Tax-sheltered annuity 403(b) plans let employees of colleges, churches and other tax-exempt organizations put money into a retirement account and defer taxes on the money until distributions are taken. Once you've left your job, you can take money out, but if you're not 59 1/2, you'll owe not only taxes, but a 10-percent early-withdrawal penalty on your distributions. Instead, consider rolling the money to an individual retirement account (IRA).
Maintain Tax-Sheltered Growth
Both 403(b) plans and IRAs offer tax-sheltered growth for the money in the account. Suppose you don't want to leave the money in your 403(b) plan after leaving employment, but you plan to continue to save that money for retirement. By transferring it to an IRA, any further gains on your investments continue to grow tax-free. If you didn't roll the money into a qualified account, you'd have to pay taxes on the gains each year.
Avoid Withdrawal Taxes
When you roll over the money from a 403(b) plan to a traditional IRA, you also postpone having to pay any income taxes until you take distributions. You won't avoid taxes if you roll the money to a Roth IRA, because Roths are after-tax retirement accounts. However, you'll get all the money out tax-free when you take qualified distributions. With a rollover to either a traditional or Roth IRA, you avoid the early-withdrawal penalty that you would face if you simply took a distribution from your 403(b) plan.
IRAs offer more investment options than 403(b) plans. With a 403(b) plan, you're limited to investing in annuities and mutual funds. With an IRA, you can choose an annuity or mutual fund if you want, but you can also choose other investments like individual stocks and bonds or real estate investment trusts. The only prohibited investments for IRAs are collectibles -- think baseball cards or art -- and investments used for personal benefit. For example, though you can invest in real estate, you can't use your IRA to buy a vacation home for your family.
Early Withdrawal Penalty Exceptions
IRAs offer additional early withdrawal exceptions that are not available on early withdrawals from a 403(b) plan. These include exceptions for higher education expenses and up to $10,000 for your first home, and you can start using the exceptions immediately after the rollover. Suppose you leave your job to go back to graduate school. if you take an early withdrawal from your 403(b) plan to pay for graduate-school tuition, you'll owe the 10-percent early withdrawal penalty on top of the income taxes. If you transfer the money to an IRA first, you won't pay the penalty.
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