Publication 571 (3/2006), Tax-Sheltered Annuity Plans (403(b) Plans)

8. Distributions and Rollovers

Table of Contents

Hurricane relief provisions. New rules provide for tax-favored withdrawals, repayments, and loans from certain retirement plans (including 403(b) annuity contracts) for taxpayers who suffered economic losses as a result of Hurricane Katrina, Rita, or Wilma. See Publication 4492 for details.

What's New

Roth contribution program. For tax years beginning after December 31, 2005, your 403(b) plan may allow you to contribute to a Roth contribution program. Qualified distributions from a Roth account are excludible from your gross income. A qualified distribution is a distribution that is made after the nonexclusion period and:

When you are age 59½ or over,
Because you are disabled, or
On or after the death of the plan participant.

The nonexclusion period is the 5-year-tax period beginning with the earlier of:

The first tax year you made a designated Roth contribution to any Roth account, under the same plan, or
If a rollover contribution was made to your designated Roth account from a designated Roth account, previously established for you under another retirement plan, the first tax year you made a designated Roth contribution to your previously established account.

Distributions

Generally, a distribution cannot be made from a 403(b) account until the employee:

Reaches age 59½,
Has a severance from employment,
Dies,
Becomes disabled, or
In the case of salary reduction contributions, encounters financial hardship.

In most cases, the payments you receive or that are made available to you under your 403(b) account are taxable in full as ordinary income. In general, the same tax rules apply to distributions from 403(b) plans that apply to distributions from other retirement plans. These rules are explained in Publication 575. Publication 575 also discusses the additional tax on early distributions from retirement plans.

Minimum Required Distributions

You must receive all, or at least a certain minimum, of your interest accruing after 1986 in the 403(b) plan by April 1 of the calendar year following the later of the calendar year in which you become age 70½ or the calendar year in which you retire.

Check with your employer, plan administrator, or provider to find out whether this rule also applies to pre-1987 accruals. If not, a minimum amount of these accruals must begin to be distributed by the later of the end of the calendar year in which you reach age 75 or April 1 of the calendar year following retirement, whichever is later. For each year thereafter, the minimum distribution must be made by the last day of the year. If you do not receive the required minimum distribution, you are subject to a nondeductible 50% excise tax on the difference between the required minimum distribution and the amount actually distributed.

For more information on minimum distribution requirements and the additional tax that applies if too little is distributed each year, see Publication 575.

No Special 10-Year Tax Option

A distribution from a 403(b) plan does not qualify as a lump-sum distribution. This means you cannot use the special 10-year tax option to calculate the taxable portion of a 403(b) distribution. For more information, see Publication 575.

Transfer of Interest in 403(b) Contract

If you transfer all or part of your interest from a 403(b) account to another 403(b) account, the transfer is tax free. This is known as a 90-24 transfer. However, this treatment applies only if the transferred interest is subject to the same or stricter distribution restrictions. This rule applies regardless of whether you are a current employee, a former employee, or a beneficiary of a former employee.

Transfers that do not satisfy this rule are plan distributions and are generally taxable as ordinary income.

Tax-free transfers for certain cash distributions. A tax-free transfer may also apply to a cash distribution of your 403(b) account from an insurance company that is subject to a rehabilitation, conservatorship, insolvency, or similar state proceeding. To receive tax-free treatment, you must do all of the following.

Withdraw all the cash to which you are entitled in full settlement of your contract rights or, if less, the maximum permitted by the state.
Reinvest the cash distribution in a single policy or contract issued by another insurance company or in a single custodial account subject to the same or stricter distribution restrictions as the original contract not later than 60 days after you receive the cash distribution.
Assign all future distribution rights to the new contract or account for investment in that contract or account if you received an amount that is less than what you are entitled to because of state restrictions.

In addition to the preceding requirements, you must provide the new insurer with a written statement containing all of the following information:

The gross amount of cash distributed under the old contract.
The amount of cash reinvested in the new contract.
Your investment in the old contract on the date you receive your first cash distribution.

Also, you must attach the following items to your timely filed income tax return in the year you receive the first distribution of cash.

A copy of the statement you gave the new insurer.
A statement that includes:
1. The words ELECTION UNDER REV. PROC. 92-44,
2. The name of the company that issued the new contract, and
3. The new policy number.

Direct trustee-to-trustee transfer. If you make a direct trustee-to-trustee transfer, from your governmental 403(b) account to a defined benefit governmental plan, it may not be includible in gross income.

The transfer amount is not includible in gross income if it is made to:

Purchase permissive service credits, or
Repay contributions and earnings that were previously refunded under a forfeiture of service credit under the plan, or under another plan maintained by a state or local government employer within the same state.

Permissive service credit. Permissive service credit means credit for a period of service recognized by your defined benefit governmental plan, only if you voluntarily contribute to your defined benefit plan an amount that does not exceed the amount necessary to fund the benefit attributable to the period of service and that is in addition to the regular employee contribution, if any, under the plan. Check with your plan administrator as to the type and extent of service that may be purchased by this transfer.

Tax-Free Rollovers

You can generally roll over tax free all or any part of a distribution from a 403(b) plan to a traditional IRA or an eligible retirement plan, except for any nonqualifying distributions, described below. The most you can roll over is the amount that, except for the rollover, would be taxable. The rollover must be completed by the 60th day following the day on which you receive the distribution. For information on eligible retirement plans, see Publication 575.

Hardship exception to rollover rules. The IRS may waive the 60-day rollover period if the failure to waive such requirement would be against equity or good conscience, including cases of casualty, disaster, or other events beyond the reasonable control of the individual.

To obtain a hardship exception, you must apply to the IRS for a waiver of the 60-day rollover requirement. You apply for the waiver by following the general instructions used in requesting a letter ruling. These instructions are stated in Revenue Procedure 2006-4 found in Internal Revenue Bulletin 2006-1. You must also pay a user fee with the application. The user fee for a rollover that is less than $50,000 is $500. For rollovers that are $50,000 or more, see Rev. Proc. 2006-8, 2006-1 I.R.B. 245.

In determining whether to grant a waiver, the IRS will consider all relevant facts and circumstances, including:

Whether errors were made by the financial institution,
Whether you were unable to complete the rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error,
Whether you used the amount distributed (for example, in the case of payment by check, whether you cashed the check), and
How much time has passed since the date of distribution.

For additional information on rollovers, see Publication 590.

Contributions from a designated Roth account can only be rolled over to another Roth account or a Roth IRA.

Rollovers to and from 403(b) plans. You can roll over, tax free, all or any part of a distribution from an eligible retirement plan to a 403(b) plan. Additionally, you can roll over, tax free, all or any part of a distribution from a 403(b) plan to an eligible retirement plan, except for any nonqualifying distributions, described below. For information on eligible retirement plans, see Publication 575.

If a distribution includes both pre-tax contributions and after-tax contributions, the portion of the distribution that is rolled over is treated as consisting first of pre-tax amounts (contributions and earnings that would be includible in income if no rollover occurred). This means that if you roll over an amount that is at least as much as the pre-tax portion of the distribution, you do not have to include any of the distribution in income.

For more information on rollovers and eligible retirement plans, see Publication 575.

If you roll over money or other property from a 403(b) plan to an eligible retirement plan, see Publication 575 for information about possible effects on later distributions from the eligible retirement plan.

Eligible retirement plans. The following are considered eligible retirement plans.

Individual retirement arrangements.
Qualified retirement plans. (To determine if your plan is a qualified plan ask your plan administrator.)
403(b) plans.
Government eligible 457 plans.

Nonqualifying distributions. You cannot roll over tax free:

Minimum distributions (generally required to begin at age 70½),
Substantially equal payments over your life or life expectancy,
Substantially equal payments over the joint lives or life expectancies of your beneficiary and you,
Substantially equal payments for a period of 10 years or more,
Hardship distributions, or
Corrective distributions of excess contributions or excess deferrals, and any income allocable to the excess, or excess annual additions and any allocable gains.

Direct rollovers of 403(b) plan distributions. You have the option of having your 403(b) plan make the rollover directly to the IRA or new plan. Before you receive a distribution, your plan will give you information on this. It is generally to your advantage to choose this option because your plan will not withhold tax on the distribution if you choose it.

Distribution received by you. If you receive a distribution that qualifies to be rolled over, you can roll over all or any part of the distribution. Generally, you will receive only 80% of the distribution because 20% must be withheld. If you roll over only the 80% you receive, you must pay tax on the 20% you did not roll over. You can replace the 20% that was withheld with other money within the 60-day period to make a 100% rollover.

Voluntary deductible contributions. For tax years 1982 through 1986, employees could make deductible contributions to a 403(b) plan under the individual retirement arrangement (IRA) rules instead of deducting contributions to a traditional IRA.

If you made voluntary deductible contributions to a 403(b) plan under these traditional IRA rules, the distribution of all or part of the accumulated deductible contributions may be rolled over assuming it otherwise qualifies as a distribution you can roll over. Accumulated deductible contributions are the deductible contributions plus income and gain allocable to the contributions, minus expenses and losses allocable to the contributions, and minus distributions from the contributions, income, or gain.

Excess employer contributions. The portion of a distribution from a 403(b) plan transferred to a traditional IRA that was previously included in income as excess employer contributions (discussed earlier) is not an eligible rollover distribution.

Its transfer does not affect the rollover treatment of the eligible portion of the transferred amounts. However, the ineligible portion is subject to the traditional IRA contribution limits and may create an excess IRA contribution subject to a 6% excise tax (see chapter 1 of Publication 590).

Qualified Domestic Relations Order. You may be able to roll over tax free all or any part of an eligible rollover distribution from a 403(b) plan that you receive under a qualified domestic relations order (QDRO). If you receive the interest in the 403(b) plan as an employee's spouse or former spouse under a QDRO, all of the rollover rules apply to you as if you were the employee. You can roll over your interest in the plan to a traditional IRA or another 403(b) plan. For more information on the treatment of an interest received under a QDRO, see Publication 575.

Spouses of deceased employees. If you are the spouse of a deceased employee, you can roll over the qualifying distribution attributable to the employee. You can make the rollover to any eligible retirement plan. You cannot roll it over to a Roth IRA.

If after you roll over money and other property from a 403(b) plan to an eligible retirement plan, you take a distribution from that plan, you will not be eligible to receive the capital gain treatment or the special averaging treatment for the distribution.

Second rollover. If you roll over a qualifying distribution to a traditional IRA, you can, if certain conditions are satisfied, later roll the distribution into another 403(b) plan. For more information, see IRA as a holding account (conduit IRA) for rollovers to other eligible plans, in Publication 590.

Frozen deposits. The 60-day period usually allowed for completing a rollover is extended for any time that the amount distributed is a frozen deposit in a financial institution. The 60-day period cannot end earlier than 10 days after the deposit ceases to be a frozen deposit.

A frozen deposit is any deposit that on any day during the 60-day period cannot be withdrawn because:

The financial institution is bankrupt or insolvent, or
The state where the institution is located has placed limits on withdrawals because one or more banks in the state are (or are about to be) bankrupt or insolvent.

Gift Tax

If, by choosing or not choosing an election, or option, you provide an annuity for your beneficiary at or after your death, you may have made a taxable gift equal to the value of the annuity.

Joint and survivor annuity. If the gift is an interest in a joint and survivor annuity where only you and your spouse have the right to receive payments, the gift will generally be treated as qualifying for the unlimited marital deduction.

More information. For information on the gift tax, see Publication 950, Introduction to Estate and Gift Taxes.