Saturday, September 10, 2011
Can the 403(b) what it should be?
Labor Day has passed and the passing of that date signals the beginning of the school year with crosswalks filled with school aged kids - so be cautious out there. But inside the building, there are teachers in the crosswalks of retirement and their caution can cost them in terms of what future they envision.
Unlike the private sector workers with the 401(k) plan, a self-directed tax deferred plan the sometimes comes with a company match, teachers have the 403(b) plan. Also tax-deferred and almost always void of any school district matches, the 403(b) does a poor job of mimicking the attributes of the 401(k). So I thought I'd take a moment and make current and potential teachers (and those in no-profit institutions) aware of some of the pitfalls that await them.
In theory, as most things are when the thought materializes for the first time, the 403(b) plan should have been just as good as the 401(k). Of course, most 401(k) plans lack many of the features that would make them more worthwhile and yet, even with those problems, the retirement grass does seem greener in those plans when compared to 403(b)s. The reasons boil down to the same problems facing 401(k) plans.
Fees are always an issue. In 401(k) plans they can come from two directions: the cost of the investments and the administration of the plan. It is no different in the 403(b). Often it is worse. The administrative costs of running these plans is an haphazard affair. Unlike corporations who might assign a person to oversee the plan's direction, choosing from different administrators as they search for the best one, school districts often do not. Because of this, 403(b) plans often have numerous administrators and no real trained inner office personal to watch over the process.
In other words, the single most important aspect of the plan is often neglected. Without prudent guidance from the person in charge of the plan at company level (or in the case of a school, the district level) the investment houses they hire often charge whatever they feel the market will bear. They mask this effort with investments they claim are designed for the group but are often not suitable for any investor.
And the choices you have can be so vast as to be daunting. In California, teachers can pick from over 3,000 investment options spread amongst six providers. It is often common wisdom that choice is good. And it is often warned that too many choices is quite the opposite. Confusion and investing make awkward bedfellows. The average 401(k) plan could serve most of its participants with as little as 20 choices, most of which will come as index funds followed by some target date offerings. Too many choices actually raises the costs of administration and stifles active participation.
And the choices they do get include annuities. This escalates the concern for fees amongst retirement plan advocates. These plan participants could be paying not only upfront sales charges of the annuities they are purchasing, deducted directly from savings. But also could be faced with higher than anticipated surrender charges. While some 401(k) plans would do well to offer some annuities to their plan participants, the 403(b) has been doing so and with little success for the participants.
Even as the government has mandated that these plan be better monitored, you the investor needs to stand-up and complain. It often works in these plans. Asking for low cost alternatives is serving to cull some of the bad plan providers from the mix.
And you the investor, once you get the low cost you seek, need to invest more often, with or without the match.
With only 10% of the school districts throwing a match their way, and expect that number to go down, not up, retirement investors need to make up the shortfall. If the typical match is 3% and you planned on investing 6%, you will need to make your investment 9% of your pre-tax income to come even. And even the best of calculations, over a thirty year career will not give you more than 50% of your current income in retirement worth that investment contribution.
If you do get a low cost plan, invest with diversity. Even as we hear stories about how the S&P 500 essentially was flat over the last decade, investing in six different index funds including that large cap fund would have given you over 8% - provided you didn't panic in 2008-2009 and held tight.
If the plan is not low-cost enough, consider investing in an IRA (which is tax deductible) or a Roth IRA (which is funded with after-tax contributions). But you must do something.
Yes it might put a crimp in your current lifestyle. And yes, it won't be easy to bring not only your retirement outlook into focus while reining in your financial house at the same time. And yes, try as it might, 403(b) plans won't ever be 401(k) plans. But no plan is worth its while if you don't use it.
Paul Petillo is the Managing Editor of Target2025.com/BlueCollarDollar.com and a fellow Boomer.