Many privately held companies offer their employees a 401(k) retirement plan as part of their benefits package. Public employees typically have a similar option, with most schools offering educators a 403(b) plan.
These retirement plans are a great option for educators looking to boost their retirement savings beyond the amount in their pensions. Let’s face it, budget cuts and rising costs make planning for the future more important than ever. What’s more, state budget shortfalls in many areas have led to some state governments either cutting pensions entirely or making significant changes to the pension plan.
This is where your 403(b) retirement plan can help fill in the gaps. Take care, though, and do your research. Not all 403(b) plans are created equal.
403(b) Retirement Plans: The Basics
Though these plans are part of the IRS code, they vary widely not only from state to state, but school district to school district. This is not unusual; you see this same level of variety with 401(k) plans in the private sector. What this means is that you, as the investor, need to take the time to review the plan’s options and fees.
The 403(b) retirement plan works in much the same way as a 401(k) does. Employees contribute a certain percentage of their salary toward the plan. These contributions are invested as per the employee’s elections. Contributions and investment growth are tax-deferred until the employee begins withdrawing funds upon retirement. The IRS taxes withdrawals according to the income tax rate the employee paid before he or she retired.
Contribution limits may change yearly. In 2017, employees may contribute up to $18,000 per year to a 403(b) account. If your employer matches contributions, the limit is either $54,000 per year or the equivalent your yearly salary, whichever amount is less.
As in 401(k) accounts, employees aged 50 or older are permitted to “catch up” with extra contributions. In 2017, this amount is $6,000 per year.
If you have 15 years of service AND your employer allows it AND your average annual contribution was less than $5,000 per year, you may increase your annual contributions by $3,000.
Investing in Your 403(b)
The average American aged 55 to 64 has less than $104,000 in retirement savings. Though most of us would love to receive a lump-sum check for $104,000, it’s not an amount that will see you through your golden years.
In the early days of the 403(b), participants could invest in annuity properties only. Beginning in 1974, however, investment opportunities expanded to include mutual funds as well. It depends on the plan offered by your school, and not all plans include mutual fund options.
Many teachers fail to invest in their 403(b) plan for two main reasons. First, they already invest in a pension plan. This tends to make some people a bit lazy about planning for retirement, as they assume their pension will amply provide for their needs. Second, they don’t have enough information regarding their 403(b) options. This often leads to these educators making poor decisions, as they don’t have enough information on the fees and total annual cost of the fund they choose when they do decide to invest.
Variable v. Fixed Index Annuities
Many of the brokers who sell directly to teachers focus on selling variable annuities. This is due in part to the fact that most annuities have relatively low fees, whereas variable annuities’ fees are quite a bit higher, often over 2 percent.
In addition to the high fees, variable annuities do not come with the income guarantee fixed index annuities offer. Your investment goes toward sub-accounts, similar to a mutual fund. You determine the level of risk you’re comfortable taking, and your funds are invested accordingly. In an up market, the returns are greater than what you find with fixed index annuities. However, in a down market, your funds may shrink.
A fixed index annuity, on the other hand, provides a guaranteed income as well as lower annual fees. The fund is tied to one of the stock market indexes, such as Dow Jones or the S&P 500. In an up market, the investor earns a higher return, but in a down market, he or she does not lose any capital and still earns the minimum rate (typically under 2 percent).
Building Your 403(b) Plan
Like a 401(k), contributions to your 403(b) both lower your taxable income and are non-taxed. If your employer also matches your contributions, the smart move is to take advantage and contribute as much as you can (or at least up to the amount your employer matches). This is the best way to maximize your benefits and build the kind of retirement you want.
Look carefully at the fees on the investment choices offered to you. This includes all fees, including surrender charges, guarantees, and other costs, such as the M&E charge. Pay special attention to the fees charged for switching. A lot of the plans that charge higher fees also have long surrender periods (around eight years on average), so look carefully before you make any changes. In some instances, it might be better to start a new plan and roll over the funds in your high-fee plan once the surrender period ends.
If the fees for all of your 403(b) choices are high, you may want to invest in a Roth IRA instead, especially if your employer doesn’t match contributions. It doesn’t offer the same tax advantages, but withdrawal is tax-free if you wait until you reach age 59-1/2.
When it comes to investing, the more information you have, the better. Do your research and schedule a consultation with a financial advisor. Write down any questions or concerns you have ahead of time, so you don’t forget anything. The better prepared you are for this consultation, the better able your advisor is to guide your investment efforts to help you reach your retirement goals.