How Does a 403(b) Work When You Retire? Your Guide to Accessing Your Savings

Remember setting up that 403(b)? The 403(b) is a tax-advantaged retirement strategy for employees of public schools, certain non-profits, and religious organizations.

You contributed a portion of your salary for retirement, perhaps benefiting from an employer contribution match (sometimes called a company matching contributions), and watched your savings grow, tax-deferred.

This tax deferral was fantastic while you were working. You didn't pay income tax on your contributions or their earnings. But now, retirement flips the script. The government wants its share. Understanding how does a 403(b) work when you retire largely revolves around navigating these future withdrawals and their tax consequences, and is a critical choice for retirees.

Accessing Your Funds

The big question on many retirees' minds: When can you start taking money out without getting a tax penalty?

• The Magic Age: Generally, you must be at least 59 ½ years old to withdraw funds from your 403(b) without incurring a 10% early withdrawal penalty from the IRS. Think of it as the standard retirement threshold for most employer-sponsored retirement plans.
• The "Separation from Service" Rule (Rule of 55): If you leave your job (separate from service) during or after the calendar year you turn 55, you can often take penalty-free withdrawals from that specific 403(b) plan.
  
  Important note: This rule applies to the 403(b) associated with the employer you just left. Funds rolled over to an IRA generally lose this specific age 55 exception and revert to the standard 59 ½ rule for penalty-free access.
• Special Circumstances: Disability and certain other specific situations might also allow for penalty-free withdrawals before 59 ½.

How to Decide What to Do With Your 403(b) After Retirement

Step 1: Assess Your Personal Retirement Situation

Before looking at the account options, look inward. Understanding your needs and resources is essential.

• Income Needs: How much money do you realistically need each month or year to cover your expenses in retirement? Consider living expenses, healthcare, travel, hobbies, and potential unexpected costs. Be honest and thorough.
• Other Income Sources: Where else will money come from? Factor in Social Security benefits (and when you plan to claim them), any pension income, spouse's retirement income, potential part-time work, savings, or investment income from your retirement portfolio outside of your 403(b).
• Tax Situation: What's your current and projected federal and state income tax bracket in retirement? This heavily influences decisions, especially regarding pre-tax vs. Roth funds.
• Risk Tolerance: How comfortable are you with potential investment fluctuations? Your need for guaranteed income versus potential growth will shape your choices.
• Retirement Goals: Are you aiming for extensive travel early on? Do you prioritize leaving a legacy for heirs? Are potential long-term care costs a major concern?
• Timeline: What is your planned retirement age? How long do you anticipate needing your retirement funds to last? Consider your health and family longevity.

Start with a retirement savings calculator to quickly assess if your savings and income are sufficient  for retirement. Then use a retirement cost-of-living comparison calculator to further estimate your needs .

Step 2: Understanding Your Specific 403(b) Plan

Not all 403(b) plans are created equal. You need to understand the specific features, benefits, and drawbacks of your plan. Gather your plan documents, summary plan description, and recent statements from your administrator. Look for:

• Investment Options:
  • What types of accounts or funds are available? Is there a good mix of stock, bond, and stable value options?
  • How have the available funds performed?
  • Are you satisfied with the current investment choices, or do you wish you had more flexibility?
• Fees and Expenses: This is critical! Identify all associated costs:
  • Administrative Fees: Flat fees and asset-based fees charged by the plan provider.
  • Investment Fees: Expense ratios of the mutual funds or costs (mortality & expense charges, surrender charges, rider fees).
  • Advisory Fees: Are you paying for advice within the plan?
  • Compare these fees to what you might pay elsewhere (like in an IRA). Seemingly small fee differences compound significantly over time.
• Withdrawal Options and Flexibility:
  • How easy is it to set up systematic withdrawals? What frequencies are allowed (monthly, quarterly, annually)?
  • Are partial withdrawals straightforward? Are there any restrictions or processing delays?
  • How good is the customer service and online access for managing distributions?
• Special Plan Features:
  • Does the plan offer a Stable Value Fund (an option providing principal preservation and modest interest, not usually available in IRAs)?
  • Does the "Rule of 55" apply (allowing penalty-free withdrawals if you separated from service in the year you turned 55 or later)? This benefit is lost if you roll the funds to an IRA before age 59 ½.
  • Are there any specific payout options unique to your plan (like certain annuity features)?

Step 3: Explore the 5 Main Options for Using Your 403(b)

Based on your assessment and plan knowledge, consider these five primary paths for your 403(b) funds after retirement:

Option 1. Leave the Money in your 403(b) Plan (and potentially take withdrawals later)

You don't necessarily have to start withdrawals immediately upon retiring, especially if you retire before age 59 ½ (or 55 under the separation rule) or if you have other income sources. Required Minimum Distributions (RMDs) will eventually force withdrawals.

• Focus: Keep assets within the existing plan structure without immediately starting income payments.
• Pros: Simplicity (no action needed initially), potential access to unique low-cost institutional funds or stable value options, retain Rule of 55 access if applicable, strong ERISA creditor protection (usually).
• Cons: Limited investment choices, potentially higher fees than alternatives, potentially less flexible withdrawal options, or subpar service when you do start withdrawals, subject to Required Minimum Distributions (RMDs) starting at age 73 (for both Traditional and Roth 403(b)s).

Option 2. Roll Over to an IRA

You can move your 403(b) funds to another retirement account, like a Traditional IRA or, if converting, a Roth IRA. This approach doesn't trigger immediate taxes (unless converting to a Roth) and keeps your money growing tax-deferred.

• Focus: Move assets to an account you control directly, outside the former employer's plan.
• Pros: Vast investment flexibility (stocks, bonds, ETFs, mutual funds, etc.), potential for lower overall fees (shop around!), consolidation of multiple retirement accounts, freedom to choose your own financial advisor, potentially more flexible withdrawal options, Roth IRA rollovers avoid RMDs for the original owner.
• Cons: Lose access to any unique 403(b) features, lose Rule of 55 access (must wait until 59 ½ for penalty-free IRA withdrawals unless another exception applies), IRA creditor protection varies by state (may be less robust than ERISA), and requires opening and managing a new account.
• Sub-Option: Traditional vs. Roth IRA Rollover: Rolling a traditional (pre-tax) 403(b) to a Traditional IRA is tax-free. Rolling it to a Roth IRA is a conversion – you pay income tax on the rolled amount now for tax-free qualified withdrawals later. Rolling a Roth 403(b) to a Roth IRA is tax-free and avoids future RMDs.

Option 3. Annuitize the Balance (If Offered by Your Plan):

Many 403(b) plans, especially older ones, are based on annuity contracts. You might have the option to annuitize your balance, essentially trading your lump sum for a guaranteed stream of income for a set period of time or for life.

• Focus: Convert your account balance into a guaranteed stream of income payments.
• Pros: Provides a guaranteed income stream for a set period or life, simplifying income planning and reducing longevity risk (risk of outliving savings).
• Cons: Usually irrevocable (you give up control of the principal), payouts may be lower than managing withdrawals yourself (especially in low-interest environments), less flexibility for lump-sum needs, and inflation can erode the purchasing power of fixed payments.

Option 4. Take a Lump-Sum Distribution:

You can take all your money out at once. However, this is often not advisable. A large lump sum from a traditional (pre-tax) 403(b) means the entire amount is typically taxed as ordinary income that year. This approach could push you into a much higher tax bracket, significantly reducing the net amount you receive.

• Focus: Withdraw the entire account balance at once.
• Pros: Full access to all your money immediately.
• Cons: Usually a very poor choice for traditional 403(b)s due to the massive income tax bill in one year. Significantly reduces your retirement nest egg. Generally, only considered in specific, rare circumstances or for very small balances.

Option 5. Take Systematic Withdrawals Directly from the 403(b):

You can set up regular payments – monthly, quarterly, annually – directly from your 403(b) provider. This approach provides a predictable income stream. You decide the amount and frequency, though you'll need to manage this carefully, considering your account balance and longevity.

• Focus: Actively draw regular income with distributions over time from the 403(b) plan without rolling it over. This approach is different from option 1, where the focus is just leaving it as it is initially.
• Pros: Provides a regular, predictable income stream directly from the plan; relatively simple to set up through the plan provider; keeps assets invested within the plan, and avoids the step of setting up a new IRA.
• Cons: You are still subject to the plan's limitations (investment choices, fees, withdrawal flexibility); requires careful management of the withdrawal amount to ensure funds last; doesn't offer the consolidation benefits of an IRA rollover; subject to RMDs starting at age 73.

Step 4: Make the Decision Based on Your Priorities

Now, weigh the options against your personal needs (Step 1) and plan specifics (Step 2).

• While an IRA rollover can offer wider investment choices, whether it provides lower fees depends on your specific situation, as many employer plans actually have competitive or even lower expenses than individual IRA options.
• If simplicity and access under the Rule of 55 (between 55-59 ½) are crucial, keeping funds in the 403(b) might be better, at least initially.
• If guaranteed income is paramount and you're comfortable giving up control, annuitization might be considered.
• If you have multiple old retirement accounts, consolidating them into an IRA simplifies management.
• If you have significant Roth 403(b) assets and want to avoid RMDs, rolling them into a Roth IRA is often advantageous.
• If your 403(b) has exceptionally low-cost, high-quality funds unavailable elsewhere, or a valuable stable value option you want to keep, staying put might make sense.

Step 5: Consider Seeking Professional Guidance

This decision is complex with long-term consequences. If you're feeling overwhelmed, unsure about tax implications, or want a personalized strategy, consider consulting with a qualified financial advisor. They can help you:

• Analyze your specific 403(b) plan's details.
• Compare fees and investment options objectively.
• Model different withdrawal scenarios and tax impacts.
• Align your decision with your overall financial plan and retirement goals.

Conclusion

As you approach retirement, your decisions about your 403(b) will significantly impact your financial well-being for decades to come. Take time to assess your personal situation, understand your plan's specific features, and carefully weigh all available options.

Withdrawals from Roth 403(b) accounts are generally tax-free if the account has been held for at least five years and the account holder is age 59½ or older.

    Discover optimal strategies for your 403(b) when you retire. Start Your Free Plan  

Sources

1. Retirement plan and IRA required minimum distributions FAQs - Internal Revenue Service. https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs
2. Retirement topics - Required minimum distributions (RMDs) - Internal Revenue Service. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
3. IRC 403(b) tax-sheltered annuity plans - Internal Revenue Service. https://www.irs.gov/retirement-plans/irc-403b-tax-sheltered-annuity-plans