CHAPTER 7: When You Can Get Out of Dodge

It’s extremely important to know that if you are in a personal 403(b), meaning no employer contributions, and often 401(k) depending on your employer, you can often move your assets out of an employer sponsored plan and into an IRA when you sever service from your employer or reach the age of 59.5. If you are in a plan that you don’t like, you should have this date marked on your calendar, keeping in mind that my recommendations might change depending on the situation and other factors including surrender penalties.

Why might you want to consider rolling your money out of a 403(b) after 59.5? Well, if you had optimal options within your 403(b) Plan, I guess you might not, but that’s not currently the case everywhere. So, 59.5 might be your first chance to pick a plan that better suits your specific needs.

Example: I’m working with a client who is 57 years old and plans to work until he is 67, which is his full Social Security age. He has 20 years of service with his current school district. About 15 years ago, he took some terrible advice and moved his money out of the defined benefit plan (pension) and into the defined contribution plan (investment plan). It was terrible advice because what the guy really needs in retirement is guaranteed income! And aside from Social Security he does not have any. He’s been a good saver though, and has about 100k in a 403(b), but his district does not have any options that would create guaranteed income. If this client was 59.5 or older (or had

severed service from his employer), he could look into rolling that 100k into a plan that suited his needs, specifically income. But since he’s not that age yet, unfortunately he has to wait another 2.5 years to put a plan in place that he can feel confident about.

Side note: 457(b)s often do not allow withdrawals until you sever service or are 70.5, so there is far less portability with those plans.

Help! I don’t have a 403(b). I have something else…

There are a lot of different types of retirement plans and it’s hard to cover the minutia without sounding like Ben Stein. We are not covering all of them, just the ones we see most frequently. You can consider this extra credit. I’m going to breeze through them and then recap in a way that might help you put it all together. Note: we’re only talking right now about the elective ones, the plans you started on your own, or with the help of somebody like Cliff. But first…

Our good old Uncle Sam is going to help us with the next part, because taxes are kind of important when we discuss tax codes. We have two categories here. We’ll start with:

Traditional

A traditional plan is one where contributions are made pre-tax. Traditional plans reduce your taxable income now; you do not pay taxes on the money you contribute to your plan in the year you contribute it. But, since you have not paid taxes on any of this money, and come on, Uncle Sugar isn’t going to let you get away from that forever, you have to pay taxes on this money

when you take it out of the plan. At that time, it will be taxed as ordinary income. If you have not touched any of the money inside your plan by the time you are 72 (formerly 70.5), Uncle S makes you start taking withdrawals annually from your plan. This is called a Required Minimum Distribution or RMD. There are tables to tell you exactly how much you have to withdraw, but it starts at just under 4% and goes up from there as you get older. If you don’t take out your RMD each year, the IRS will penalize you 50%--yes 50% of the funds you should have taken out but didn’t.

There are a lot of people who really don’t need to use their traditionally saved money in retirement—and yet they have to start taking the 4ish% every year. Some ask, “What do we do with all this money?” It makes me think of the 1998 hit by Semisonic, Closing Time that goes like this, “Closing time, you don’t have to go home, but you can’t stay here.” The IRS doesn’t care what you do with the money. Go on a trip, remodel the kitchen again, open up a different type of plan and dump the money in there after you’ve paid the taxes. Point is, they make you start taking it out, whether you want to or not. This applies to all of the following except Roth IRAs.

403(b)

403(b) is the most common type of tax code we see inside K-12 and Universities. While you are working you have to choose a provider from your employer’s Menu. You can usually move your funds out of the plan once you have severed service (no longer working there) or you are the magical age of 59.5.

401(k)

Every once in a while, we work in a school district that has a 401(k) option in addition to its 403(b) and 457 plans. This isn’t necessarily a bad thing. 401(k)s sometimes have lower plan expenses than 403(b)s. The little hiccup with a 401(k) is that there is usually only one option. It’s as if they brought you out a menu that had one Daily Special on it. Like 403(b), you can usually move your funds out of the plan once you have severed service (no longer working there) or you are the magical age of 59.5.

457(b)

457(b)s or just 457s were created for government workers, so this applies to many K-12 and some university workers as well. Much is the same as a 403(b) and you have to pick a provider from the menu.

A big benefit to a 457 is that IF you retire before full retirement age of 59.5 and you want to access some or all of your money, you will not pay the 10% early withdrawal penalty that you would pay with most other types of plans. This is what makes them good plans for firefighters and police officers that often retire earlier than other types of workers.

The not-so-great part of 457s is that you don’t actually own them, your employer does, and you often can’t move your funds out of the plan until you have severed service (no longer working there) or you are the magical age of 70.5!

IRA

Okay, Individual Retirement Accounts or IRAs are not employee sponsored plans, but a lot of people have them. You can run out and start yourself an IRA today, with any company you want, but you can ’t contribute anywhere near as much as you can with your employer sponsored plan.

You own your IRA, and you can decide at any time what you want to do with it; change plans, change advisors, cash it in…however, if you are under 59.5 you will pay a 10% penalty for taking the money out before you are technically old enough. IRAs are usually the “catch all” for all other types of plans, meaning if you were to leave employment with a 401(k), a 403(b), and a 401(a), you could combine them all into your IRA. Since this money is already pre-tax it can go right into your IRA and the event is non-taxable.

Post-Tax or Roth

With Roth plans you pay Uncle Sugar before the money goes into the plan. These plans do NOT give you a tax break when you contribute to them, but the money does grow tax deferred and when you take the money out in retirement the money come to you tax free! Yay! It’s a personal choice as to whether Traditional or Roth is a better fit for your financial picture.

Roth IRA

Roth IRAs work pretty much the same way as traditional IRAs. The contribution limits are the same as traditional IRAs, and significantly less than what you can contribute to an employer

sponsored plan. Provided five years have passed since your first contribution to the account and you are over 59.5, you do not have to pay any taxes at all on the money coming out of this account. If your income is above a certain level, you cannot contribute at all to a Roth IRA.

Roth 403(b)

Roth 403(b)s are almost exactly the same as traditional 403(b)s. You have to pick off The Menu, and you can roll into a Roth IRA when you sever service or turn 59.5. The only difference is that like Roth IRAs, you pay your taxes on the money now, so you do NOT have to pay taxes later, provided you have followed the rules. The song Closing Time does apply to Roth 403(b)s though. Even though you ’ ve paid your taxes you do have to take RMDs from Roth 403(b)s. I often suggest clients roll a Roth 403(b) into a Roth IRA when eligible, 59.5 or older, to avoid this problem.