What Are the 403(b) Withdrawal Rules?

403(b) plans are an incredibly powerful retirement planning tool that allows employees of not-for-profit organizations, and some public institutions, to invest more for their retirement than a standalone IRA, but when can you withdraw your funds, and what kind of fees can you expect to pay when you do? What are the 403(b) withdrawal rules?

The high-net-worth retirement planners at Avidian Wealth Solutions are here to tell you what you need to know about the 403(b) withdrawal rules and talk a bit about how a 403(b) can fit within a larger comprehensive retirement plan. 

What is a 403(b)?

403(b)s are tax-sheltered workplace retirement accounts (also known as tax-sheltered annuities, or TSAs) only offered to employees within specific industries, more often than not tax-exempt organizations or government organizations. 403(b) plans are frequently offered to employees of:

• Public schools
• Universities and higher education institutions
• Nonprofits and 501(c)(3) charitable organizations
• Some churches
• Cooperative hospital service organizations
• Government agencies

403(b) plans allow you to contribute a percentage of your salary to your retirement fund pre-tax, which increases the amount you can contribute and lowers your overall taxable income. Money put into 403(b)s grows tax-deferred and will avoid taxation until withdrawal during retirement. 

There are now also Roth 403(b)s, which would allow you to withdraw your money tax-free after retirement, but require that you make after-tax contributions to the fund now. 

This brings us to the question of withdrawals; if funds in a 403(b) aren’t meant to be withdrawn until retirement age, what effect will early distributions, cashouts, or transfers have on all that money saved? 

When can you withdraw money from a 403(b) without penalty?

Although the primary function of any retirement account is to accumulate funds so that you can safely enjoy your golden years, circumstances do arise in which you may need to make withdrawals. 

403(b) accounts are set up so that you can begin withdrawing without penalty at the age of 59 ½, the normal retirement age according to the IRS. Withdrawals made before reaching the age of 59 ½ are typically subject to a 10% early withdrawal penalty. 

You may qualify for a hardship withdrawal if you have experienced a significant life event that has put a strain on your finances or need some quick liquidity. 

What qualifies for a 403(b) hardship withdrawal?

According to the IRS, hardship withdrawals must take place due to “immediate and heavy financial needs.” Although this language is vague enough for them to make case-by-case decisions based on individual circumstances, they do list a few things that often qualify:

• Medical bills or cost of ongoing care
• Real estate costs related to a primary residence
• Tuition or education-related fees
• Payments to prevent eviction from or foreclosure on a primary residence   

They also stipulate that 403(b) hardship withdrawals should be for no more than the amount required and that you must show a lack of other resources to take care of these costs, which includes spousal and family assets. 

How much tax do you pay on a 403(b) withdrawal?

This question has a simple answer, but one that might not necessarily simplify life for high-net-worth individuals. If you have reached the age of 59 ½ and are withdrawing from your 403(b) account with no early withdrawal penalty, your 403(b) distributions should be treated as normal, taxable income.* 

This means that the tax rate for your 403(b) withdrawals will depend on your total taxable income for the year that the withdrawal occurs and, as is the case with normal income taxation, the higher your tax bracket, the more you will owe. 

Although 403(b) taxation alone might not be too complicated, when combined with other sources of retirement income and other tax considerations things can get complex fast. We recommend that anyone doing retirement income planning also consult with retirement tax planning professionals to get a comprehensive understanding of what your future may hold. Talking with the retirement planning professionals at Avidian can help make sure you know what to expect, allowing you to pave a smooth road through your golden years. 

*This does not apply to Roth 403(b)s

Can I cash out my 403(b) if I quit my job?

Wondering what to do with that money if you move on from the job offering the 403(b) plan? You have a few options available to you: 

• You can cash out your 403(b) account and treat it as a large distribution.
• You can transfer the money in your account into another qualified retirement plan — either another 403(b) plan at your new employer or into an IRA. 
• You can choose to leave the money there. Not every employer will allow you to do so, but many do. If you leave your money in your 403(b) account you will no longer be able to contribute to it, but the money you have invested will continue to grow. 

So, you can cash out your 403(b) account if you leave a job, but you should be aware that you will have to pay taxes on the entire amount that you withdraw (which will be treated as income tax) and you will be subject to a 10% early withdrawal penalty if you cash out while under the age of 59 ½. This is why most individuals who move from one job to the next typically elect to retain their old plan or transfer their balances to a new plan to avoid any immediate tax concerns until they are ready to retire.

Continue reading: Where is the safest place to put your retirement money?

Can I withdraw from 403(b) while still employed?

Withdrawing money from a 403(b) account while you are still employed by the company that offers the plan is allowed under certain circumstances, and is called an in-service withdrawal. In-service withdrawals are permitted under the following circumstances: 

• You are over the age of 59 ½ 
• You or the plan’s owner either die or become disabled
• You qualify for a hardship withdrawal

It is important to note that all withdrawals will be subject to income tax, but only early in-service withdrawals will be subject to the 10% early withdrawal penalty. 

There is another way to withdraw from a 403(b) before retirement age: the Substantially Equal Periodic Payment (SEPP). SEPPs can allow you to withdraw funds from your 403(b) before retirement age in amounts that are determined by the IRS every year. This can be a great way to supplement your income if you need a stop gap before retirement income begins, but your regular salary from your employment has ended. 

How much should I have in my 403(b) to retire?

Determining how much you should have in your retirement accounts to comfortably retire is a complex and personal calculation that should take into account your lifestyle, expected income, expected retirement age, expenses, and more. 

While there isn’t an answer that is right for everyone, there are steps you can take to help make sure you have more than enough to see you through retirement. 

1. Define specific retirement goals. Not everyone wants the same thing out of retirement. Consider whether you’ll be traveling extensively, staying put, or even buying a boat for that trip down to South America. 
2. Consider all income sources. Unless you worked at the same organization for 40 years, you likely have more than just your 403(b) account. Consider all of your retirement accounts as well as any other income that you will have moving forward. 
3. Calculate potential costs. You should essentially create a budget to decide on what your spending will look like during your retirement. 
4. Factor in inflation and contingencies. You should also consider potential healthcare costs, life events, and any estate planning considerations that might affect your savings.
5. Review and adjust often. Once you’ve put together a sound plan, you and a trusted high-net-worth retirement planning professional should review and adjust this plan as needed — which should be more often than you think. 

A successful retirement starts with clearly defined goals and a comprehensive plan to achieve them and ends with you living out your golden years in the way that you’ve always dreamed of. Work with a trusted retirement planning professional to make sure that you’re on the right track. 

Questions about the 403(b) withdrawal rules? Avidian can help.

While knowing the 403(b) withdrawal rules is important, it is no substitute for having a comprehensive and sound retirement plan that uses the funds from your 403(b) to give you and your family the future you deserve. 

When making decisions about withdrawals, transfers, or reinvestment of retirement funds, it is always recommended that you consult a trusted financial advisor to make sure that you’re making the right decision for your future. 

Avidian Wealth Solutions offers high-net-worth retirement planning in Houston, Austin, Sugar Land, and The Woodlands. If you want to work to make sure that your current financial plan is aligned with the future that you envision, schedule a conversation with one of our advisors today!

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• 10 Questions to Ask a Financial Advisor at Your Initial Consult
• What Are The New FinCEN Requirements?
• What You Need To Know About 529 Accounts for Grandchildren

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