Roth 403b "rule of 55" question.

[Anita]

Hey guys....newbie here.

I have a Roth 403b. My company allowed me to use the "rule of 55" exception to retire early. I met the criteria set forth by the IRS and I then retired at the age of 56.

Here is my problem.. I made my first withdrawal of $30K from my account the other day. It was a money market account which has only returned about a half of one percent earnings in ten years. This means my earnings should have been negligible. Anyway...I never received a breakdown of the details in the mail or by email. When I received the check I was horrified that the fund administrator (not affiliated with my company) withheld over $3k (about 10%) from my distribution. I called them and they told me that the "age of 55 exception" does not apply to ROTH 403b accounts and that he is required by law to withhold 10% of the entire withdrawal. He called it "taxes" and not a "penalty".

Is this correct? Before I retired, I spoke sevetal times to other consultants from my fund management company and they informed me that I would not be subject to any 10% penalty or 10% taxes. I even clarified this with my company.

Anyway....does a Roth 403b allow for the "age of 55 exception" like the normal 403b does? Can someone reference the IRS rule or publication?
If not, shouldn't the fund manager have only withheld 10% of the "earnings" on my $30k withdrawal instead of the entire amount? If so...my earnings would be less than $150 which means they should have only withheld less than $15.

Anyway....thanks a bunch

 

[38Chevy454]

It very well could have a required tax withholding minimum of 10%. That is not the same as the early withdrawal penalty of 10%. The penalty is done on your taxes when you file, not by the 403b administrator. You may not like the 10% tax withholding, but it will balance out when you do your taxes with all income included and you have your final overall tax rate. Since the 403b was pretax money, the full withdrawal is taxable, not just the earnings on top of your contributions. Therefore you got 10% tax withheld of the total withdrawal.

 

[youbet]

Since the 403b was pretax money, the full withdrawal is taxable, not just the earnings on top of your contributions.

Didn't OP say that this was a ROTH 403b and thus it would be post-tax money?

 

[Anita]

Yes....that is correct. I am discussing a ROTH 403b.
The money has already been taxed.

Let me ask another simple question that may help. Does the age of 55 rule apply to a Roth 403b or 401k?

 

[Out-to-Lunch]

My understanding is that the withdrawal rules for Roth 40x accounts differ from the withdrawal rules from Roth IRAs. (This has nothing to do with Rule of 55.)

Consider: https://www.aicpastore.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2012/Tax/Accounts_Early_Retirement.jsp

A second way of having Roth funds for early retirement is through the use of a Roth 401(k) account. The Roth 401(k) distribution rules are different from the Roth IRA distribution rules. While the Roth IRA has distribution "tiers," the Roth 401(k) follows normal annuity distribution rules. That means that every Roth 401(k) distribution is part tax-free return the basis, and part income. That income is subject to taxes if under age 59½, and may be subject to the 10 percent penalty tax. This is why your clients should not take early retirement distributions from a Roth 401(k).

However, the planning opportunity is that upon separation of service, the Roth 401(k) can be rolled over into a Roth IRA. Once that is done, the Roth IRA distributions will follow the Roth IRA tier rules, meaning that the contributions to the Roth 401(k) — now considered as contributions of the Roth IRA — come out first.

Example: Andrea has contributed $100,000 to her Roth 401(k). It is now worth $125,000 and Andrea has separated from service at age 50. She wishes to take a $20,000 distribution. If she withdraws $20,000 from a Roth 401(k), 20 percent of that amount, or $4,000 will be subject to income tax and the additional 10 percent penalty tax. Instead, Andrea should roll her Roth 401(k) into a Roth IRA. Her $20,000 distribution would then be deemed to come from the $100,000 she contributed and will be tax and penalty free.

Also, note that WHICH subaccount you draw from does not matter, in either a Roth IRA or a Roth 40x account. They aren't tracking your basis in the different investment options, just the overall basis.

 

[Anita]

Thanks. But from my understanding, that is referring to the hierchy of tiers in your distribution. IOW...in a IRA, the original contributions are are paid out first and gains are not distributed and taxed until after the original is gone.
401ks and 403bs are taxed Pro Rata.

What amazes me is that the simple question of whether the age of 55 rule applies is to a Roth 403b is not spelled out clearly. I think the IRS considers the Roth as simply a subset of a normal 403b so the age of 55 rule would be allowed but I can't find that specifically in writing. Only in articles.

 

[Out-to-Lunch]

Thanks. But from my understanding, that is referring to the hierchy of tiers in your distribution.

What is the antecedent of the word "that" in your post? I am having a hard time understanding why you prefaced that statement with the word "But," but perhaps I could understand if I knew to what the "that" referred.

 

[Anita]

Sorry...I thought I was clear in my reply. "That" refers to the distribution hierchy forementioned in the example quote you posted.

 

[Anita]

Bump...anyone?

 

[fosterscik]

I think this IRS page may well tell you what's happened:
https://www.irs.gov/retirement-plan...qs-on-designated-roth-accounts#4distributions

What is a qualified distribution from a designated Roth account?
A qualified distribution is generally a distribution that is made after a 5-taxable-year period of participation and is either:
made on or after the date you attain age 59½
made after your death, or
attributable to your being disabled.

and

Is a distribution from my designated Roth account for reasons beyond my control (for example, plan termination or [bold]severance from employment[/bold]) a qualified distribution even though it doesn't meet the criteria for a qualified distribution?
No, if you have not held the account for more than 5 years or if the distribution is not made after death, disability, or age 59 ½, then the distribution is not a qualified distribution. However, you could roll the distribution over into a designated Roth account in another plan or into your Roth IRA. A transfer to another designated Roth account must be made through a direct rollover.

 

[Out-to-Lunch]

I actually spent a bit of time reading through IRS publications (Pub.571, Pub. 575, Topic 558...) and other webpages. I was unable to convince myself of a definitive answer to your question.

I will ask, however: Could your needs be met by rolling your Designated Roth 403(b) account to a Roth IRA? You would not have penalty-free access to the earnings, but you would have access to the contributions.

(Of course, this does not address the question of your already-made distribution.)

 

[Anita]

I know....weird, huh? I would think this would be a simple question that is answered all the time.
Anyway...nah...I want access to the money without having to pay a 10% penalty. I don't mind having to pay taxes on earnings because that is small. But it kills me to have 10% withheld when there is no IRS rule requiring it.
But...as soon as I turn 59.5 I will take all my money out and transfer to a Vanguard IRA.

 

[Out-to-Lunch]

I know....weird, huh? I would think this would be a simple question that is answered all the time.
Anyway...nah...I want access to the money without having to pay a 10% penalty. I don't mind having to pay taxes on earnings because that is small. But it kills me to have 10% withheld when there is no IRS rule requiring it.
But...as soon as I turn 59.5 I will take all my money out and transfer to a Vanguard IRA.

Maybe I did not state my claim plainly: I am pretty sure that you can roll the whole thing into a Roth IRA now, as a tax-free event. You could then have tax- and penalty-free access to the contributions. As you said earlier, in an IRA, the have different distribuition rules, so contributions come out first, not pro-rata.

This plan, I believe, would work as described, but it would require you to have sufficient contributions to last until you are 59.5 and have a Roth IRA account open for 5 years for you to access the earnings tax- and penalty-free.

 

[pb4uski]

I'm not finding anything that indicates that the rule of 55 can be applied to a Roth 403b... everything that I am finding regarding a Roth 403b indicates that you need to be 59 1/2 for withdrawals to be penalty free... but if you have held the account for 5 years that contributions can be withdrawn penalty free.

In general, to make a qualified tax- and penalty-free withdrawal of Roth contributions and earnings, the following conditions must be met:

• the account must have been established for at least five years, and
• the withdrawal must be taken at or after age 59 1/2, or as the result of disability or death.

Distributions that don't meet these conditions are considered nonqualified and may be subject to taxes and penalties.

From everything that I am reading the rule of 55 applies to a regular 403(b) but not to a Roth 403(b).

Note in the below that they have a section that talks about 403(b) penalty free withdrawals that mentions the rule of 55 but two questions later they refer to qualified Roth 403(b) distributions and the rule of 55 isn't mentioned at all.

 

[pb4uski]

Maybe I did not state my claim plainly: I am pretty sure that you can roll the whole thing into a Roth IRA now, as a tax-free event. You could then have tax- and penalty-free access to the contributions. As you said earlier, in an IRA, the have different distribuition rules, so contributions come out first, not pro-rata.

This plan, I believe, would work as described, but it would require you to have sufficient contributions to last until you are 59.5 and have a Roth IRA account open for 5 years for you to access the earnings tax- and penalty-free.

While I would have thought what you wrote would work too, I found this in a TIAA-CREF document that suggests that it may not unless the OP also happens to have a Roth IRA that is 5 years old.

Keep in mind that if you roll over your Roth 403(b) balances into a new Roth IRA, your five-year time frame for the Roth IRA begins on the date you roll over the Roth 403(b) account. Your five-year period from your Roth 403(b) account is not carried over to the Roth IRA with the money. On the other hand, if you roll over savings into an established Roth IRA, the five-year Roth IRA period begins with the date you make your first contribution to a Roth IRA and is unaffected by the transfer of Roth 403(b) balances into the account.

https://hrs.wsu.edu/wp-content/uploads/2016/03/Roth-403b-09-final.pdf

 

[pb4uski]

From what I'm reading it looks like that the $30k withdrawn will not be taxed (I assume that the OP's contributions exceeded $30k) that it will be subject to a 10% premature withdrawal penalty because the OP isn't over 59 1/2.

 

[38Chevy454]

Didn't OP say that this was a ROTH 403b and thus it would be post-tax money?

Oops, I need to check my reading comprehension.......

 

[Out-to-Lunch]

While I would have thought what you wrote would work too, I found this in a TIAA-CREF document that suggests that it may not unless the OP also happens to have a Roth IRA that is 5 years old.

I agree with you. But this 5-year period is only to have penatly-free access to your earnings. You would still have access to your contributions, I believe. Check out this well-stated passage from Fairmark:

https://fairmark.com/retirement/roth-accounts/designated-roth-accounts/five-year-requirement-for-designated-roth-accounts/

Account age doesn’t transfer to IRA

The age of your designated Roth account doesn’t transfer to a Roth IRA when you do a rollover. This peculiar rule can work to your advantage or disadvantage.

*Suppose you’ve had a Roth 401k for just a few years, but you’ve had a Roth IRA more than five years. In this case, you can satisfy the five-year test for all your money by rolling the Roth 401k to a Roth IRA.

*The reverse situation is more awkward. You might have held your Roth 401k account several years without holding a Roth IRA. When you create a Roth IRA to receive the rollover from the Roth 401k, you’ll start a new five-year waiting period before you can take qualified distributions.

For most people this won’t be a problem, because you don’t have to pay tax on your Roth IRA distributions until you’ve withdrawn all your basis. [emphasis added]

 

[Anita]

I agree with you. But this 5-year period is only to have penatly-free access to your earnings. You would still have access to your contributions, I believe. Check out this well-stated passage from Fairmark:

https://fairmark.com/retirement/roth-accounts/designated-roth-accounts/five-year-requirement-for-designated-roth-accounts/

Oh...I see. I can roll all of my Roth 403b funds into a Roth IRA. Then I can withdrawal my contributions only without any penalty or tax liability. This would only become problematic if I ran out of Roth contributions and had to dip into earnings. Do I understand correctly?
That may work and is doable for me.

Regarding whether the age of 55 rule applies to a Roth 403b or not, read this article and tell me what you think:

https://smartasset.com/retirement/roth-403-b

Thanks

 

[Anita]

Also...half way down in this article it implies that the age of 55 rule works with a Roth 403b when it says:
" Bear in mind that the rule of 55 does not remove your income-tax obligations on your 401(k) withdrawals — only the 10% penalty. With a traditional 401(k), that means you owe tax on any amount you take out. With a Roth 401(k), that means any earnings generated by the account if you've held it for fewer than five years"

https://www.businessinsider.com/personal-finance/rule-of-55-401k-early-withdrawal

Or this article at the bottom where it implies that thebage of 55 rule works with Roth 401k:

https://obliviousinvestor.com/roth-401k-distribution-rules/

Or this Forbes article where it specifically says that the age of 55 rule applies to 401k
https://www.forbes.com/advisor/retirement/what-is-roth-401k/

Thanks guys. I realize you all are putting in a lot of time.

 

[Out-to-Lunch]

Oh...I see. I can roll all of my Roth 403b funds into a Roth IRA. Then I can withdrawal my contributions only without any penalty or tax liability. This would only become problematic if I ran out of Roth contributions and had to dip into earnings. Do I understand correctly?
That may work and is doable for me.

Regarding whether the age of 55 rule applies to a Roth 403b or not, read this article and tell me what you think:

https://smartasset.com/retirement/roth-403-b

Thanks

Yes, you understood me correctly. I was formulating this as a fallback plan for you in the case that Rule-of-55 R403(b) distributions are NOT qualified.

Also...half way down in this article it implies that the age of 55 rule works with a Roth 403b when it says:
" Bear in mind that the rule of 55 does not remove your income-tax obligations on your 401(k) withdrawals — only the 10% penalty. With a traditional 401(k), that means you owe tax on any amount you take out. With a Roth 401(k), that means any earnings generated by the account if you've held it for fewer than five years"

https://www.businessinsider.com/personal-finance/rule-of-55-401k-early-withdrawal

Or this article at the bottom where it implies that thebage of 55 rule works with Roth 401k:

https://obliviousinvestor.com/roth-401k-distribution-rules/

Or this Forbes article where it specifically says that the age of 55 rule applies to 401k
https://www.forbes.com/advisor/retirement/what-is-roth-401k/

Thanks guys. I realize you all are putting in a lot of time.

I am increasingly convinced that the Rule of 55 works for R403(b) plans. I think it should, and don't see any reason it wouldn't. However, I would STILL like to see it an IRS publication! One of their typical examples would be nice, like "Juan is 56, and has been contributing to a Roth 401(k)... blah blah blah. His distribution is qualified."

 

[Anita]

Yes, you understood me correctly. I was formulating this as a fallback plan for you in the case that Rule-of-55 R403(b) distributions are NOT qualified.




I am increasingly convinced that the Rule of 55 works for R403(b) plans. I think it should, and don't see any reason it wouldn't. However, I would STILL like to see it an IRS publication! One of their typical examples would be nice, like "Juan is 56, and has been contributing to a Roth 401(k)... blah blah blah. His distribution is qualified."

Yeah...me too. I think...and correct me if I am wrong, the IRS publications just doesn't distinguish between Roth and Non Roth rules when it comes to the age of 55 rules. They may consider the Roth as as as subset of the basic 403b so the age of 55 exception would apply to all 403b...Roth or not.. That's why there are no specific examples. Who knows...
Do you think I should all the IRS and ask? Will I be able to actually speak to someone that can clarify this? Again...I can't imagine that this topic hasn't been settled with an absolute answer before.
Thanks

 

[Out-to-Lunch]

Yeah...me too. I think...and correct me if I am wrong, the IRS publications just doesn't distinguish between Roth and Non Roth rules when it comes to the age of 55 rules. They may consider the Roth as as as subset of the basic 403b so the age of 55 exception would apply to all 403b...Roth or not.. That's why there are no specific examples. Who knows...

That is exactly what I think, too. On a non-IRS site, I saw words to the effect of "The access rules for Roth 403(b) are the same as traditional 403(b). No better, no worse."

Do you think I should all the IRS and ask? Will I be able to actually speak to someone that can clarify this? Again...I can't imagine that this topic hasn't been settled with an absolute answer before.
Thanks

I really don't know, as I have never had to deal with calling the IRS. Maybe they are better than I imagine!

One idea that struck me was to post that question on Bogleheads. Someone there should know. (One user, "Alan S.," is an expert on distribution rules.) For that matter, Mike Piper, who is the auther of the "Oblivious Investor" site that you quoted upthread, is an active Boglehead.

 

[pb4uski]

Good idea. I haven't been able to find anything supporting that the rule of 55 applies to a Roth 403(b) in any source that I would consider to be authoritative. But if Alan S or Mike Piper or Ed Slott or Michael Kitces published something supporting it rather than some XYZ journalist then it would have more credibility.

 

[Anita]

Thanks.
I will join and ask on Bogleheads. It's frustrating. My money is in a TransAmerica account. I can only speak to a call center person. They claim that the rule of 55 does not apply. But they are not an authority and are only following the directions set forth by my ex employer. They will not let me speak to the "processor" who made the decision to withhold taxes from my withdrawal. I accept that I may be wrong...I just want to see something definitive in writing.
Thanks again for all of your help.