You’ve contributed to your 403(b) plan faithfully for a number of years. You’re about to retire. Now what? How (or if) you should withdraw that money depends on a number of factors and options available to you.
Types of 403(b) Plans
Your contributions were likely made on a pretax basis (like those to a 401(k) plan). Some 403(b) plans offer the option to make what is called a Designated Roth contribution with after-tax dollars. (Read more about Roth features.)
The Basic Rules
First of all, you are not required to take all or, in fact, any funds out of your 403(b) account when you retire. If you leave funds in your 403(b) account, they will continue to accumulate until you withdraw them, annuitize them or roll them over later.
However, if you do plan to make withdrawals – and you retire before age 55 – you will have to pay regular income taxes, plus a 10% penalty on the amount, unless you agree to “substantially equal periodic payments” for at least five years or until you reach the age of 59½ (whichever is longer). The size of those payments will be based on your expected lifespan. This applies to the conventional 403(b) plan; with the Roth version, you don't pay income tax, since the contributions were made with net (post-tax) income; but the penalty probably will still apply.
If you are 55 or older when you retire, you can choose to withdraw some or all of your funds in a lump sum. Paradoxically, however, any amount you withdraw does not qualify as a lump-sum distribution under the 10-year tax option, according to the IRS. This means you cannot spread your tax liability over a decade but must pay all the income taxes due on the amount the year you withdraw the funds. Bear in mind that, if the withdrawal is sizable, it could move you into a higher tax bracket.
When you turn 70½, the government decrees you have to start withdrawing funds from your account. There's a required minimum distribution (RMD) that you must take annually, which is based on your age and the age of your spouse (if any). Gradually increasing with the passing years, it's determined by dividing the prior year-end value of the retirement account by a distribution period from one of the IRS' life expectancy tables. If you fail to take the correct distribution one year, you will be subject to a 50% nondeductible excise tax. Most plan administrators provide for automatic calculation and distribution of RMDs annually.
What to Do: Annuity Option
No matter what type of 403(b) plan you have, you may wish to annuitize some or all of it when you retire. By arranging to receive periodic, fixed payouts, you provide yourself with a guaranteed income stream for life (or some period), no matter how the stock market or the economy performs. Most experts warn against annuitizing the entire balance in your retirement plan – especially if you are already receiving a defined benefit pension. If you are, it means part of your retirement income is already in annuity form, so to speak; you might want to retain flexibility with your other assets.
Your annuity doesn't have to stop when you do; you can bequeath it to someone else. Depending on elections you make or options you choose (or do not choose), the beneficiary may be subject to a gift tax upon your death. If, however, it’s a joint and survivor annuity, where only you and your spouse have the right to receive payments, the annuity will likely qualify for the unlimited marital deduction, according to the IRS.
What to Do: The Rollover Option
You may wish to roll over part (or all) of your 403(b) plan into another sort of tax-advantaged account: a 401(k) (at another employer), a traditional IRA, a Roth IRA, a corporate 403(a) annuity-based plan, or a government-sponsored 457 plan. Why? More ready access to your funds; different and more varied investment options, or better money management during your retirement years.
There are rules regarding what you may or may not roll over. In general, you must roll over distribution amounts received within 60 calendar days in order for the amount to be treated as nontaxable. You may not roll over RMDs or any of those “substantially equal periodic payments” from an early retirement (before age 55). You can roll 403(b) funds into a Roth IRA only if the account has the same restrictions as with a rollover from a traditional IRA. For more on rollover options, see IRS Publication 571.
If you are a retired public safety officer (police officer, fire firefighter, chaplain, rescue/ambulance crew member), you have an extra perk. You can withdraw up to $3,000 from your 403(b) plan and use it to pay for accident, health or long-term care insurance. If it goes directly to pay the premiums, that withdrawal will not be included in your taxable income. IRS Publication 575 offers more details.
The Bottom Line
In terms of treating the hard-earned contents of your 403(b) plan, the majority of 403(b) plan owners may find a combination of some sort of annuity and investment portfolio is best. This provides a steady income stream as well as the ability to achieve some capital appreciation.
To begin any sort of withdrawal or transfer process, you simply contact your plan sponsor and indicate how much you wish to withdraw. There will be paperwork. Often, the sponsor will withhold automatically a portion of that amount for taxes (typically 20%), so be sure to account for that when making your request, or be sure to indicate you do not want the taxes withheld.