One of the advantages of qualified plans and IRAs is the portability with rollover contributions. The ability to transition funds from one account or plan to another allows for tax-free transactions that aid with retirement and estate planning. Understanding the portability rules — in particular with 403(b)s and IRAs — can prevent an unwelcome tax consequence.
It is possible to roll 403(b) pre-tax accounts into a Roth IRA, traditional IRA, SIMPLE IRA, SEP IRA, governmental 457(b), qualified plan pre-tax, 403(b) or in-plan Roth conversion account. Any conversion or rollover into Roth involves income recognition. Designated 403(b) Roth accounts can be rolled to a Roth IRA, a Roth 403(b), a Roth 401(K) or a governmental Roth 457(b) account. A 403(b) account cannot be rolled into an already established inherited IRA. Only inherited 403(b) accounts can be rolled into an inherited IRA.
A beneficiary inheriting a 403(b) account has several options including the inherited rollover option, cash-out distribution, or maintaining the funds within the plan based on the balance size and terms of the plan document. Note that 403(b) plan rollover IRA options include traditional, non-deductible and Roth IRAs upon conversion. A plan generally allows a distribution upon completion of required paperwork and receipt of a special tax notice, 402(f). Similar rules apply to beneficiaries of other qualified plans.
Traditional IRAs can be converted to a Roth IRA, or rolled over to another traditional IRA, SIMPLE IRA, SEP IRA, governmental 457(b), qualified plan and 403(b) pre-tax accounts.
Inherited IRAs have special rules that vary depending on whether the assets are received by the spouse or other beneficiary. When a non-spouse inherits a traditional IRA, these options vary whether or not the beneficiary is over or under the age 70.5. If under the age of 70.5 the beneficiary may open an inherited IRA in his or her own name. If an inherited IRA uses the life expectancy method, distributions must begin no later than Dec. 31 of the year after the account holder died. The annual distributions are determined using the beneficiary’s single life expectancy. In general, a 10% early withdrawal penalty does not apply; however, the distributions are taxable.
Under the five-year method, all assets much be fully distributed by end of the fifth year after the year in which the account holder died. Similarly, a 10% early withdrawal penalty does not apply, and all distributions are taxed but grow tax-free until the distributions occurs.
If death occurs after age 70.5, non-spousal beneficiaries of an inherited IRA may use the life expectancy method. This works in the same manner as an IRA inherited under the age of 70.5 except any missed required minimum distribution not taken by the decedent in the year of death must be taken by Dec. 31 in the same year. Additionally, a lump sum distribution is also available.
Spouses have more options available with an inherited IRA including treating the IRA as their own. Under the life-expectancy method, the assets are transferred into an IRA held in the name of the spouse. Distributions must begin no later than Dec. 31 of the year the spouse beneficiary reaches age 70.5. Similar to non-spouse beneficiaries the lump sum option is available.
Rollover rules, especially in regards to 403(b) plans and IRAs are complex. It is important to discuss these rules with a qualified tax consultant when making decisions related to conversions and other potential tax consequences.