Is your 403 (b) plan a good investment?
403 (b) plans are the retirement savings plans for educators and employees of tax-exempt organizations. They are also known as tax sheltered annuity plans (TSAs). Participants include teachers, school administrators and other personnel, nurses, doctors, professors, librarians, and ministers. Many of these folks also receive a pension, but often the pension is not enough to give them a secure retirement so they add to their retirement savings by reducing their salary and having that amount contributed to a 403 (b) plan.
403 (b) plans are similar to 401 (k) plans available in the private sector whereby employees may make salary deferral contributions, and employers may (or may not) provide a matching contribution. Here are 3 main investment choices: 1) annuity and variable annuity contracts provided by an insurance company; 2) custodial accounts invested in mutual funds; or 3) for churches only, retirement income accounts. Unfortunately, many employers only provide the option to invest in annuities with higher expenses than low-cost mutual funds.
The money in the plan is set aside on a pre-tax basis and the earnings inside the plan also accumulate tax free. Salary reduction agreements for 403 (b) benefits do not reduce salary for purposes of computing future social security benefits or for the payment of current social security taxes.
There are limits on the amount of salary that can be deferred. There is an annual Maximum Allowable Contribution (MAC). There are two parts to computing this, your limit on annual additions (which can include any contributions made by the employer) and your limit on elective deferrals. In 2011, the limit for annual additions is $49,000 or 100% of includable compensation. The 2011 limit on elective deferrals is $16,500. There is a special rule that may apply if you have at least 15 years of service. After age 50 there is an opportunity for catch-up contributions up to $5,500. You should consult your plan administrator if you have trouble determining your MAC.
403 (b) plans have multiple expenses, including administrative costs and investment management fees. Investment management fees are often charged by the investment company as a percentage of the total assets under management – the total value of your account. These fees range from about 0.2% on the low end to 3% on the high end. There can also be custodial fees, mortality and expense fees in the case of annuities, transfer fees, wrap fees and surrender charges.
If your 403 (b) plan investment choices are too expensive, ask you employer to add other lower cost options. Especially make sure there is a low-cost mutual fund option available. These plans are not limited to annuities. If your employer refuses, perhaps a committee of employees would have more clout. In general, unions have not gone to bat for 403 (b) plan participants because the investment and financial service companies who are selected for participant investment choices sometimes make big contributions to the unions. The wheels within wheels. . . .
This column examined 401 (k) fees a few weeks ago. As high as 401 (k) fees can be, unfortunately, most 403 (b) plans have higher fees than 401 (k) plans. Unlike 401 (k) plans, administrators of 403 (b) plans are not considered fiduciaries – and, therefore, have no legal or ethical obligation to monitor plans to ensure they’re in the best interest of the participants.
Many financial advisors say that if your 403 (b) only has high cost investments, you are better off foregoing participation and contributing to a Roth IRA, a traditional IRA, or even in some instances a taxable account. Why? Because high costs can overrun the advantage of the tax deferral.
Robert Brokamp writing for The Motley Fool Retirement Center says, ” For most people, annuities are a last-resort investment because they are too expensive, offer mediocre insurance coverage, restrict the owner’s investment choices, and lack liquidity. Because of the large fees (read: commissions for your broker) associated with annuities, they are a favorite of brokers and planners. It’s not uncommon for Rule Your Retirement members to regale us with annuity pitches offering outrageous claims. When it comes to a legitimate pitch, annuities are most suitable for investors who:
• Have contributed the maximum to their defined-contribution plans and IRAs and desire further tax deferral on investment gains
• Prefer investing in mutual funds as opposed to individual securities
• Will keep the annuity for at least 15 to 20 years
• Are in a 25% or higher income tax bracket today, but expect to be in a lower income tax bracket in retirement
• Don’t need the annuity proceeds prior to age 59½
• Are unconcerned that heirs must pay ordinary income taxes on any appreciation
• Desire a ‘guaranteed’ income for life in retirement”
Tax deferral is important and is a valuable benefit, but its value can be eroded by high fees. Make sure you know what you are paying for your plan.