a 401(k) plan designed for private sector workers, but it's designed specifically for non-profit employees.  Contributors can put their own money into their retirement account, and employers have the option of contributing to the 403(b) as well.

With a traditional 403(b) plan, employees contribute money to their retirement accounts before they pay taxes.  This decreases the gross income shown on their year-end tax return, and therefore lowers the tax rate and tax payment for the year.  When employees take cash out of the plan, they must count the cash as income and pay federal income tax for the year the amount was withdrawn.

The Roth 403(b) plan combines the benefits of both the Roth IRA and the 403(b) plan.  With the Roth 403(b), employees contribute money to the retirement and do not take the tax benefit for that year.  The amount they put in retirement is included in their gross income for the year, and therefore they pay taxes on that amount.  However, the benefit comes later.  When monies from a Roth 403(b) are cashed in at retirement, employees pay no federal income tax on that amount.

There are some contribution imitations to the Roth 403(b), just as there are with other types of retirement plans.  A worker may contribute only up to $16,500 per year to the plan.  For the years 2010 and 2011, employees 55 years of age and older may contribute an additional $5,500 more.  Employers are also allowed to contribute to an employee's plan.  The maximum contribution allowed (including both employee and employer contributions) is $49,000 or no more than 100 percent of the employee's annual compensation.

In addition, contributors must pay attention to withdrawal rules as well.  Withdrawals from the 403(b) are tax-free if the money is withdrawn after five years of the first 403(b) contribution, and if the contributor is 59 1/2 years or older.  The worker must start taking contributions by 70 1/2 years of age.  If these rules are not met, there is a possible penalty for withdrawal.  The exceptions to these withdrawal rules are death or disability of the worker.

If an employer puts money into a 403(b) account for a worker, those monies are contributed on a pre-tax basis.  Because the worker has not paid taxes on that money, that portion of the 403(b) is subject to taxation when it is withdrawn.

Requirements for employers administrating the 403(b) are fairly simple.  Employers must place contributions from their employees' Roth 403(b) plans into a separate bank account and keep the funds separate from other monies.

To determine whether a Roth 403(b) is the right retirement option, the employee must make a guess as what his/her finances will look like in the future.  If an employee believes he/she is in a higher tax bracket today then upon retirement, avoiding the tax bill now and staying with a traditional 403(b) may be a better decision.  However, if it looks as if the employee's tax rate will be higher in retirement, the Roth 403(b) has to offer and may be the most attractive option.

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