A 403(b) rollover to an IRA: five costly mistakes and how to avoid them

What could I lose by leaving the 403(b) for an IRA?

Three ways to handle a 403(b) at retirement each carry different risks. Leave everything in the 403(b) and you keep penalty-free access until 59½ if you separated after turning 55, but you may pay more in fund fees every year.

Roll everything to an IRA and you get more fund choices and lower fees in most cases, but you lose that penalty-free access—any withdrawal before 59½ faces a 10% penalty, even if you are otherwise allowed to take the money. Split the difference: roll most of it to an IRA for growth and keep enough in the plan to cover your spending until 59½, if the plan allows partial draws. That requires asking your vendor a direct question: "Can I take partial distributions and leave some money here?" If the answer is no, the split is off the table.

Before Harbourfront Wealth Management suggests moving a dollar, it compares what you pay now with what you would pay in an IRA. A $300,000 403(b) balance filled with funds that charge 0.80% yearly costs $2,400 a year. Rolled into an IRA where the funds charge an average of 0.60%, it costs $1,800 a year. That $600 gap sounds small until you do the math: over 20 years, assuming no additional growth, the difference is $12,000 before investment returns. But if the plan charges 1.20% and the IRA runs 0.40%, the gap is $2,400 a year, which adds up to $48,000 over 20 years. Ask the plan to send you a current fee breakdown, and ask the prospective IRA custodian for its fund expense ratios.

Any annuity contract inside your 403(b) also affects the choice. If $200,000 of a $500,000 balance sits in an annuity with a surrender schedule that runs for another five years, moving it now might cost 5% to 7% of the balance to exit. Another page on this site walks through annuity costs. For now, know that a surrender charge can swallow the savings from lower fees, and that tradeoff needs its own conversation before you commit.

• When you left your job relative to age 55 and 59½ (these ages control penalty-free access)
• The yearly cost of each 403(b) fund compared with the funds the IRA would hold
• The end date of any annuity surrender charge and the charge amount
• Any Roth or after-tax money in the plan and where it needs to go
• The beneficiary names currently on file in the plan

Do I have to roll my 403(b) into an IRA when I retire?

No. Most 403(b) plans let you leave the money where it is after you separate from your school district, although the vendor's rules and your state's laws vary. A representative telling you that "everyone rolls over" is not stating a rule. It is a sales message. Your choice is yours alone.

If you do choose to roll over, the first decision is how the money moves. A direct rollover sends the check to your new IRA custodian, made payable to that custodian for your benefit. No money passes through your hands, and no tax is owed—it is a tax-free exchange between accounts. An indirect rollover means the check comes to you. Federal withholding of 20% is automatic, and you have 60 days to deposit the full amount (including the $8,000 withheld) into an IRA to avoid tax on the withheld dollars. Miss the 60-day deadline by even one day and the $8,000 becomes taxable income.

A third option is a Roth conversion. You can roll the 403(b) into a Roth IRA instead of a traditional IRA. The full amount becomes ordinary income in the year of the conversion, and you owe tax on it. Roth conversions make sense if your income is low that year (perhaps you just retired in June) or if you want tax-free growth and no required minimum distributions later. Roth conversions are a separate decision from rollovers, and the timing matters.

Teachers who left their school job during the calendar year they turned 55 or later can take money from that 403(b) without the 10% early-withdrawal penalty. Keisha, born after 1960, left her job at 56, so this rule applies to her: she could withdraw $20,000 from the 403(b) with no penalty. But if she rolls the money into an IRA, that exception stays with the 403(b). The IRA has its own penalty exception—age 59½—and no other age gets a penalty-free pass from a 403(b) rollover. Required minimum distributions start at 75 for anyone born in 1960 or later, whether the money sits in a 403(b) or an IRA.

If the check is made out to me, what do I lose?

Keisha's situation is common. At 56, an old pension system where she taught for three years early in her career offers to pay out her $40,000 account (hypothetical, round numbers). This is separate from her main 403(b) that she rolled the year before. She receives the check in her name in July.

Here is what happens if the money is paid to Keisha instead of moved directly. Federal withholding of 20% is required on any eligible rollover paid to the participant—that is the law. So on $40,000, the plan withholds $8,000, and Keisha receives $32,000. The 60-day clock starts the day she opens the envelope, not the date printed on the check.

If Keisha deposits only the $32,000 in an IRA within 60 days, the missing $8,000 is taxable. At an assumed 22% tax bracket, that is $1,760 in income tax. Because she left that pension job long before she turned 55, the $8,000 also carries a 10% early-withdrawal penalty—another $800. Her total tax bill is $2,560. The rest of the $8,000 comes back as a refund when she files her tax return that year, but she has already sent the money to the IRS and waited for it to return.

To avoid the whole cost, she could deposit $40,000 into an IRA—the $32,000 she received plus $8,000 of her own cash. The entire distribution is treated as rolled over, $0 is taxable, and the $8,000 withheld is a refund when she files. The cost of that refund is zero.

A direct rollover avoids this problem entirely. If the pension system deposits the $40,000 directly into an IRA custodian's account in Keisha's name, no withholding occurs. She owes $0 tax. That single choice—direct instead of indirect—is the whole fix.

When should I move the money, and in what order?

Timing the 403(b) rollover against your pay schedule and your tax year can mean the difference between a clean process and a second form or a missed deadline. Three timing mistakes come up often.

Moving too early: if your school district spreads pay over 12 months, a June or July rollover might still have 403(b) deferrals coming out of July and August paychecks. A few weeks later, HR sends a notice that a small balance is still in the plan—maybe $3,000. Now you need a second distribution form and a second rollover. It costs nothing, but it doubles the paperwork. Ask HR which date the payroll system closes for your deferrals, and schedule the rollover to start the day after.

Moving too late or in the wrong order: an indirect rollover received on day 61 after the initial payout is taxable. Rolling everything to an IRA and then selling it all two months later because you need cash brings the 10% early-withdrawal penalty on top of tax. A Roth conversion in the same tax year as a $40,000 pension payout stacks two big income events on one tax return, raising your adjusted gross income sharply and potentially triggering Medicare income surcharges (IRMAA) earlier than planned. The order matters.

Notice in the table below that the 60-day window closes the same day for any rollover amount, but the Form 1099-R—the payout form that tells you what to report on your taxes—does not arrive until January. That means the rollover has to be done well before the year ends and before you see the form that explains it on your tax return. Do not wait.

How do I set up a direct rollover from the school's vendor?

A direct rollover protects you from withholding and gives you a 60-day grace period you do not need. Here is how to run it.

Step one: Open the IRA at a custodian first. Call or visit the custodian's website and request the account. Most custodians charge nothing to open an account. Ask the custodian for its "rollover receiving instructions"—that is the information you will give to the old plan so it knows where to send the check. Write it down.

Step two: Go to your 403(b) vendor or call its customer service. Ask for the "distribution form" or "rollover request form." On that form, choose "direct rollover" or "trustee-to-trustee transfer." Do not choose "indirect rollover" or "pay me." Write the new custodian's name and the receiving instructions on the distribution form exactly as the custodian provided them. The check should say "[Custodian name] FBO [Your Name]" (FBO means "for the benefit of").

Step three: Mail the signed form to the vendor, or upload it to the vendor's website if that option exists. Some vendors mail the check to the custodian; some mail it to your house by mistake, even though it is made out to the custodian. If a check payable to the custodian arrives at your house, you are not in trouble—it is still a direct rollover. Just forward it to the custodian within a few business days.

Step four: Once the IRA custodian deposits the money, choose the IRA's funds right away. Do not leave the money in the default cash account for weeks. Cash usually pays next to nothing and earns no growth toward your retirement. Call the custodian or log into the website and select the funds you want to own. Investments can lose value, and your IRA can end up worth less than the amount you rolled in, so choose based on your goals and how soon you expect to use the money.

Step five: In January, check that Form 1099-R from the vendor shows rollover code G (direct rollover). By May 31, check that Form 5498 from the IRA custodian reports the same amount you deposited. If either form is wrong, call the custodian to correct it before you file your tax return.

Which answers from the 403(b) vendor should make me stop?

Before you commit to a rollover, ask your vendor three direct questions. The answers will tell you whether to move forward or pause.

Ask: "Is any part of my 403(b) balance in an annuity contract, and what is the surrender charge this year?" Any percentage above zero, with years still left on the schedule, is a reason to pause. A surrender charge of 5% on a $200,000 annuity is $10,000. That cost can wipe out years of fee savings, and moving an annuity out early needs its own comparison. If the answer is "Yes, you have an annuity and the surrender charge is 0%," you are clear to move.

Ask: "Can I take partial distributions and leave some money in the plan?" This one opens up the split-rollover strategy: move most of it to an IRA and keep enough in the plan to cover your spending before 59½. If the vendor says "We only release the full balance," the split option disappears. You have to choose all-or-nothing.

Ask: "Will you send the money directly to my new IRA custodian, or do you only pay the participant?" Two answers should worry you. If the vendor says "We only pay the participant," you are locked into an indirect rollover with 20% withholding. If a representative says "The money must go into an annuity I will set up for you," that is a sales pitch, not a policy. Your money is yours; you choose where it goes.

Who inherits the IRA if I die, and does the rollover change that?

Beneficiary designations do not move with the money. When you open a new IRA for the rollover, the form asks you to name beneficiaries. This is a separate document from your 403(b) beneficiary form, and the two do not sync up.

If you do not fill it out, some custodians default to your estate, which can force heirs into a ten-year deadline to empty the account and may lock them out of spreading the tax over their own lifetimes. Keisha is single, so she named her sister as beneficiary. She filled out the IRA beneficiary form the same day she opened the account.

Most non-spouse heirs must empty an inherited IRA within ten years (the ten-year rule under the Secure Act), so naming the right people and spelling their names correctly decides how they can manage the tax of taking that money out. Spouses have more options: they can roll an inherited IRA into their own IRA and delay distributions until they are required. If this matters to you, a conversation with Harbourfront Wealth Management or a tax professional can clarify what the rules mean for your heirs.

Which rollover steps can I do alone, and which deserve a Harbourfront Wealth Management review?

You can run the checklist against your own statements, open the IRA at a custodian, and request a direct rollover from the vendor on your own. These are mechanical steps and they are straightforward once you know which questions to ask.

A conversation with Harbourfront Wealth Management is worth having on three points: Timing the move against your pension start date, so you do not accidentally stack income and raise Medicare premiums; deciding what to do with the annuity portion that is still inside its surrender schedule, because moving it early might cost more than it saves; and comparing the yearly cost of your 403(b) fund by fund with the IRA's funds, so you know whether lower fees actually wait for you on the other side, or whether you are simply switching cost for cost. Those questions need a closer look at your actual accounts and your own timeline.