Job changes are becoming the norm rather than the exception. If you've moved on from your job at a non-profit and are considering cashing out your 403(b) plan, you need to know the tax consequences. However, if you want to avoid taxes and penalties, you've got to act fast after cashing out.
Treated as Taxable Income
You may not have noticed it because it's not a deduction you take on your tax return, but you didn't pay taxes on your 403(b) contributions. When you cash out, the time has come to pay the piper. The amount of your 403(b) distribution must be included in your taxable income for the year. The amount of tax depends on what income tax bracket you fall in for the year. For example, if you cash out $5,000 and you fall in the 25 percent tax bracket, you'll owe $1,250 on the distribution.
Additional Tax Penalties
If you're under 59 1/2, Uncle Sam gets upset that you aren't waiting until retirement age to take out the money and imposes an extra 10 percent tax penalty on the distribution. The penalty applies even if you wouldn't otherwise owe any taxes. For example, if you take a $5,000 distribution before age 59 1/2, whether you fall in the 15 percent or 35 percent tax bracket, the penalty is always going to be $500.
If you're under 59 1/2, there's a few circumstances where Uncle Sam has mercy on you and waives the penalty (but not the income taxes). For example, if you have medical expenses in excess of 7.5 percent of your adjusted gross income (10 percent in 2013 and beyond), that amount is exempted from the penalty. You also avoid the penalty if you're permanently disabled, cash out because of a divorce court order or the IRS levies the plan.
Postponing Income Taxes
If you're taking the money out of your retirement plan permanently, you won't be able to avoid the income taxes on the distribution. However, if you're cashing out because you're leaving the employer, you can postpone the income taxes by rolling over the distribution into another tax-deferred retirement plan, such as a traditional IRA, within 60 days. This way, you keep the money growing in a tax-free account and don't have to pay taxes until later.
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