Public school employees, church employees and employees of certain tax-exempt organizations may have access to a retirement plan called a 403(b) plan. 403(b) plans can generally be rolled over into an IRA; however, if you have a 403(b) plan, you may also have a separate annuity that is governed by 403(c), which contains funds that can be rolled over, but the rollover is taxable.
What is a 403(b) Plan?
A 403(b) plan, also known as a tax-sheltered annuity plan, is an employer-sponsored retirement plan available to employees of public schools, churches and tax-exempt organizations. The plan is so named because its requirements are outlined in Section 403(b) of the Tax Code. 403(b) plans take your money and invest it in either an annuity or a mutual fund. Any interest earned on these funds will also not be taxed until you withdraw money from the plan.
One benefit of a 403(b) plan is that contributions are made pre-tax, thus reducing your taxable income and the amount of tax you pay. You will be taxed on that money later, after you retire or begin taking withdrawals. Another benefit is that if you meet certain criteria, you may be eligible for a tax credit of up to $1,000 ($2,000 if you're married and filing jointly).
A 403(b) plan can be funded through three types of contributions:
- Elective deferrals. Elective deferrals are amounts you choose to have taken from your gross pay under a salary reduction agreement with your employer. Elective deferrals are capped at $18,000 for the 2017 tax year ($18,500 for 2018).
- Nonelective contributions. Non-elective contributions are contributions that are not made under a salary reduction agreement, and they include matching contributions, mandatory contributions and discretionary contributions.
- After-tax contributions. Some plans allow beneficiaries to make contributions after the taxes come out of their pay. These are not deducted from your tax return or excluded from your income.
The cap on all three types of contributions combined is the lower of $54,000 for the 2017 tax year (it will be $55,000 for 2018), or 100 percent of the "includible compensation" for your most recent year of working at that position ("includible compensation" is the amount of taxable wages and benefits you received from your employer). For example, if your salary and benefits total $100,000, your cap on all contributions is $54,000 for the 2017 tax year; on the other hand, if your salary and benefits total $35,000, then your cap on all contributions is $35,000.
You may end up contributing more than your cap permits, which will leave you with excess contributions. That's where 403(c) comes into play.
What is 403(c)?
Section 403(c) of the Tax Code generally provides that any excess contributions are not subject to the tax-free benefits of the rest of the funds in your plan. That means that if you go above the contribution caps, you have to pay taxes on those contributions as you do on any other income.
If you exceed your amount under elective deferrals ($18,000), you can request a correcting distribution, and your employer will pay you the amount in excess of the cap and take taxes out as usual. If you exceed the annual addition cap ($54,000 or the total of your compensation, as set forth above), the excess amount will be included in your taxable income. You may also be subject to an excise tax if your account is invested in a mutual fund and not an annuity.
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Rolling Over a 403(b) Subject to 403(c)
When you rollover a 403(b) to an IRA, the rollover is tax-free, and the funds you roll over remain untaxed as they were in your 403(b) plan. However, any portion of the rollover comprised of excess contributions may be subject to the 6 percent excise tax, and it may also be capped by the IRA contribution limit, which is $5,500 per year. You can also simply withdraw the excess contributions and pay the taxes rather than including the excess contributions in your rollover.
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