403b to Roth IRA Rollover: Rules and Tax Implications
Learn the critical considerations for moving a 403(b) to a Roth IRA, including the tax impact of the conversion and the rules for a successful transfer.
A 403(b) to Roth IRA rollover involves transferring funds from an employer-sponsored retirement plan into a personal retirement account. This transaction, also known as a Roth conversion, provides access to a broader array of investment choices. A primary reason for a conversion is the strategic decision to pay income taxes on the funds now, which allows for tax-free withdrawals during retirement.
Determining Rollover Eligibility and Tax Implications
The ability to roll over funds from a 403(b) plan is contingent on specific circumstances. The most frequent event is a separation from service, meaning you are no longer employed by the plan’s sponsoring organization. Other situations include the employer terminating the plan or you reaching age 59½. Rollover rules differ between plans, so you must consult your plan administrator for specific provisions.
Moving funds from a traditional, pre-tax 403(b) to a Roth IRA is a taxable event. The entire amount rolled over is added to your ordinary income for that tax year. For instance, if you are in the 22% federal tax bracket and roll over $50,000, you could owe an additional $11,000 in federal income taxes, plus any applicable state taxes.
If the funds originate from a Roth 403(b) account, the process is tax-free. Contributions to a Roth 403(b) are made with after-tax dollars, so transferring them to a Roth IRA does not create a new tax liability and allows you to consolidate your Roth retirement savings.
The Pro-Rata Rule
If your 403(b) account contains a mix of both pre-tax and after-tax (non-Roth) contributions, the pro-rata rule applies. This IRS rule dictates that any rollover is a proportional distribution of both taxable (pre-tax) and non-taxable (after-tax) funds. You cannot choose to roll over only the after-tax portion to avoid taxes.
For example, if a $100,000 account is 80% pre-tax and 20% after-tax, any rollover is treated proportionally. A $50,000 rollover to a Roth IRA would result in $40,000 of taxable income and a $10,000 tax-free return of contributions. This rule prevents individuals from isolating their after-tax contributions for a tax-free rollover while leaving the pre-tax funds behind.
Information and Documentation for the Rollover
Before initiating a rollover, you must open a Roth IRA with a financial institution if you do not already have one. You will also need to gather several pieces of information and documentation.
- Your most recent 403(b) statement, detailing the fund composition (pre-tax, Roth, etc.).
- Your 403(b) account number and plan administrator’s contact information.
- The account number for your new Roth IRA.
- The name and address of the financial institution holding your new Roth IRA.
The process requires completing forms from both your 403(b) provider and your new Roth IRA custodian. You will need a distribution form from your 403(b) provider and a transfer initiation form for your new Roth IRA. Both will require your personal information, the rollover amount, and details of the new account.
The Rollover Process
The most common method for moving retirement savings is a direct rollover, or trustee-to-trustee transfer. You submit the distribution form to your 403(b) plan administrator, who then sends the funds directly to your new Roth IRA custodian. This method avoids tax withholding, and the transfer usually takes several business days to a few weeks.
An alternative is the indirect rollover. In this case, your 403(b) provider sends a check to you, but is required to withhold 20% of the distribution for federal income taxes. You receive a check for only 80% of your total rollover amount.
You have 60 days from receiving the funds to deposit the full original amount into your Roth IRA. This requires using your own money to make up for the 20% that was withheld. If you fail to deposit the full amount within 60 days, the un-deposited portion is treated as a taxable distribution and may be subject to a 10% early withdrawal penalty if you are under age 59½.
Post-Rollover Rules and Reporting
After the rollover, the Roth IRA 5-year rule becomes a factor. This rule consists of two separate five-year clocks affecting your ability to withdraw funds tax- and penalty-free. For a Roth conversion, a distinct 5-year clock begins on January 1 of the year the conversion was made.
This conversion clock determines when you can withdraw the converted principal without a 10% penalty if you are under age 59½. A separate clock, starting with your first-ever contribution to any Roth IRA, determines when you can withdraw earnings tax-free. Each conversion has its own 5-year holding period for penalty-free principal withdrawals.
In the year following your rollover, you will receive tax forms. Your former 403(b) provider will send Form 1099-R to report the distribution. Your new Roth IRA custodian will send Form 5498 to confirm receipt of the rollover contribution.
You will also likely need to file Form 8606, Nondeductible IRAs, with your federal tax return. This form is used to report the taxable amount of your Roth conversion, ensuring that you accurately account for the income generated by the rollover on your tax return.