Using a 403(b) plan to save for retirement helps you lower your taxes in the years you make contributions because the money you deposit in the plan isn’t included in your taxable income. Plus, the money grows tax free while it’s in the account. However, all good things come to an end, and when you take distributions, you’ll have to pay income taxes. If you’re not 59 ½, you might also have to pay additional tax penalties.
TL;DR (Too Long; Didn't Read)
Your 403(b) withdrawals are taxed as ordinary income, the rate of which depends on your total income.
403(b) Withdrawal Rules
The distributions from your 403(b) plan are taxed as ordinary income, which means the distribution amount is added to your other taxable income and taxed at your marginal income tax rate. Your marginal tax rate depends on your total income and filing status. The higher your total taxable income, the higher the marginal rate. In addition, your distributions won’t qualify for the lower capital gains rates even if you were investing in mutual funds within your plan. This is the same tax structure as a 401(k), so you can use a 401(k) cash out calculator to calculate your taxes.
Penalties for Premature Distributions
If you take money out of your 403(b) plan prior to turning 59 ½ years old, you must pay an additional 10 percent tax penalty on top of the ordinary income taxes, which is the same as the 401(k) early withdrawal penalty. For example, if you take out $7,000 when you’re 50, you’ll owe income taxes plus an extra $700 penalty. However, there are limited exceptions to the early withdrawal penalty. These exceptions include if you are permanently disabled, if you are taking distributions from an inherited 403(b) plan, if you are paying for deductible medical expenses or if you’ve left your job after turning 55 years old.
Tax Rates Lower in 2018
Under the new tax law effective for the 2018 tax year, the tax rates have been lowered, so you’ll pay less on your 403(b) distributions. The lowest tax bracket is still 10 percent, but the subsequent tax brackets are 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and a maximum of 37 percent.
Higher Tax Rates in 2017
In 2017, the tax brackets were higher. The lowest bracket was still just 10 percent, but subsequent brackets were 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and a maximum of 39 percent. So, all else being equal, you can expect to pay a little less in federal income taxes on your 2018 403(b) distributions when compared to 2017.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."