With such an uncertain future for Social Security, individuals look to the safety of retirement savings plans such as the 403(b). But there comes a time when an individual may need to take a distribution, or make a transfer, from their 403(b) account, and the rules they need to follow can be quite complex.
In this article, we're going to explain how to avoid tax penalties associated with the withdrawal of money from a 403(b) account. That explanation will include a discussion of allowable distributions, as well as the most efficient way to make a transfer.
To discourage the early use of money earmarked for retirement, there are some strict rules that apply to 403(b) distributions. In general, a distribution cannot be made until an individual:
As is the situation with other retirement plans, if the money is contributed on a pre-tax basis, or earnings grew without paying taxes, then income taxes are owed on any early distribution taken from a 403(b) plan. Individuals planning to take an early distribution should also be prepared to pay both state and federal income taxes. Early distributions may also be subject to an additional 10% tax penalty.
One of the big benefits of Roth IRAs is there are no minimum required distributions; that's not the case with 403(b) plans. If the plan was started before 1986, the help of the plan administrator is essential. In general, there are two minimum required distribution rules that apply to 403(b) accounts:
As mentioned, only a plan administrator can provide the exact process to follow, since the rules will depend on how the plan was established. If a required minimum distribution is not taken, then the accountholder may be subject to a non-deductible 50% excise tax on the difference between the required minimum distribution and the amount actually distributed. That can be a very expensive penalty to pay.
It is possible to transfer either all, or part, of the interest from one 403(b) account to another on at tax-free basis. This is sometimes referred to as a transfer of interest contract, or a 90-24 transfer. This tax-free treatment may also apply if the transferred interest is subject to the same, or stricter, distribution rules.
This transfer rule applies to current employees, former employees, and the beneficiaries of former employees. If a transfer does not satisfy the rule mentioned above, the distribution will likely be viewed as ordinary income and is taxable.
If an insurance company is in rehabilitation or insolvency, then it's possible to make a cash transfer to a 403(b) account and receive tax-free treatment. To make this cash transfer without incurring a penalty, the following steps must be taken:
When making this type of cash transfer, the new insurer must be provided with a written statement that contains the following information:
In addition to the information sent to an insurer, the income tax return for the year an individual first received a cash distribution must have attached to it:
Finally, it's possible to make a direct trustee-to-trustee transfer of a 403(b) account to another defined governmental benefit plan, and not include the transfer amount in gross income. Two scenarios that apply to this non-includable transfer include:
Once again, these trustee transfers can be complex, so it's important to check with the plan administrator as to the type, and the extent, of service that may be purchased by this type of transfer. Getting the plan administrator involved will help complete all transactions in a timely manner, and avoid unnecessary tax penalties.
About the Author - 403(b) Distributions and Transfers (Last Reviewed on October 19, 2016)