The Top 403(b) Plan Providers
If you work for a public school, charitable organization, or faith-based organization then you are likely eligible for a 403(b) plan. This includes teachers, school administrators, professors, government employees, nurses, doctors, librarians, etc. Unfortunately, these employees do not have control over the administrator or the available investment options. If you are enrolled in a 403(b) plan, then read along as I will teach you how to analyze your plan, and alternative options if it’s sub-par.
Key Takeaways:
· What is a 403(b)?
· Types of 403(b) Plans
· What To Do if You’re in a Sub-Par Plan
· Alternative Investment Options
What is a 403(b)?
A 403(b) is a tax-deferred retirement plan like a 401(k). Although, the 403(b) is only available to certain types of State employees such as teachers, nurses, and government employees. When it was originally established, participants were only allowed to purchase annuity products. This was changed in 1974 to allow the plan participants to purchase mutual funds as well. Currently, the three main offerings through a 403(b) are mutual funds, variable annuities, and fixed annuities.
The contributions to a 403(b) are made pre-tax. That money is then allowed to grow “tax deferred” which means you won’t pay tax on the contribution(s) until they are withdrawn. Unfortunately, you cannot withdraw money from a 403(b) before age 59 and a half without penalty. If you attempted to make a distribution before, then you would be subject to taxes and a 10% penalty for an early withdrawal. However, you must begin taking distributions by age 73 as that is when your Required Monthly Disbursements (RMD’s) begin.
The 403(b) has a maximum contribution limit of $22,500 in 2023. This is the same contribution allowed to 401(k) holders, so the difference between the two comes down to the investment options allowed. As stated above, 403(b)’s is limited to mutual funds. To contrast, 401(k) plans are allowed to invest in ETF’s, Mutual Funds, and whatever else the plan administrator includes. In addition to this contribution, individuals ages 50 and up are allowed a $7,500 catch-up contribution each year.
Types of 403(b) Plans
If you currently have a 403(b) plan, then there are a few things you should look at. First are the investment options. Which plan options are available? Mutual funds, variable annuities, or fixed annuities? Ideally, you would have mutual funds, if not, then variable annuities.
If your plan allows you to invest in mutual funds, then you are going to have the most flexibility. It gives you the most control over the diversification of your portfolio, and the subsequent expense ratios. Given a list of mutual funds that you can invest in, you can tweak how much exposure you have to large-cap, small-cap, domestic vs. international, etc. You can also calculate the annual expense of holding certain funds and manipulate your holdings to keep fees low.
Next are the 403(b) plans with a variable annuity. Within the annuity, you are given a list of investment options. You can choose how the underlying assets will be invested, which directly impacts your benefit. If those assets do well and the portfolio value increases, then you will receive a larger benefit and vice versa. Therefore, these annuities do provide a larger potential benefit compared to the following option. One issue with a variable annuity is that poor investments can decrease the value of your retirement benefit. The other issue is that they typically have high fees which would further reduce your benefit.
The last way your 403(b) could be set up is as a fixed annuity. This is the most conservative option as it pays a “fixed” benefit based on your account value. Since there is little risk, the fixed annuity will likely pay the lowest benefit compared to the other two options because performance is not tied to investment results. In addition to the lowest potential benefit, a fixed annuity is also subject to high fees. Like the variable annuity, they are subject to high annual fees and potential surrender charges. If you withdraw the funds before the surrender period is over, then you would end up paying a fee that decreases the closer you get to the end of the surrender period.
What To Do if You’re in a Sub-Par Plan
Unfortunately, a lot of 403(b) plans have high fees. A lot of the financial firms that administer these plans include expensive, commissions-based products which is not ideal for the plan participants. These fees put a large drag on the performance of these plans which disadvantages the account holder as they are trying to save for retirement. If you find yourself in a plan with high fees, poor performance, or both, then there are a few things you can do.
The first thing you should do is locate your district’s 403(b) vendor list. You can analyze these options yourself, or you could post the options on the 403bwise Facebook Group to hear their feedback. 403(b) wise has gone through the available plan administrators and classified them into groups of green light, yellow light, and let’s assume a red light. You can learn which companies were categorized as green and yellow lights on their website, 403bwise.org. Green light represents those with a diverse list of low-cost investment options, while yellow light includes several high-cost funds with alternative low-cost options.
If you don’t have any green or yellow light options, then you should speak with the internal person in charge of choosing the plan administrator. 403bwise offers advocacy resources that could help you persuade your employer to add at least one low-cost administrator so you can check that out on their page. However, if one is available, then you should open an account with them. You would then fill out a Salary Reduction Agreement with your employer which indicates which firm and account number your contribution should be sent to. The final step would be to cancel future contributions to your previous 403(b) plan and to determine if there are any transfer fees you will need to cover.
Alternative Investment Options
There are a few alternate investment options available to those who don’t have a great 403(b). The first one would be a 457 Plan which is available to all State and Local government employees. If you are eligible for a 403(b), then you should be eligible for the 457 plan as well. One key difference between the 403(b) and 457 is the 457’s preferable treatment of distributions. There are circumstances where individuals would not be subject to the premature withdrawal penalty of 10% under the 457 plans. Therefore, if you are concerned about needing funds soon, then it could be better to invest in the 457 plan anyways.
The other alternative investment option is a Roth IRA. In 2023, you can contribute up to $6,500 and an additional $1,000 for those age 50 and older. A key difference between the Roth and the 403(b) and 457 is that it takes post-tax contributions compared to pre-tax in the other two. This allows the funds from a Roth IRA to be withdrawn tax-free in the future once certain criteria has been met. The other key difference is that you cannot make a Roth IRA contribution in 2023 if your income is over $138,000 as a single filer or $218,000 as a married couple filing jointly. Which is unfortunate because many will be disallowed from contributing to the Roth IRA.
So how do you know which account would make sense for you? If you are currently in a low tax bracket, then it could make more sense to contribute to the Roth IRA. This way you would pay taxes on the money while you are in a low-tax bracket and would be able to withdraw the funds tax-free in the future. This assumes that your income will continue to grow, which would put you in a higher tax bracket in retirement. To contrast, if you are currently in a high tax bracket, potentially for those near their top earning years, then it could make more sense to invest in the 457 plans. This way you would pay tax on your distributions in retirement when we can assume you will be in a lower tax bracket.
Now let’s cover how the investment process would look. If you are offered an employer match on your 403(b) then you would want to invest enough to get the maximum employer match. It’s free money, and if one isn’t offered, then you can skip investing in your 403(b). Excess funds that you want to save for retirement would then go into the 457 Plan or Roth IRA depending on your situation. If you decide to invest in the Roth IRA, then you must bear in mind that the contribution limit is $6,500-$7,500 depending on your age. Once you’ve made the Roth, you could then contribute any excess funds from the rest of the year into the 457 plans. This way you would have a mixture of pre- and post-tax funds that you could draw from in retirement.
This decision is not black and white, there are many factors to consider when determining which accounts to invest in. Therefore, I would recommend that you reach out to your local Financial Planner or CPA for help with this. A CPA will likely provide advice based on your previous tax return. To contrast, specific Financial Planners will help you estimate your current and future income and use those values to run scenario analysis to understand how contributing to these certain accounts would affect your total taxes. I personally do this for my clients, and if you are interested, then you can follow the link to my calendar to book a consultation. This would be a quick 20-minute phone call where we can discuss your needs to understand if my expertise is a fit for your needs.
If you are a CT State employee, then you may be interested in reading:
What Connecticut State Employees Should Do with Extra Vacation Days or
How to Calculate the Cost of Living Adjustment for CT State Employees