403(b) Distribution Rules – How They Work


Are you counting on a 403(b) plan to help you in retirement? It helps to understand your 403(b) distribution rules so that you can make the most of your money. After spending so many years building up those retirement assets, you want to make the best possible use of them.

Many public employees have a 403(b) account. In retirement planning, they find that they can retire at as much as 60 percent or so of their career income without using any individualized income planning. However, some people will prefer to have a retirement income that is more than just that.

This article will cover 403(b) distribution rules and options at a high level. The goal is to help you make more well-informed decisions about your retirement savings and your financial future. You will also learn some options to help close any income gaps between what you expect to get and what you need to cover your preferred lifestyle in retirement.

The first option – always available – is simply to keep your savings in your 403(b) retirement plan. However, the mutual funds or other investment options in these plans can vary widely in terms of fees and investment options available. If you are happy with how your money has done so far, you might choose to keep it where it is.

However, you will still face required withdrawals in the future via required minimum distributions (see below) if you choose this route. Let’s get more into the various 403(b) distribution rules now.

Important Ages for 403(b) Distributions

It’s good to keep two critical ages in mind when considering 403(b) distributions.

Age 59.5

The IRS always lets you withdraw from any tax-qualified retirement account at age 59.5 or older without penalty. This age covers 401(k) plans, 403(b) plans, IRAs, and other retirement-savings accounts of pre-tax status.

Rule of 55

The Rule of 55 is an IRS policy that will allow you to take withdrawals before age 59.5 without paying a penalty so long as you meet the requirements. To take advantage of the Rule of 55, you must be at least 55 years of age and leave the job where you have a current 403(b) account. Older accounts from former employers aren’t eligible.

The Rule of 55 is important for 403(b) account owners because some may be eligible for retirement before 59.5. For example, if you have a 30-years-of-service retirement provision in your school’s pension plan and became employed by your district at the age of 25, you may be eligible to retire with full benefits at age 55.

Also, it’s good to know that the Rule of 55 only waives the 10 percent penalty. You still owe whatever income taxes that are otherwise due on those funds. Note also that the Rule of 55 only applies to 403(b)s and 401(k)s. It doesn’t apply to IRAs.

403(b) Distribution Options

Once you decide that you will taking money from your 403(b), whether at 55, 59.5, or some other age, it’s time to figure out how and when you want to make those withdrawals.

Standard Withdrawals from a 403(b)

The standard withdrawal rules for a 403(b) are the same as those for other retirement accounts. You will need to meet one of these conditions:

  • Reach age 59.5
  • Terminate your employment
  • Become disabled
  • Encounter a designated financial hardship or emergency
  • Pass away when your beneficiaries can make various withdrawals

Whenever you withdraw money from your 403(b) account, the amount withdrawn is taxable at your standard income tax rate. If, on the other hand, you have a Roth 403(b) account, it was funded with after-tax dollars like other Roth accounts. So long as you meet the withdrawal conditions, including having had the account for at least five years, you can generally take out money tax-free.

It’s important to remember that none of the events above requires that you take a withdrawal. You can simply leave your money there if you think that is your best option. A financial advisor can guide you in making that decision.

Early Withdrawals from a 403(b)

As discussed above, you can take early withdrawals under the Rule of 55. You must be leaving your job and at least 55 years old. However, using the Rule of 55 requires that your funds remain in the 403(b) plan.

You can also take substantially equal periodic payments under Rule 72(t). You can do this anytime but must continue taking the payments for the longer of five years or reaching age 59.5. Again, 72(t) eliminates only the 10 percent penalty. Any taxes due will still be due as you receive your money.

There are a few things that are good to know about this option. Sometimes funds inside a 403(b) account can take time to withdraw, as you will usually need approval from your 403(b) plan’s third-party administrator to access them. No matter what tax bracket you fall in, many 403(b) plans also impose mandatory 20 percent tax withholding on cash withdrawals. You might also have fewer options in general.

Early withdrawals for disability or unreimbursed medical expenses above a certain percentage of your adjusted gross income won’t incur a penalty, either. In other words, your retirement savings can be a safety net for catastrophic out-of-pocket medical expenses.

Required Minimum Distributions and 403(b)s

As with other retirement accounts, your 403(b) account requires you to take required minimum distributions (RMDs). For most people, this starts at either age 72 or 73. Check out our article on RMDs here, and ask your financial professional for more guidance on this if needed.

The amount you must take out is calculated on the prior year-end balance and IRS life expectancy charts. Many plan administrators will handle this automatically for you. However, it’s good to be sure to confirm it’s done because the penalties for missing an RMD include a 50 percent tax.

If you should have withdrawn $1,000, you will still need to take it out and pay the taxes on it, but you will also give $500 of it to the IRS. Your financial advisor can help you remember to do all your RMDs. They can also assist you with ideas for using the funds after you withdraw them.

403(b) Rollover Options

Rolling your 403(b) over into another retirement vehicle may be another option after you switch jobs and retire.

These plans often charge administrative fees on top of the fees already charged by the investment options in your plan. Rolling over into another retirement account can often be less costly and give you broader investment options.

Technically, a rollover is a distribution. However, putting the funds into another tax-advantaged requirement account won’t be subject to penalties or taxes. The critical thing to remember is that the funds must be moved into the new account within 60 days of receiving your funds.

If not, you will have a taxable distribution. Often, your plan administrator will transfer assets in a trustee-to-trustee transfer with reduced risk of an accidental distribution. You can ask your financial professional to explain this if you have questions or need more information.

You may also consider using your 403(b) assets to create a guaranteed income stream for your retirement years. A financial professional licensed to offer annuities can help you understand the various annuity types and applicable riders that can create a retirement account tailored to your needs.

Remember, though, that annuity guarantees are based solely on the claims-paying ability of the issuing insurance company, so be sure to do your due diligence.

Your options for rolling over your 403(b) include:

  • IRAs (Roth or traditional)
  • Other IRAs such as SIMPLE IRA
  • 457(b) plan (if one is available to you)
  • 401(k) plan (if available)
  • Other 403(b) plan (also if available)

Should you roll the assets into any kind of Roth account, you will owe taxes on the entire rollover amount. Further, if you have a Roth 403(b), you can only move it into another Roth vehicle.

Moving your funds from a 403(b) to another qualified retirement account can reduce your expenses and give you much more flexibility in your investment options.

Working with a financial professional can help you understand the options available, and which options might make sense for you.

403(b) Loans

You may need to access some of your 403(b) assets, but none of the withdrawal options fits your circumstances very comfortably. In that case, if your plan permits, you may take a loan from your plan and pay yourself back with interest over time.

Certain rules apply as to how much you can borrow. Check with your plan administrator for more information.

What happens if you leave the company before you repay your entire loan? Then you will either have to pay it immediately or treat the balance as a withdrawal, subject to taxes and penalties, as applicable.

Questions to Ask Before Making Decisions on 403(b) Distributions

Now that we have covered what options are available, these questions can help in exploring what options for your 403(b) might be right for your situation:

  • What does your financial picture look like?
  • When will you retire? When will you actually need these assets?
  • Do you need to cover a gap between retirement and Social Security?
  • What will your retirement income be?
  • How much of that income is guaranteed so that you can be sure to cover your lifestyle?
  • What does your 403(b) offer you in retirement?
  • What are its limitations (fees, investment options, etc.)?

If you would like assistance in answering these questions, you might consider working with an independent financial professional. They can help you get through these rules and regulations, along with the what-ifs, and maybes, to explore different options for your situation.

If you are looking for someone to guide you, many independent financial professionals are available at SafeMoney.com. Use our “Find a Financial Professional” section to connect with someone directly, where you can discuss your financial goals, concerns, and situation. Should you want a personal referral, please feel free to contact us at 877.476.9723.

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