Inherited 403(b): Rules and Options for a Beneficiary

A 403(b) plan is a retirement savings vehicle for employees of public schools and certain 501(c)(3) tax-exempt organizations. These plans allow individuals to contribute a portion of their salary to an account, and the funds are not subject to income tax until withdrawn. When an account holder passes away, the assets in their 403(b) are transferred to a designated beneficiary. Inheriting a 403(b) involves a distinct set of rules and tax implications that beneficiaries must navigate to make informed decisions about their inherited assets.

Required Information and Documentation for Beneficiaries

Before a beneficiary can take any action with an inherited 403(b), they must gather specific documents. The first item required is a certified copy of the original account owner’s death certificate, as plan administrators will not process any claims without this official verification. The beneficiary must also provide their own personal identification, which includes a government-issued photo ID and a Social Security or Taxpayer Identification Number.

You will also need the deceased’s 403(b) account number and the contact information for the plan administrator, which can be found on an old account statement. This information is needed to obtain the plan-specific beneficiary claim packet from the administrator. This packet contains the forms to officially claim the assets and will guide you through the options available under the plan’s rules.

Distribution Options for Spousal Beneficiaries

A surviving spouse who is the sole beneficiary of a 403(b) has flexible options not available to other types of beneficiaries. A common choice is to treat the inherited 403(b) as their own by rolling the assets directly into their own Individual Retirement Arrangement (IRA) or another qualified retirement plan.

By choosing a spousal rollover, the surviving spouse treats the funds as if they were always their own. This means that Required Minimum Distributions (RMDs) will be calculated based on the surviving spouse’s own age and life expectancy. This can be advantageous for a younger spouse, as it allows the funds to continue growing tax-deferred for a longer period before withdrawals are mandated.

Alternatively, a surviving spouse can choose to remain a beneficiary of the 403(b) by transferring the assets into a new, properly titled inherited 403(b) account. In this scenario, RMD rules are based on the deceased spouse’s age. If the original account owner passed away before their required beginning date for RMDs, the surviving spouse can delay taking distributions until the year the deceased would have reached RMD age.

Distribution Rules for Non-Spousal Beneficiaries

For most non-spousal beneficiaries, the rules for inheriting a 403(b) were changed by the Setting Every Community Up for Retirement Enhancement (SECURE) Act. If the original account owner passed away on or after January 1, 2020, these beneficiaries are subject to the 10-Year Rule. This rule mandates that the entire balance of the inherited account must be distributed by the end of the 10th calendar year following the year of the owner’s death.

The 10-Year Rule has tax planning implications, as beneficiaries must strategically decide when to take distributions within that period to manage the income tax impact. For instance, taking the entire amount in one year could push the beneficiary into a higher tax bracket, whereas spreading withdrawals could result in a lower overall tax liability. All withdrawals from a traditional pre-tax 403(b) are taxed as ordinary income.

A nuance to the 10-year rule is whether the original account owner had started taking their own RMDs. If the owner died after their required beginning date, the beneficiary must not only empty the account within 10 years but may also be required to take annual RMDs during that period. These annual RMDs are calculated based on the beneficiary’s life expectancy.

Eligible Designated Beneficiaries

The SECURE Act created a category known as “Eligible Designated Beneficiaries” (EDBs), who are exempt from the 10-year rule. EDBs can “stretch” distributions over their own life expectancy, an advantage that allows for extended tax-deferred growth. This group includes:

• The surviving spouse
• Minor children of the account owner
• Disabled or chronically ill individuals, as defined by the IRS
• Beneficiaries who are not more than 10 years younger than the deceased account owner

For a minor child of the account owner, the ability to stretch distributions is temporary. They can take distributions based on their life expectancy only until they reach the age of 21. Once the child reaches age 21, the 10-year rule is triggered, and the remaining account balance must be withdrawn by the end of the 10th year after they turn 21.

To qualify as a disabled or chronically ill EDB, the beneficiary must meet IRS definitions and may need to provide documentation to the plan administrator to prove their status. This exception provides these individuals with a potentially lifelong stream of income from the inherited account.

Executing Your Chosen Option

Once you have decided on a distribution strategy, the next step is to formally execute your choice. The process begins by submitting the completed beneficiary claim forms to the 403(b) plan administrator. This submission must be accompanied by the certified death certificate and any other required documentation.

The claim form is where you will provide specific instructions for your chosen action. If you are a spouse rolling the funds over, you will need to provide the account details for your existing IRA. For a non-spouse beneficiary moving funds to an inherited IRA, it is important to ensure the new account is titled correctly—for example, “(Deceased’s Name) for the benefit of (Beneficiary’s Name)”—to preserve its tax-advantaged status. A direct trustee-to-trustee transfer is recommended to avoid mandatory 20% federal income tax withholding.

If you elect to take a cash distribution, the form will ask for your bank information for a direct deposit or an address for a check. This option will trigger an immediate income tax liability on the withdrawn amount. After submitting the paperwork, the plan administrator will process the request, which can take several weeks. You will receive a confirmation statement and, by January 31 of the following year, an IRS Form 1099-R detailing the distribution for tax reporting.