With most people transitioning through several employers during their career, it is fairly common for them to leave a trail of employer-sponsored retirement accounts behind. While it’s possible to let each of these accounts continue growing on their own, this is rarely the best option for your finances. In fact, you would almost always be much better off taking your old retirement accounts, including 403(b) plans, with you.
Fortunately, it’s not that difficult or time-consuming to roll your 403(b) into a new account you can monitor yourself. Once you have left an employer, you have several options for rolling over your 403(b) funds into another type of retirement account such as a traditional IRA or a Roth IRA.
What is 403(b)?
When you are talking to someone who has a 403(b), it’s fairly common for them to not understand what type of retirement account they actually hold. In fact, when asked, they will usually refer to it their “tax-sheltered annuity”.
This is primarily because, when 403(b)’s were initially adopted, insurance companies were the first ones to get their foot in the door. Because of this fact, most people who had a 403(b) had an annuity that was tax-sheltered.
However, that isn’t always the case these days. While tax-sheltered annuities were popular at first, you will find that many other investment companies take part in modern 403(b) plans.
In fact, 403(b) plans and the investments they hold are extremely diverse. As such, the definition for this type of account is fairly diverse and broad as well. According to the Internal Revenue Service, 403(b) plans can be described as follows:
A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations, and certain ministers.
Individual accounts in a 403(b) plan can be any of the following types.
- An annuity contract, which is a contract provided through an insurance company.
- A custodial account, which is an account invested in mutual funds.
- A retirement income account set up for church employees. Generally, retirement income accounts can invest in either annuities or mutual funds.
As you can see, 403(b) plans can take on a different shape or set-up depending on where they are offered and what type of selections the plan administrator has chosen.
The most important factor to remember, however, is that 403(b) plans are treated much like employer-sponsored 401(k) plans in the real world. First off, both types of plans are funded with pre-tax dollars, allowing the investments to grow on a tax-deferred basis until retirement. Second, a 403(b) plan offers the same maximum contribution annual as 401(k) plans, which is $18,000 for 2016 if you are ages 50 and below. If you are over age 50, you can make an additional $6,000 in contributions in 2016 with what is known as a “catch up contribution.”
Advantages of Using a 403(b)
If you are offered a 403(b) plan by your employer, it is almost always a smart idea to begin making contributions. In fact, 403(b) plans offer several distinct advantages, some of which are similar to those offered through employer-based 401(k) plans. Here are some of the biggest benefits you’ll get from using a 403(b):
Contributions are made on a pre-tax basis, which can lower your taxable income. Just like contributions you may have made to an employer-sponsored 401(k) plan, the money you deposit into a 403(b) is pre-tax. As such, the contributions you make annually can lower your taxable income and help you save on your tax annual tax bill.
Your savings grow tax-free. After you make pre-tax contributions to a 403(b) plan, your money will continue to grow tax-free until you reach retirement and beyond. You’ll only be required to pay income taxes on distributions when you take them.
Take contributions later in life when you might be in a lower tax bracket. Since you won’t pay taxes on 403(b) funds until you are in retirement in most cases, you have the potential to pay lower taxes in the future as well. Since most people in retirement fall into a lower tax bracket, it is reasonable to assume they might pay lower taxes in the future.
You may get an employer match. Just like employer-sponsored 401(k) plans, many not-for-profit employers who administer 403(b) plans offer a company match. This is the closest thing to “free money” you’ll ever find, so it’s always wise to contribute enough money to your work-sponsored 403(b) plan so that you’ll get the full benefit.
Contribution limits remain relatively high in 2016. Just like employer-sponsored 401(k) plans, maximum contribution levels remain high for 403(b) accounts. For 2016, you can contribute up to $18,000 to a qualifying 403(b) plan if you are age 50 or younger. If you are ages 50 and older, you can contribute up to an additional $6,000 in what is known as a “catch up contribution.”
How to do a 403(b) Rollover
If you do a direct rollover of funds into a traditional IRA account, you will avoid the mandatory 20% federal income tax withholdings assessed on retirement funds withdrawal. You can open an IRA account at any financial institution offering this type of account. Generally, speaking, you will need to complete the 403(b) rollover by the 60th day following the day distribution is received.
The IRS does allow for two exceptions to the 60-day rollover rule, however. In the case of financial hardships or unforeseen circumstances, you may be allowed an exemption. Exemptions are not guaranteed and the IRS will require proof of financial hardship, such as hospitalization or any other kind of financial crisis. Unforeseen circumstances can come in different forms, but they typically include situations where your funds are frozen in your account for some reason.
Typically, you only need to complete a signed contribution form which is required by the IRA trustee in order to rollover the funds into the IRA account. You will need to check with the specific financial institution regarding its rollover policies prior to conducting the transaction to avoid delays in processing.
To roll your 403(b) into a traditional IRA, you will also need to consult with the plan administrator of your 403(b) account to make sure you are completing the appropriate paperwork. Some will require a distribution request to be completed before assets can be rolled over. Meanwhile some administrators will also need a letter of acceptance from the IRA trustee/financial institution. These documents will provide proof that funds are being transferred to a legitimate retirement plan account.
One important note: You’ll need to make sure the rollover is processed as a ‘direct’ roller, meaning that fund distributions are payable and sent to only to the IRA trustee. If the fund distribution is made payable to you, your plan administrator is required to keep a deduction of 20% for federal tax withholdings. Rolling over a 403(b) account into an IRA needs to be done correctly or you will face stiff tax penalties for early withdrawals.
Pros and Cons of Rolling Your 403(b) into a Traditional IRA
While the benefits of rolling an old 403(b) into a new account can vary depending on the situation, the biggest benefit you'll likely receive is the gift of having more options than you had before.
Generally speaking, IRAs offer more investment options than 403(b) plans. The biggest advantage you get when you roll over a 403(b) into an IRA is the fact that IRAs offer greater flexibility when it comes to how you invest your money. Once your funds are rolled over, you can invest them into mutual funds, index funds, and even individual stocks.
If your 403(b) plan offered fairly limited investment options, having a traditional IRA will make you feel like you have unlimited options at your fingertips. And if you prefer a certain investment style – such as investing mostly in index funds – having a traditional IRA makes it much easier for you to stick to that plan for the long haul.
The biggest disadvantage that comes with rolling an old 403(b) into a traditional IRA is that an IRA may cost more money to maintain over time. Where you may not have paid transaction costs for your 403(b), you will find that running a traditional IRA can be costly.
Another disadvantage that comes with traditional IRAs is the fact that, in the event you ever file for bankruptcy or are on the receiving end of a lawsuit, your funds in an IRA are not protected by the Employee Retirement Income Security Act. This act was established to ensure invested monies are designated especially for retirement and cannot be used for debt purposes.
Note: Regarding the ERISA ruling and your IRA, at least $1 million in IRA assets would be protected if you filed a bankruptcy claim. With lawsuits, it’s a different story. It really depends on the type of lawsuit you are embroiled in and, most importantly, the rules created in the state you live in.
Another Option: Convert Your 403(b) to a Roth IRA
If you don’t want to roll your 403(b) into a traditional IRA, you can consider rolling it into a Roth IRA instead. Since Roth IRAs are funded with after-tax dollars, however, there are huge tax considerations to contemplate if you choose to roll your 403(b) into this type of account.
When you roll your 403(b), 401(k), or other tax-deferred retirement account into a Roth IRA, you’ll have to pay income taxes on the amount you roll over that year. This can result in a huge upfront expense if you have a lot of money saved in your 403(b) already, but many people do it anyway for myriad reasons.
Since Roth IRAs are funded with after-tax dollars, they work differently when you use them and when you’re ready to begin taking distributions. Here are some of the benefits you can get from rolling your 403(b) into a Roth IRA:
You won’t have to pay income taxes when you begin taking distributions. Since Roth IRAs are funded with after-tax dollars, you can begin taking tax-free income distributions when you are ready to retire. If you think you might be in a higher tax bracket when you retire several years or decades from now, having an income stream that is not taxed can be a huge boon for your finances.
Owning a Roth IRA can help you diversity your tax liability in future years. If you also have a 403(b) or 401(k) plan, adding a Roth IRA is a smart way to diversify your tax liability. Where you’ll pay income taxes on distributions from tax-deferred accounts when you retire, you won’t need to when you take distributions from your Roth IRA.
You don’t have to take required minimum distributions (RMDs) at any age. Where most tax-advantaged retirement accounts like 401(k)s and 403(b)s require you to begin taking required minimum distributions (RMDs) at age 70 1/2, the Roth IRA has no such requirement. If you want to keep your money in your account for a lifetime, the Roth IRA will let you do so with no penalty.
Your heirs won’t face a tax bill when they inherit your Roth IRA. Since Roth IRAs are funded with after-tax dollars, they make it easy for your heirs to inherit tax-free money when you die. If you’re worried about leaving your heirs with a huge tax bill and lots of red tape, you can rest assured that your Roth IRA will leave neither.
The Bottom Line
If you have a 403(b) or several retirement accounts left with old employers, it’s smart to determine whether you should roll those accounts into a new one. Most of the time, doing so will help you simplify your life by consolidating your retirement into one place. Plus, you may even become eligible for more or better investment options if you choose a traditional IRA or Roth IRA for your rollover.
As always, it’s smart to consult your financial advisor and tax consultant before you make any big financial moves or roll over old accounts. The more you know and the more questions you ask, the better off you'll be.