How to Convert a 403(b) to a Roth IRA

A 403(b) plan is a retirement account for employees of organizations like public schools, non-profits, and religious groups. Contributions are made on a pre-tax basis, and the money grows tax-deferred. A Roth IRA is funded with after-tax dollars, allowing for tax-free qualified withdrawals in retirement. Moving funds from a 403(b) to a Roth IRA is a conversion, which shifts savings from a pre-tax to a post-tax environment and changes their future tax treatment.

Determining Eligibility and Conversion Rules

The ability to move funds from a 403(b) plan depends on the plan’s rules and your work status. Most plans permit a rollover only after a triggering event occurs, such as separation from service (quitting, retiring, or being laid off). Some plans also allow for in-service distributions once an employee reaches age 59½, even while still working. A plan termination, where the employer ends the 403(b) plan, is another qualifying event. To confirm your options, review the plan’s official documents or contact the plan administrator.

A five-year holding period applies to converted funds. If you are under age 59½, a 10% early withdrawal penalty may apply to the taxable portion of a conversion if you withdraw those funds within five years of the conversion date. However, if you are over age 59½, this penalty does not apply to withdrawals of your converted principal. Each conversion starts its own five-year clock.

The pro-rata rule can affect the taxation of the conversion if you hold other pre-tax IRA assets, such as in Traditional, SEP, or SIMPLE IRAs. The IRS requires you to calculate the taxable portion of the conversion based on the proportion of pre-tax and after-tax money across all your aggregated IRA accounts. This can result in a larger tax bill than anticipated if you have significant pre-tax balances in other IRAs.

Understanding the Tax Implications

Converting a pre-tax 403(b) to a Roth IRA is a taxable event. The entire amount you move is treated as ordinary income for the year the conversion occurs. This additional income can significantly impact your annual tax liability, potentially pushing you into a higher tax bracket. For example, if your taxable income is $90,000 and you convert $50,000, your total taxable income becomes $140,000 for that year.

Your 403(b) provider will give you the option to withhold funds for taxes. While convenient, this has a drawback: the withheld money is sent to the government, and only the net amount is deposited into your Roth IRA. For instance, if you convert $50,000 and elect 20% withholding, only $40,000 moves to the Roth IRA. The withheld $10,000 is still considered part of the distribution and could be subject to a 10% early withdrawal penalty if you are under 59½.

To avoid reducing the amount invested and a potential penalty, a better strategy is to pay the estimated taxes from a separate source, like a savings account. Paying taxes with outside funds ensures the full conversion amount is transferred into the Roth IRA, maximizing its potential for tax-free growth. This approach requires careful planning to have sufficient cash available to cover the tax liability.

Required Information and Documentation

Before starting the conversion, you must gather specific information to ensure a smooth process. You will need:

• Your 403(b) account number and the plan administrator’s contact information.
• The exact dollar amount you intend to convert.
• The account details for your destination Roth IRA, including the account number.
• The name and address of the financial institution holding the Roth IRA.

The primary document for this transaction is the distribution or rollover request form from your 403(b) plan administrator. This form requires personal identifying information, such as your name, address, and Social Security number. You must also specify the exact amount to be rolled over and select the type of distribution. Clearly indicate that you are executing a direct rollover to a Roth IRA, as this selection defines the transaction as a conversion. The form will also have a section for tax withholding elections.

The Step-by-Step Conversion Process

After completing the rollover request form, submit it to your 403(b) plan administrator. Submission methods vary by provider and may include mail, fax, or a secure online portal. This action formally initiates the request to move your funds.

You have two options for transferring funds: a direct or an indirect rollover. In a direct rollover, the 403(b) provider sends the money directly to your Roth IRA custodian. This is the recommended method as it is simpler and avoids tax complications. In an indirect rollover, the provider sends you a check, and you have 60 days to deposit the funds into your Roth IRA. The provider is required to withhold 20% for federal taxes, so you must make up the difference with your own money to complete the full rollover.

After submitting the form for a direct rollover, you will receive a confirmation notice from your 403(b) administrator that the transaction has been processed. The funds are then sent to your Roth IRA provider. The entire process, from submitting the form to seeing the funds appear in your Roth IRA, typically takes several business days to a few weeks, depending on the procedures of the financial institutions involved.

Annual Tax Reporting for the Conversion

After the conversion, you must report the transaction to the IRS on your annual income tax return. Your former 403(b) plan administrator will send you Form 1099-R, which provides the official details of the distribution. You should receive it by late January of the year following the conversion. Box 1 on this form shows the total gross distribution amount, and Box 7 contains a distribution code that helps the IRS understand the transaction.

The information from Form 1099-R is used to complete IRS Form 8606, Nondeductible IRAs. You will use Part II of this form to report the conversion and calculate the taxable portion. Since a pre-tax 403(b) is treated like a traditional IRA for this purpose, the entire converted amount is taxable. The calculated taxable amount from Form 8606 is then carried over and reported on your Form 1040, where it is added to your other income for the year.