What Are the Withdrawal Rules for a 403(b) Plan?

I taught myself to write grant proposals early in my freelance writing career. I volunteered to write proposals for a year to gain experience and secure funding.

After several months of securing grant funding for a nonprofit organization in my hometown, the founder and CEO hired me as an independent contractor. I happily accepted the role.

Many nonprofit organizations offer participation in a 403(b) plan as part of a benefits package to help employees save for retirement. Although these plans differ from other retirement plans, they offer tax advantages.

What a 403(b) Plan Is

Many charities, religious organizations, and public schools offer a 403(b) plan as part of an employee benefits package:

• This tax-advantaged retirement account allows participants to make plan contributions directly from their paycheck, often on a pre-tax basis.

• The contributions and earnings grow tax-deferred until withdrawal.

• Roth 403(b) plans offer post-tax options for tax-free qualified withdrawals during retirement.

When You Can Withdraw from a 403(b) Plan

Withdrawing funds from your 403(b) plan is typically permitted under the following circumstances:

• Reaching age 59 ½, the common retirement age for penalty-free access

• Leaving your job during or after the year you turn 55 years old

• Receiving a qualified domestic relations order related to divorce

• Experiencing a qualifying financial hardship, if your plan allows

• Becoming totally and permanently disabled

• Qualifying for certain in-service withdrawals permitted by your plan

• Your employer terminates the plan

• You pass away, allowing your beneficiary to withdraw funds

Early Withdrawal Rules for a 403(b) Plan

Withdrawing funds from your 403(b) plan before you turn age 59 ½ can result in a 10% early withdrawal penalty on the taxable portion, in addition to regular income taxes. For instance, if you withdraw $20,000 early and are in the 22% federal tax bracket, you could pay $4,400 in federal taxes plus a $2,000 penalty, reducing your retirement savings by $6,400.

Conversely, withdrawing contributions from a Roth 403(b) is typically tax-free and penalty-free. However, early withdrawal of the earnings usually triggers taxes and a penalty.

Exceptions to the Early Withdrawal Penalty

Although ordinary income tax typically still applies, the IRS allows exceptions to the 10% penalty for early withdrawal from a 403(b) plan under any of the following circumstances:

• Leaving your employer in or after the year you turn 55 years old

• Covering qualified birth or adoption expenses of up to $5,000 per parent

• Receiving certain distributions as a qualified military reservist called to active duty

• Becoming totally and permanently disabled

• Covering unreimbursed medical expenses exceeding 7.5% of your adjusted gross income (AGI)

• Making payments under a qualified domestic relations order related to divorce

• Taking substantially equal periodic payments

• Releasing an IRS levy on your account

• Passing away, allowing your beneficiary to take distributions

Be sure to verify your eligibility for any exception to the 10% penalty before considering an early withdrawal from your 403(b) account.

Hardship Withdrawals

If your 403(b) plan permits hardship withdrawals, you must meet strict IRS criteria to withdraw funds after exhausting other resources. Common qualifying hardships include:

• Certain medical bills or expenses

• Specific tuition and education expenses

• Costs for buying a principal residence

• Certain home repair costs

• Payments to prevent eviction or foreclosure

• Funeral expenses for immediate family

Withdrawals from a 403(b) Plan After Age 59 ½

Withdrawing from your 403(b) plan after age 59 ½ typically eliminates the 10% early withdrawal fee. However, withdrawals from a pre-tax account are subject to income taxes.

Tax Implications of Withdrawals

The tax implications of withdrawals from your 403(b) account depend on whether the contributions were pre-tax or post-tax:

• Traditional 403(b) funds have not yet been taxed. Therefore, contributions and earnings are taxed as ordinary income on federal and state tax returns upon withdrawal.

• Roth 403(b) funds were taxed before contribution. As a result, contributions can be withdrawn tax-free at any time. Earnings are tax-free if the account is held at least five years and you are age 59 ½, disabled, or deceased, enabling your beneficiary to withdraw the funds. Conversely, withdrawals of earnings before age 59 ½ typically are subject to ordinary income tax and a potential 10% penalty.

Required Minimum Distributions for a 403(b) Plan

The IRS requires you to take required minimum distributions (RMDs) from a traditional 403(b) account beginning by April 1 of the year after you reach age 73:

• The RMD amount depends on your prior year-end account balance and IRS life expectancy tables.

• Failure to take an RMD can result in a 10-25% penalty.

• A Roth 403(b) has no RMDs.

Distribution Options

You have the following options for distributions from your 403(b) account:

1.  Lump sum: Withdrawing all funds at once offers immediate cash and a potentially large tax bill.

2.  Periodic payments: Regular monthly or annual distributions provide steady income and help manage taxes.

3.  Rollover: Moving funds to another qualified retirement plan, such as an Individual Retirement Account (IRA) or another employer-sponsored retirement plan, avoids immediate taxation and keeps the funds growing tax-deferred.

4.  Annuity: If your plan’s investment options include annuities, you can convert your balance into guaranteed payments.

The best option depends on your needs, tax situation, and retirement income options strategy. Consider consulting a licensed financial professional for advice.

Integrating Withdrawals into Your Retirement Plan

Your 403(b) account distribution plan should blend with your overall retirement income planning. Consider the following:

• Timing and taxes: Focus on when you need income. You should time the withdrawals to reduce the tax impact.

• Income mix: Think about how the withdrawals fit with your Social Security, pensions, and other savings to ensure you have adequate income during retirement.

• Tax diversification: Strategically use your taxable, tax-deferred, and tax-free accounts to reduce your tax burden.

• Longevity: Ensure your funds last throughout retirement.

• Guidance: Consider talking with a licensed financial professional for personalized strategies.

*This information is for educational purposes only.