What Happens to Your 403(b) When You Die: A Complete Beneficiary Guide

The Importance of Beneficiary Designations

Your 403(b) doesn't automatically follow your will. In fact, these workplace retirement accounts transfer based on something seemingly simple but immensely powerful: the beneficiary designation form.

Many account holders mistakenly assume they completed this paperwork years ago and never need to revisit it. Wrong! Major life events like marriage, divorce, births, or deaths necessitate immediate updates to ensure your current wishes are reflected.

Your plan provider maintains your beneficiary designations. Most 403(b) providers allow you to name both primary beneficiaries (first in line) and contingent beneficiaries (backup recipients if your primary beneficiaries predecease you).

What Happens When You Die: The Transfer Process

When the original account holder passes away, the 403(b) plan doesn't simply vanish. Instead, it enters a transition period where several critical processes occur:

1. Notification: Your beneficiaries or estate executor must notify the plan provider of your death, typically by submitting a death certificate.
2. Verification: The plan provider verifies the beneficiary designation on file.
3. Options presentation: The provider contacts identified beneficiaries about their distribution options.
4. Transfer execution: Assets move according to beneficiary choices and applicable regulations.

This process can take anywhere from a few weeks to several months, depending on the complexity of your situation and the plan provider's procedures.

The most crucial factor determining what happens next is who you've named as beneficiary. Different categories of beneficiaries face dramatically different rules, options, and tax consequences.

Who Inherits? The Different Categories of Beneficiary

The rules governing how your 403(b) is distributed vary significantly depending on who inherits it. The SECURE Act of 2019 introduced major changes, particularly for non-spouse beneficiaries. Let’s break down the main categories of beneficiary options:

1. Spousal Beneficiary

When it comes to inheriting a 403(b), spousal beneficiaries enjoy privileges no other beneficiary type receives. If you've named your spouse as the primary beneficiary of your 403(b), they have unique options that provide maximum flexibility and potentially significant tax advantages.

Your surviving spouse can:

• Roll the inherited 403(b) into their own retirement account. This option essentially converts your retirement assets into their personal IRA or retirement plan, allowing them to delay required minimum distributions until their own required beginning date.
• Establish an inherited IRA. Unlike other beneficiaries, a spousal beneficiary can stretch distributions over their life expectancy using the single life expectancy calculation from the IRS single life expectancy table.
• Leave the assets in the 403(b) plan. Some plans allow the spouse to keep the assets in the original 403(b), maintaining the account as a beneficiary account owner while taking required distributions.
• Take a lump-sum withdrawal. While generally not the most tax-efficient option, spousal beneficiaries can withdraw the entire balance as a single distribution.

Your spouse's decisions regarding an inherited 403(b) carry significant long-term tax implications. Immediate withdrawal could thrust them into a higher tax bracket, while thoughtful planning might stretch tax liability over an extended period of time.

2. Non-Spouse Beneficiary (Designated Beneficiary)

This category includes most individuals other than a spouse, such as children, grandchildren, siblings, or friends named on the beneficiary form. Before the SECURE Act, these beneficiaries could often "stretch" distributions over their own life expectancy. Now, most non-spouse beneficiary individuals fall under the 10-year rule.

The 10-Year Rule Explained:

This rule requires the entire balance of the inherited 403(b) to be withdrawn by the end of the 10th calendar year following the year of the original account holder's death.

• Required Minimum Distributions (RMDs): Under the 10-year rule, most non-spouse beneficiaries of a 403(b) plan must fully withdraw the account within 10 years of the original owner's death. The SECURE Act requires that RMDs be taken during this period, even if the original account holder hadn’t started distributions.
• Tax Implications: Every withdrawal from a traditional (pre-tax) 403(b) is taxed as ordinary income in the year it's taken. This can push beneficiaries into higher tax brackets, especially if they take a large lump-sum withdrawal.
• Exception: If the original account holder died after their Required Beginning Date (RBD) for RMDs, the beneficiary must also take annual RMDs within the 10-year period, based on their own life expectancy or the deceased's, whichever is longer. The account must still be emptied by year 10.

3. Eligible Designated Beneficiaries (EDBs)

The SECURE Act carved out exceptions to the 10-year rule for certain categories of beneficiary, known as Eligible Designated Beneficiaries (EDBs). These individuals can still stretch distributions based on their own life expectancy using the single life expectancy table provided by the IRS.

EDBs include:

• The surviving spouse (as discussed above).
• A minor child of the account holder. Important: The stretch is only allowed until the child reaches the age of majority (typically 18 or 21, depending on the state). Once they reach majority, the 10-year rule kicks in, and the remaining balance must be withdrawn within 10 years from that point.
• A disabled individual (meeting strict IRS criteria).
• A chronically ill individual (meeting strict IRS criteria).
• An individual not more than 10 years younger than the deceased account holder (e.g., a sibling close in age).

These beneficiary rules allow for potentially longer tax deferral than the standard 10-year rule.

4. Non-Designated Beneficiaries

This happens if you name your estate, a charity (unless specific rules for charitable beneficiary designation are met, like a Charitable Remainder Trust), certain types of trusts as your beneficiary, or if you fail to name any beneficiary. The rules here are less favorable:

• If death occurs before the Required Beginning Date (RBD): The entire account balance must generally be distributed within five years of the time of death.
• If death occurs on or after the RBD: Distributions must be taken over the deceased account holder's remaining life expectancy, calculated in the year of death.

Naming a person directly is usually much more tax-efficient than naming your estate. Leaving assets to charities directly via beneficiary designation can be very tax-smart, as the charity pays no income tax on the withdrawal.

Tax Implications of Inherited 403(b) Plans

The tax treatment of inherited 403(b) assets hinges primarily on whether the original account was traditional (pre-tax) or Roth (after-tax):

Traditional 403(b) Inheritance

When beneficiaries withdraw from an inherited traditional 403(b), those distributions are subject to ordinary income taxes in the year received. There's no 10% early withdrawal penalty, regardless of the beneficiary's age, making these penalty-free withdrawals.

Mandatory withholding applies unless the beneficiary arranges a direct transfer to an inherited IRA. The IRS requires plan administrators to withhold 20% of distributions for federal income tax withholding unless properly transferred.

Roth 403(b) Inheritance

Roth 403(b) distributions can be entirely tax-free for beneficiaries, but only if:

1. The original account satisfied the 5-year rule (meaning the first contribution was made at least five years before the time of death).
2. The distribution qualifies as a "qualified Roth distribution".

Non-qualified Roth distributions may result in taxation of earnings (but not contributions), so timing matters significantly.

Despite their tax-advantaged nature, inherited Roth 403(b)s must still follow the same distribution timeline requirements as traditional accounts. The tax-free status doesn't exempt them from the 10-year rule or other distribution requirements.

Common Mistakes to Avoid

1. Outdated Beneficiary Designations: Life changes rapidly—marriages, divorces, births, deaths—yet beneficiary forms often remain frozen in time. Review your designations at least every 3-5 years or after any major life event.
2. Missing Contingent Beneficiaries: If your primary beneficiary predeceases you and you haven't named contingent beneficiaries, your 403(b) may end up distributed according to the plan's default provisions or through probate.
3. Neglecting Tax Planning: Failing to consider the tax implications of various distribution strategies can significantly diminish the value of your legacy.
4. Assuming Your Will Controls Your 403(b): Your will has no authority over your 403(b) assets. Only the beneficiary designation form matters.
5. Forgetting About Required Minimum Distributions: If you die after your required beginning date for distributions, your beneficiaries must continue taking required distributions based on complex rules that vary by beneficiary type.

Conclusion

Ensuring your 403(b) assets are distributed according to your wishes requires proactive planning, centered on maintaining accurate beneficiary designations. Understanding the rules for different beneficiary types and the associated tax implications prevents costly mistakes and protects your legacy.

Don't leave this critical task to chance; review your beneficiaries today and consult with financial professionals to solidify your plan.

   Proper estate planning can help ensure your 403(b) is distributed according to your wishes. Start Your Free Plan  

Sources

1. Retirement Topics - Beneficiary - Internal Revenue Service. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary
2. Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs) - Internal Revenue Service. https://www.irs.gov/publications/p590b
3. IRC 403(b) tax-sheltered annuity plans - Internal Revenue Service (IRS). https://www.irs.gov/retirement-plans/irc-403b-tax-sheltered-annuity-plans
4. Retirement plans FAQs regarding 403(b) tax-sheltered annuity plans - Internal Revenue Service (IRS). https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-403b-tax-sheltered-annuity-plans