IRS Rules For Terminating a 403(b) Plan

IRS Rules For Terminating a 403(b) Plan
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A 403(b) plan is a retirement account that certain public employees and tax-exempt organizations provide. Those who are eligible for these types of accounts include school administrators, professors, teachers, government employees, physicians, nurses, librarians and others.

A 403(b) plan has several advantages over a traditional 401(k) in that employees are vested more quickly, and you can make additional catch-up contributions. Some of the disadvantages are that you do not have as many choices of investment instruments, and some accounts offer less protection from creditors. If you cash out your plan early, you could face stiff penalties.

What Are the Penalties?

If you have a 403(b), and you lose or are terminated from your job, you might be wondering what happens to the money. The answer to this is not simple, and it depends on what options your new employer offers.

In some cases, you may be able to cash it out or leave it alone, but in these cases, penalties and fees can apply. If your new employer offers a 401(k), you might be able to roll it over into the new plan without penalty. You might also be able to move the plan into an IRA without consequence. If you choose this option, you might miss out on matching contributions. In some cases, your old employer might allow you to leave your money in the plan, even if you are no longer working there.

Typically, the best option is to roll over the 403(b) plan into another account. The worst option is often cashing it out, and you should only do this if it is a dire emergency and your only choice. For one, you are missing out on any future tax-advantaged growth. Also, if you are under the age of ​59 1/2​, you may face a ​10 percent​ penalty for early distribution.

One of the questions that many people ask is whether they can take money out of their 403(b) plan to pay for unexpected expenses. In most cases, the answer is no. However, you can take out a loan on your 403(b) account, but you will have to pay back the full amount to avoid heavy tax penalties. If you do not keep up with regular payments, it will be considered a withdrawal.

In some cases of hardship, the IRS can waive penalties at its discretion, but these cases are rare. Hardships can be approved for things such as medical expenses or funeral expenses. They are usually not allowed for things such as buying a home or educational expenses.

How to Close a 403(b) Plan

Once you have weighed your options and have decided that cashing out your plan is best, then all you need to do is to request a withdrawal of the entire account balance. You can often avoid penalties by depositing the entire amount into an IRA within ​60​ days. You would also need to deposit an amount equal to what was withheld by the administrator for taxes. If your employer terminates you and you are ​55​ or older, you can withdraw your money from the 403(b) without the ​10 percent​ penalty.

If you are an employer, you must follow the IRS rules and all requirements of ERISA if you wish to end your 403(b) plan. The IRS rules give clear guidance for employers and employees regarding the termination of 403(b) plans. In both cases, you must carefully weigh all your options to avoid significant penalties.