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As an individual looking to save for retirement, many options are available, including Roth 457(b) and Roth IRA accounts. While both accounts are designed to provide tax-free retirement income, they differ in significant ways, such as contribution limits and employer involvement. For example, in 2023, the contribution limit for Roth IRA accounts will be $6,500 (or $7,500 for individuals age 50 or older), while the contribution limit for Roth 457(b) accounts will be $22,500 (or $30,000 for individuals age 50 or older). This article will explore the differences between these two retirement savings vehicles and help you determine which one is better suited to your needs.
What is a Roth 457(b) account?
A Roth 457(b) account is a type of employer-sponsored retirement savings account available to employees of state and local governments, as well as specific non-profit organizations. It is similar to a 401(k) in that it allows you to make pre-tax contributions that grow tax-free until retirement. However, unlike a traditional 401(k), Roth 457(b) contributions are made on an after-tax basis, which means that you pay taxes on your contributions upfront but enjoy tax-free growth and withdrawals in retirement.
One of the significant benefits of a Roth 457(b) account is that it allows you to contribute a substantial amount of money each year, even more than a traditional IRA or Roth IRA. As mentioned, the contribution limit for Roth 457(b) accounts in 2023 will be $22,500 (or $30,000 for individuals age 50 or older), significantly higher than the contribution limit for Roth IRAs. Additionally, Roth 457(b) accounts do not have income limits, meaning high-income earners can contribute to these accounts without any restrictions.
Another benefit of Roth 457(b) accounts is that they offer more flexibility than traditional retirement accounts. For example, you can withdraw money from a Roth 457(b) account without penalty if you have reached age 59 1/2. Additionally, you can take out loans from your Roth 457(b) account if you need to borrow money for a specific expense.
What is a Roth IRA?
A Roth IRA is a type of individual retirement account that allows you to make after-tax contributions that grow tax-free until retirement. Unlike traditional IRAs, Roth IRAs do not offer an immediate contribution tax deduction. Instead, you pay taxes on your contributions upfront, and then the money grows tax-free until retirement. When you withdraw money from a Roth IRA in retirement, it is tax-free.
One of the significant benefits of a Roth IRA is that it offers a high degree of flexibility. You can open a Roth IRA at any brokerage firm, bank, or other financial institution, and you can invest in a wide range of assets, including stocks, bonds, mutual funds, and exchange-traded funds. Additionally, Roth IRAs do not have required minimum distributions (RMDs), meaning you can leave your money in the account to grow tax-free for as long as you want.
However, as mentioned, the contribution limits for Roth IRAs are significantly lower than those for Roth 457(b) accounts. For example, in 2023, you can only contribute $6,500 (or $7,500 if you are 50 or older) to a Roth IRA. Additionally, Roth IRAs have income limits, which means that high-income earners may be unable to contribute to these accounts.
Which is better, 457-b or Roth IRA?
Roth 457(b) accounts may be a better option for those looking to contribute more money to their retirement savings after-tax. In comparison, Roth IRAs may be a better option for those who value flexibility and the absence of RMDs.
- Roth 457(b) accounts are employer-sponsored retirement savings accounts available to employees of state and local governments, as well as specific non-profit organizations.
- Roth IRA accounts are individual retirement accounts that can be opened at any brokerage firm, bank, or other financial institution.
- Roth 457(b) contributions are made on an after-tax basis, while Roth IRA contributions are made on an after-tax basis.
- The contribution limit for Roth 457(b) accounts in 2023 will be $22,500 (or $30,000 for individuals age 50 or older), which is significantly higher than the contribution limit for Roth IRAs ($6,500 or $7,500 if you are age 50 or older).
- Roth 457(b) accounts do not have income limits, while Roth IRAs do have income limits, which means that high-income earners may be unable to contribute to these accounts.
- Roth 457(b) accounts offer more flexibility than Roth IRAs regarding withdrawals and loans.
- Roth IRAs do not have required minimum distributions (RMDs), meaning you can leave your money in the account to grow tax-free for as long as you want.
- Roth 457(b) accounts may be a better option for those looking to contribute more money to their retirement savings after-tax. In comparison, Roth IRAs may be a better option for those who value flexibility and the absence of RMDs.
Let’s consider a scenario where an individual wants to contribute $25,000 after-tax dollars to their retirement savings account. They have already maxed out their traditional 401(k) contributions and are now considering whether to contribute to a Roth 457(b) account or a Roth IRA.
If they choose to contribute $25,000 to a Roth 457(b) account in 2023, they will need to pay taxes on that amount upfront, which will depend on their income tax rate. For this example, let’s assume they are in the 24% tax bracket, meaning they will owe $6,000 in taxes upfront (24% of $25,000). The remaining $19,000 will be invested and grow tax-free. In retirement, when they withdraw that $19,000, they will not owe any taxes, assuming they follow the IRS rules for qualified withdrawals.
If they choose to contribute $25,000 to a Roth IRA in 2023, they will also need to pay taxes on that amount upfront, which will depend on their income tax rate. For this example, let’s assume they are in the 24% tax bracket, meaning they will owe $6,000 in taxes upfront (24% of $25,000). The remaining $19,000 will be invested and grow tax-free. However, in retirement, when they withdraw that $19,000, they will not owe any taxes on it, assuming they follow the IRS rules for qualified withdrawals.
So, in this scenario, the tax treatment of the contributions and withdrawals is the same for both accounts. However, the contribution limits are different. As mentioned, the contribution limit for a Roth 457(b) account in 2023 will be $22,500 or $30,000 if over age 50, while the contribution limit for a Roth IRA is $6,500 or $7,500 if over age 50.
Therefore, if this individual wants to contribute more than $7,500 after-tax dollars to their retirement savings account in 2023, a Roth 457(b) account may be a better option. In addition, they can contribute up to $22,500 or $30,000 if over age 50, significantly more than the Roth IRA contribution limit of $6,500 or $7,500 if over age 50.
Conclusion
In summary, both Roth 457(b) accounts and Roth IRAs offer unique benefits and may be more suitable for different individuals depending on their financial goals and circumstances. Roth 457(b) accounts may be a better option for those looking to contribute more money to their retirement savings after-tax. In comparison, Roth IRAs may be a better option for those who value flexibility and the absence of RMDs.
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