403b and penalty free distributions
School teacher turned age 55 in May ’21 and retired July ’21.
Has a 403b.
Is it correct that he can take distributions from the 403b prior to age 59 1/2 and pay tax but will not have to pay the 10% early withdrawal penalty on the distribution?
is it also correct that if he rolls a portion of the 403b to an IRA, and prior to age 59 1/2 takes a distribution from the 403b, that he will owe tax and a 10% penalty on the distribution?
if he leaves all the money in the 403b, and takes a distribution from the 403b prior to age 59 1/2, therfore not having to pay the additional 10% penalty, how long does he have to wait before being able to roll the balance of the 403b to an IRA without any adverse impact for doing so (if any)?
Permalink Submitted by Alan - IRA critic on Mon, 2021-08-30 22:33
Both of your first two paragraphs are correct, assuming that the teacher does not qualify for a different penalty exception that applies to IRA distributions that would waive the early distribution penalty from the IRA.
He could withdraw what he needs from the 403b, but the plan may not offer partial distributions. If the plan offers partial distributions he could withdraw just what he needs penalty free and leave the rest there. Or if the plan only offers lump sum distributions, he could withdraw what he needs from the 403b penalty free and directly roll the rest to an IRA. The 403b provisions determine whether partial distributions are allowed.
Permalink Submitted by William Tuttle on Mon, 2021-08-30 22:46
The exception to the 10% penalty only applies to an employer plan separated from in a year >= age 55. It only applies to that plan and only while the assets are in that plan.
Keep in mind that the tax code and IRS regulations only enable the exception. The plan controls what distribution options are available. They may not allow partial discretionary distributions.
Many plans offer limited periodic distributions, but some plans may require a lump sum distribution. The participant should verify with the plan what their distribution options are.
Any amount rolled over to an IRA account will be subject to the 10% early withdrawal penalty if distributed prior to age 59 1/2.
Therefore, if a lump sum distribution is required. The participant could keep the amount necessary to cover expenses until age 59 1/2 and rollover the remainder to an IRA.
This could result in increased marginal tax rates and exceed state exemptions if applicable. If only lump sum distributions are available. There may be other options (home equity, reduce expenses, part-time income, etc…) to reduce impact from marginal tax rates.
You should advise clients in the future (where possible) to have all of this information before they make a decision to retire before age 59 1/2.
Alan beat me to it.