Considering Doing a 403(b) to IRA Rollover?
Rolling over your 403(b) to an IRA can be like upgrading from a trusty old bike to a sleek new car.
But before we go into the details, please know that this post is not meant to replace advice from a fiduciary financial advisor or financial planner.
By Written by Will Grant, CFP®, CPWA®, 360 Financial
Will helps clients create their ideal life through values-based financial planning. His process is designed to pursue each client’s objective, whether it’s preparing for retirement, ensuring smooth business succession, funding for education, implementing wealth transfer strategies, and navigating other impactful financial events.
What is a 403(b) Rollover?
When thinking of a 403(b) rollover, imagine you're re-potting a plant into a bigger pot for more room to grow.
That's kind of what a 403(b) rollover is for your retirement savings. A 403(b) rollover involves moving funds from a 403(b) plan, typically offered by non-profit organizations, schools, and hospitals, into an Individual Retirement Account (IRA) or another retirement plan.
Why do this?
It's all about growth and flexibility.
Rolling over to an IRA often gives you access to a wider range of investment options compared to a typical 403(b) plan. This means more opportunities for your investments to grow. It's likely that you'll be able to get a more optimized investment strategy based on your risk tolerance and financial goals.
Additionally, if you're changing jobs or retiring, a rollover can help keep your retirement savings consolidated and manageable, rather than scattered across different accounts.
Think of this as keeping all your plants in one garden rather than having them scattered randomly across the county.
When you keep all your investments in one retirement account, you can have them optimized for your goals. Whereas if they are all over the place, it will be hard for you to ensure that you're not overexposed and at risk.
Table of Contents
The Difference Between a Direct Transfer and an Indirect Transfer
How to Rollover a 403(b) to an Individual Retirement Account
Evaluating Retirement Savings Options: 403(b) vs. IRA Account
403(b) Rollover Considerations for Investors in Higher Tax Brackets
Basic IRS Guidelines for Eligible Retirement Account Transfers
403(b) Rollover Tax Treatment
First, let's talk tax treatment. Good news - if done correctly, a 403(b) rollover can be a tax-free event. However, if it is mishandled, you could be paying more in tax than is needed. This is where our team comes into play to help you facilitate a successful rollover.
Here's how to avoid that:
1. Direct Rollover: Ask your 403(b) provider to directly transfer your funds to the IRA which is often called a “trustee-to-trustee” transfer. The rollover check would be made payable to the custodian of where your account and for the benefit of you with your account number listed on the memo line of the check. This way, you never touch the money, sidestepping the risk of triggering taxes.
2. 60-Day Rule: If you receive the funds, you have 60 days to deposit them into your IRA and the rollover check would be made payable to your name. Miss this deadline, and Uncle Sam might expect a cut as taxes.
Remember, this isn't a race. Take your time to understand each step, ensuring a smooth, tax-efficient transition. Ready to roll? Let's dive deeper!
Potential Reasons for a Rollover
Limited Investment Options in a 403(b) May Motivate You to Do a Rollover
Rolling over your 403(b) isn't just about shuffling money around. It's a strategic move with specific goals in mind.
Here are a few reasons why you might consider this financial move:
1. Broader Investment Choices: Your 403(b) might feel like a small pond. An IRA is like an ocean, offering a wider variety of investment options. More choices can lead to a more tailored investment strategy.
2. Financial Planning and Wealth Management: Rolling over to an IRA would allows us to provide professional portfolio management and align this account with your overall LifeWealth Plan.
3. Consolidation: If you're a professional job-hopper, you might have accumulated multiple retirement accounts. Rolling them into one IRA can make managing your retirement savings easier, more efficient, and allow for better asset allocation aligned with your risk tolerance.
4. Estate Planning Benefits: IRAs often provide more flexibility for estate planning purposes. This can be crucial in ensuring your legacy is managed as you wish. For high income earners this is critical.
Remember, a rollover isn't a one-size-fits-all solution. It's about finding the right fit for your specific needs and goals. In fact, a rollover may not be the right more for you. Keep reading to learn more, or schedule a call with a 360 fiduciary financial advisor to get help with your specific situation.
How Does a 403(b) Rollover Affect Income Taxes?
How a 403(b) rollover affects your taxable income and thus your income taxes is crucial to understand to avoid any unwanted surprises.
1. Direct Rollover: By directly rolling over your 403(b) to an IRA, you typically don't touch the funds, and therefore, it doesn't count as income. No income, no tax - simple as that!
2. Indirect Rollover: Here's where it gets tricky. If you receive the funds directly and then deposit them into an IRA, you could run into trouble. The fund could be treated as taxable income if they are not deposited within 60 days. And if you're under 59½, brace yourself for a potential 10% early withdrawal penalty if that happens. If 20% of your rollover was withheld for taxes, you'll need to cover that to avoid it being counted as income.
3. The Fine Print: Always check for nuances. For example, if you have after-tax contributions in your 403(b), these don't count as taxable income when rolled over.
So, while a rollover can be a smart move, it's important to understand its tax implications. I recommend you speak with a CPA or other tax professional as well as your fiduciary financial advisor.
Indirect Rollover Tax Penalties and Risks
While we've already covered the risks of indirect rollovers, here's a more detailed breakdown. Indirect rollovers are little bit risky. Here's why:
1. Taxes on Distribution: If you opt for an indirect rollover, the amount you withdraw from your 403(b) can be considered taxable income. This could bump you into a higher tax bracket for the year.
2. Mandatory Withholding: Often, 403(b) plans withhold 20% for taxes on distributions. If you don't replenish this amount in your IRA rollover, it's considered a distribution and will be taxed.
3. The 60-Day Rule: You have 60 days to complete the rollover. Miss this deadline, and you have triggered a taxable event.
4. Early Withdrawal Penalty: Under 59½? You might face a 10% early withdrawal penalty on the distributed (withdrawn) amount.
The Difference Between a Direct Transfer and an Indirect Transfer
Deciding between a direct and indirect transfer is like choosing between a direct flight and a layover. Both get you to your destination, but the journey and convenience vary greatly.
1. Direct Transfer: This is the non-stop flight of retirement rollovers. Your funds travel directly from your 403(b) to your IRA without ever landing in your personal account. It’s smooth, efficient, and there's no tax turbulence because the IRS doesn’t view it as a distribution.
2. Indirect Transfer: Here's your flight with a layover. You receive the funds from your 403(b), and then you have 60 days to deposit them into your IRA. But be cautious - if you don't re-deposit the funds within 60 days, or if you miss redepositing any part of the distribution, it's considered taxable income. And, if you're under 59½, you might face early withdrawal penalties.
A direct transfer is typically the smoother, safer route, while an indirect transfer requires more attention to avoid potential pitfalls.
403(b) Rollover Alternatives
While a 403(b) rollover might be the best option, it's important to consider the alternatives as well. You should make the best choice for you and your financial situation. Take your time and speak with a financial professional about your situation.
Here are four options you may consider as alternatives to a 403(b) rollover:
1. Stay Put: Sometimes the best move is no move. Keeping your savings in your current 403(b) might make sense if you're happy with your investment choices and the fees are reasonable.
2. Rollover to a New Employer's 401(k): Got a new job with a 401(k) plan? You might be able to roll your 403(b) into this new plan.
3. Cash Out: This is typically not the most recommended route, but it is an option. Cashing out means paying income taxes and potentially a 10% penalty if you're under 59½.
4. Annuities: For those seeking steady income, converting to an annuity could be an option. However, tread carefully – annuities can be complex and often come with higher fees.
How to Rollover a 403(b) to an Individual Retirement Account
Rolling over a 403(b) to an IRA requires careful planning. It's important to follow the steps correctly if you want to ensure that you don't end up with a tax hit.
Below is a simple guide to doing a rollover. However, if you have access to a fiduciary financial advisor, we recommend seeking professional advice before taking action.
1. Consult a Professional: If you feel like you’re trying to read a map in a foreign language, don’t hesitate to reach out to a financial advisor.
2. Choose Your IRA: First, decide where your retirement savings will call home. This could be a traditional IRA or a Roth IRA, depending on your financial goals.
3. Contact Your 403(b) Plan Administrator: Inform them of your decision to rollover into an IRA. They'll guide you through their process and provide necessary forms.
4. Determine the balances in your Pre-Tax (Traditional) vs. Post-Tax (Roth) 403(b): It is often misunderstood that employer contributions to your 403(b) are often pre-tax contributions.
Therefore, if you make Roth 403(b) contributions as an employee, you may have pre-tax and post-tax account balances. If so, you would need to open an IRA and Roth IRA with the rollover.
5. Direct vs. Indirect Rollover: Decide if you want a direct transfer (where funds go straight from 403(b) to IRA) or an indirect transfer (where you receive the funds and then deposit into IRA within 60 days). Remember, direct is usually simpler and avoids tax complications.
6. Complete the Paperwork: Fill out all the required forms. Double-check details like account numbers – a simple typo can lead to a game of financial hide and seek.
7. Follow Up: After initiating the rollover, keep an eye on both accounts to ensure everything transfers smoothly.
Steps to Set Up an IRA Account for Your 403(b) Rollover
Before you do a rollover, you need to set up your IRA account. Here's what to do:
1. Choose the Right IRA: Decide between a Traditional IRA and a Roth IRA.
2. Select a Financial Institution: Look for a reputable bank, brokerage, or financial services company. Consider factors like investment options, fees, customer service, and ease of account management.
3. Open Your IRA Account: Complete the application process. This will typically involve providing personal information, setting up funding options, and agreeing to the account terms.
4. Understand the Investment Options: Each IRA comes with different investment choices, like stocks, bonds, mutual funds, and ETFs. Choose based on your risk tolerance and retirement timeline.
5. Fund Your IRA: Once your IRA is open, you’re ready to roll over your 403(b). If you're worried about taxes and penalties, initiate a direct rollover.
6. Set Up Beneficiaries: Don’t forget to designate beneficiaries for your IRA. This step is crucial for estate planning purposes.
7. Regular Review and Adjustments: Once your IRA is set up and funded, review it periodically to ensure it aligns with your changing financial goals.
403(b) vs. IRA: What Can You Invest In?
When diving into the investment pools of 403(b)s and IRAs, it's essential to know what swim lanes are available. Each offers unique investment options:
1. Mutual Funds: Common in both 403(b) and IRA plans. 403(b)s often focus on mutual funds, particularly those managed by insurance companies. IRAs offer a broader selection of mutual funds from various fund families. Make sure you know what kind of management fees or other costs you're paying when invested in mutual funds.
2. Exchange-Traded Funds (ETFs): Mainly available in IRAs. These are popular for their low costs and flexibility.
3. Bonds: Both plans allow investments in bonds. However, IRAs provide access to a wider range of individual bonds and bond funds.
4. Stocks: Here, IRAs take the lead. They allow for investment in individual stocks, offering more control and customization of your investment strategy. You can have a more diversified portfolio without high management fees when you work with a fiduciary financial advisor who is able to build your portfolio without relying on high-cost packaged products.
5. Certificates of Deposit (CDs): Generally an option in IRAs, offering a low-risk investment choice with fixed interest rates.
6. Annuities: More common in 403(b)s, especially those offered by insurance companies. They provide a stream of income in retirement.
7. Real Estate and Alternative Investments: Some IRAs, particularly self-directed IRAs, allow investments in real estate, precious metals, and other alternative assets. This option is not typically available in 403(b) plans. Due to the risk and illiquidity it is common that you need to meet accredited investor requirements to be eligible for these types of investments.
As you can see there are more investment options when your money is in an IRA as compared to a 403(b). That doesn't mean you should necessarily do a rollover. But it is something to consider as you create your retirement plan.
Evaluating Retirement Savings Options: 403(b) vs. IRA Account
When it comes to retirement savings, it's not just about saving money; it's about choosing the right vessel for your money. Let's compare the 403(b) and IRA accounts:
Benefits of an IRA Account:
Wider Investment Choices: IRAs often offer a broader range of investment options than 403(b) plans.
Tax Diversification: You can choose between traditional (pre-tax) or Roth (post-tax) contributions, offering flexibility for managing future tax liabilities.
Accessibility: Anyone with earned income can open and contribute to an IRA, regardless of their employer.
Pitfalls of an IRA Account:
Lower Contribution Limits: IRAs have lower annual contribution limits compared to 403(b)s.
No Employer Match: Unlike many 403(b) plans, IRAs don't offer employer matching contributions.
Income Limits for Roth IRA: High earners may be limited or ineligible to contribute to a Roth IRA.
Benefits of a 403(b) Account:
Employer Match: Many employers offer matching contributions in a 403(b), which is like getting free money towards your retirement.
Higher Contribution Limits: Generally, 403(b)s have higher contribution limits than IRAs, allowing you to save more each year.
Loan Options: Some 403(b) plans allow you to take loans against your savings, which can be a useful option in financial emergencies. That said, it's advisable to have an emergency fund or cash cushion rather than being reliant on loans.
Pre-Tax Contributions: Contributions to your 403(b) lower your taxable income, providing tax benefits now.
Pitfalls of a 403(b) Account:
Limited Investment Options: 403(b)s often have fewer investment choices, which may limit diversification and growth potential.
Potentially Higher Fees: Some 403(b) plans, particularly those with insurance products, have higher fees.
Early Withdrawal Penalties: Withdrawing funds before age 59½ can lead to penalties and taxes.
In summary, both 403(b)s and IRAs have their unique advantages and drawbacks. It's like choosing between a sedan and an SUV – each has its purpose, and the best choice depends on your exact needs and your financial situation.
Traditional IRA vs Roth IRA
If you've decided that want to do a 403(b) rollover, you'll need to decide whether to rollover to a traditional IRS or a Roth IRA. Here, you can consider the differences:
Traditional IRA:
Tax-Deferred Growth: Contributions are typically made with pre-tax dollars, reducing your taxable income now. Taxes are paid when you withdraw in retirement.
Upfront Tax Break: If eligible, contributions can be tax-deductible, giving you an immediate tax benefit.
Required Minimum Distributions (RMDs): You must start taking distributions at age 72, which can affect your tax situation in retirement.
Income Limits: No income limits for contributions, but there are limits for tax-deductibility if you or your spouse have a retirement plan at work.
Roth IRA:
Tax-Free Growth: Contributions are made with after-tax dollars, but withdrawals in retirement are tax-free.
No RMDs: There are no required minimum distributions, allowing your money to grow tax-free for longer. You won't be forced to start withdrawing funds.
Income Limits: Eligibility to contribute phases out at higher income levels.
More Flexibility: Contributions (but not earnings) can be withdrawn at any time without penalty, offering more liquidity.
403(b) Required Minimum Distributions
What are RMDs?
RMDs are the minimum amounts you must withdraw from your 403(b) account annually, starting at age 72 (as per the current rules). Think of it as the government’s way of saying that it's time to start using your retirement savings!
In the words of the IRS: "You cannot keep retirement funds in your account indefinitely. You generally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account when you reach age 72 (73 if you reach age 72 after Dec. 31, 2022)."
Calculating RMDs:
The amount is calculated based on your account balance and life expectancy. There are IRS tables to help you determine this.
1) RMD Worksheets to calculate the amount.
2) Uniform Lifetime Table – for IRA owners who are not married, IRA owners whose spouses are not more than 10 years younger, and married IRA owners whose spouses aren't the sole beneficiaries of their IRAs.
3) Single Life Expectancy is used when the beneficiaries are not the IRA owner's spouse.
4) Joint Life and Last Survivor Expectancy is for IRA owners when their spouse is more than 10 years younger AND are the IRA’s sole beneficiary.
When to Start:
Keep in mind that these dates may change. Currently, you must take your first RMD by April 1 of the year following the year you turn 72. But, be strategic! Taking two distributions in one year (your first and second RMDs) could push you into a higher tax bracket.
Subsequent RMDs:
After the first RMD, you must take them annually by December 31. Missing an RMD may result in hefty penalties of 50% of the amount that should have been withdrawn. Yes, you read that right, 50%!
Notes From the IRS: "If an account owner fails to withdraw the full amount of the RMD by the due date, the amount not withdrawn is subject to a 50% excise tax. SECURE 2.0 Act drops the excise tax rate to 25%; possibly 10% if the RMD is timely corrected within two years. The account owner should file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with their federal tax return for the year in which the full amount of the RMD was required, but not taken."
Multiple Accounts:
If you have more than one 403(b) account, you must calculate and withdraw RMDs from each account separately. It’s not a mix-and-match situation.
403(b) Rollover Considerations for Investors in Higher Tax Brackets
A rollover to a Traditional IRA might maintain the tax-deferred status of your savings. But remember, the funds will be taxed as ordinary income upon withdrawal, possibly at a high rate if you remain in a high tax bracket in retirement.
Alternatively, converting to a Roth IRA could offer tax-free growth and withdrawals, but this requires paying taxes upfront. This conversion can be significant for those in higher brackets, akin to paying a steeper entry fee for a potentially tax-free financial journey later on.
It's also important to consider the timing of a rollover in relation to your overall income for the year, as the added income from a rollover could push you into an even higher tax bracket. Strategic planning with a tax advisor would be a good idea. You'll want to ensure that your rollover decision aligns with your long-term financial goals and tax planning strategies.
Basic IRS Guidelines for Eligible Retirement Account Transfers
1. One-Year Waiting Rule: The IRS limits you to one tax-free indirect rollover from an IRA to another (or the same) IRA in any 12-month period. However, this doesn't apply to rollovers from other types of retirement plans, such as a 403(b), into an IRA.
2. Mandatory Withholding in Indirect Rollovers: For indirect rollovers from a 403(b) or a 401(k) to an IRA, the plan administrator may withhold 20% for taxes. To complete a tax-free rollover, you'll need to add funds from other sources to make up the 20% withheld.
3. No Age Restriction for Rollovers: Unlike contributions, there's no age limit for rolling over funds into an IRA.
4. Rollovers to and from Roth Accounts: Rollovers from a traditional retirement account to a Roth IRA (Roth conversions) are taxable events. Conversely, rollovers from a Roth 403(b) to a Roth IRA are not taxable.
5. Required Minimum Distributions (RMDs) Cannot be Rolled Over: If you're at the age where RMDs are mandatory, you can't roll over these amounts.
6. Direct Rollovers: The IRS allows for direct rollovers from one retirement account to another, like moving funds from a 403(b) to an IRA. This method is tax-free, as the money moves directly between accounts without you taking possession of the funds.
7. 60-Day Rule for Indirect Rollovers: If you receive the funds directly (indirect rollover), you have 60 days to deposit them into another eligible retirement account. Failing to meet this deadline can result in the funds being treated as a taxable distribution.
The Role of a Financial Advisor in Retirement Planning
If you're starting to feel overwhelmed by all the choices, you're not alone.
While there's nothing wrong with doing your retirement planning alone, if you prefer to have a guide who will help you plan for retirement and manage your investments, it would be wise to seek out a fiduciary financial advisor.
But what exactly is the role of a financial advisor in retirement planning?
Having a fiduciary financial advisor to help you with your financial planning and investing is no different than an elite athlete working with a performance coach. You're doing the critical work of earning and saving your money. Meanwhile, your advisor will ensure that you're invested in way that matches your risk tolerance and goals so that you don't have to worry about retirement and future income streams.
Your advisor also helps you to prevent financial losses in two critical ways:
1) Your advisor helps ensure that you don't lose money by triggering a taxable event (aka. a surprise tax hit) that costs you much more than you anticipated. In addition, your financial advisor optimizes your investments and retirement plan so you don't overpay your taxes.
Most people's biggest lifetime costs are actually taxes. Often your taxes cost you more than your mortgage. This is why tax planning is such a huge part of financial planning and retirement planning.
2) Your advisor is there to make sure you don't take risks that could cause a catastrophic loss. Keeping money and making money are two different skills. Even the most conservative individuals have made errors with their money management when faced with what seems like the "deal of a lifetime."
Your advisor is there to walk you through the risks and benefits of any big money decision you make so you can rest assured that you've invested wisely.
If you have a holistic wealth management team, your advisor will also help you with estate planning and insurance planning. They'll make sure you don't have too much or too little insurance. And they'll ensure your estate plan is up to date.
Common Questions about 403(b) Rollovers
Can you rollover a 403(b) to a Roth IRA?
Yes, you can rollover a 403(b) to a Roth IRA, but it will be treated as a taxable event.
What are the benefits of 403(b) plan in tax-exempt organizations?
The benefits of a 403(b) plan in tax-exempt organizations include pre-tax contributions and tax-deferred growth.
Is a Roth IRA conversion an alternative worth considering?
A Roth IRA conversion is worth considering for tax-free growth and withdrawals in retirement, despite the upfront tax payment.
Why should you consider multiple retirement accounts?
You should consider multiple retirement accounts for diversification of tax treatments and investment options.
When do you have to pay taxes during a 403(b) rollover?
You have to pay taxes during a 403(b) rollover if it's an indirect rollover or when rolling over into a Roth IRA.
How can I judge if a traditional IRA is the right choice for me?
You can decide if a traditional IRA is right for you by considering your current tax bracket and expected tax rate in retirement.
How can I file a distribution request form for a 403(b) rollover?
You can file a distribution request form for a 403(b) rollover by contacting your 403(b) plan administrator for the appropriate paperwork.
Connect with a Financial Advisor
If you need a wealth management team to help you achieve your big-picture goals, we recommend scheduling a call with a financial advisor at 360 Financial. 360 Financial is one of Minnesota’s best independent wealth management firms with over 30 years experience. We work with clients inMinnesota and across the US. If you’d like to work with a team that always puts your best interests first and is committed to helping you create a lasting legacy, please get in touch.
About the Author
William Grant
Will Grant enjoys empowering people to make informed decisions and seeing the positive impact his guidance can have on their lives. Prior to joining 360, he spent seven years serving hundreds of clients at a boutique RIA focused on healthcare executives with equity compensation and then at a large, independent RIA. He earned a Bachelor of Science degree in Finance from Miami University and holds his Series 7 and 63 licenses through LPL Financial and his 65 license through 360 Financial.
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This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including loss of principal. No strategy assures success or protects against loss.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 Ł may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 Ł or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.