If you work for a public school, a church or other tax-exempt organization, you might belong to your employer’s tax-sheltered annuity plan, also known as a 403(b). A tax-sheltered annuity is “qualified,” meaning you can roll it over tax-free into another employer plan or into an individual retirement account. A 403(c) account, however, is a different animal.
A 403(b) plan contains an annuity contract residing in a custodial account. Insurance companies sell annuity contracts, and mutual fund companies provide custodial accounts. You and your employer can contribute pre-tax dollars into a 403(b). This plan invests the money into mutual funds, where it grows tax-deferred. Later, the plan converts the cash value of your account into a stream of monthly annuity payments that continue for the rest of your life. You must include these payments in your taxable income.
403(b) Plan Limits
As of 2013, an employee can contribute any amount of their compensation into a 403(b) plan, not to exceed $17,500 for the year. However, if you are age 50 or older, you can increase your contribution by $5,500, In addition, if you’ve been on the job for at least 15 years, you can squirrel away up to $3,000 more. Therefore, if the stars align, you can stow away $26,000 in pre-tax dollars into the plan. Your employer can also kick in money, but the annual limit on all additions to the plan is $51,000. Your plan might include a vesting schedule, meaning the employer’s annual contribution isn’t yours unless you remain on the job for a set amount of time.
Section 403(c) of the Internal Revenue Code describes a secondary account that might be part of your 403(b) plan. A 403(c) account is a “bucket” for holding unvested and excess contributions. The bucket account is not a qualified annuity. If you leave the job, you’ll forfeit any unvested employer contributions. If you have excess contributions, you can return them or pay the tax on them. If you don’t return the contributions, the Internal Revenue Service might charge you a 6 percent penalty, and your 403(c) bucket will contain money that you will have to declare as taxable income.
You can roll over the money in your 403(b) plan into an IRA tax-free. However, the excess contributions in your 403(c) account are taxable. If you haven’t yet paid the tax on this money, it is a taxable part of your rollover. To avoid this, include the 403(c) money in the “cost basis” of your IRA. When you withdraw money from an IRA, the cost basis is not taxable income. If you roll over only part of your plan distribution, the IRS counts the pre-tax part -- deductible contributions and earnings -- first. This means you can withdraw all of your plan assets, roll over only the pre-tax portion, pocket the 403(c) part and avoid taxes on the full distribution. However, unless you do a trustee-to-trustee transfer, your employer will withhold 20 percent of pre-tax withdrawal. You can reclaim this amount when you next file taxes.
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