The High Cost of 403(b) Plans For Texas Teachers
What are 403(b) plans?
Generally, 403(b) plans are offered by 501(c)(3) nonprofit employers, public school systems and universities, public hospitals, and church organizations. Texas teachers can enroll in a 403(b) plan in their district along with their Teachers Retirement System pension or TRS. I discuss some of the issues to consider especially when dealing with the high costs of 403(b) plans.
401(k) versus 403(b) and Fees
TIAA is by far the largest 403(b) provider, according to PlanSponsor’s 2019 survey. Fidelity is a distant second. Following these two companies, there is an assortment of insurance companies.1
With a 401(k), according to an analysis by TD Ameritrade showed the average all-in cost of fees is around 0.45%.2While 403(b) plans are said to have about 44 basis points more than a typical 401k, plan, which is almost half a point higher!
The nation’s 401(k) plans are regulated by the Employee Retirement Income Security Act (ERISA) of 1974. This federal law that sets minimum standards for plan governance and allows employees to bring class-action lawsuits against plan sponsors. Most 403(b) plans are not regulated under ERISA and don’t have this added employee protection.3
Whereas corporate workers save for retirement in 401(k) plans, which provide them a relatively high degree of protection from ERISA, many teachers do not enjoy this benefit. Since most 403(b) plans are not subject to ERISA requirements.
About 76% of assets in the 403(b) market are held in variable and fixed annuities, according to data from Aon Hewitt. Mutual funds hold the remainder. In comparison, it is rare, with fewer than 10% of 401(k) plans even offer an annuity to participants.
Furthermore, in Texas, roughly 80% of fixed annuities and 78% of variable annuities offered to teachers in a 403(b) had a surrender charge. In addition, 45% of investment options had either a front- or back-end commission costs.
Issues with Insurance Providers
Insurance providers are very common among 403(b) plans, but unfortunately, they are not the best choice for many. Some things to consider if you have an insurance company for your 403b plan.4
- Insurance company 403(b) plans can be up to three times more expensive
- Investment choices in an insurance 403(b) is limited compared to 401k plans
- An insurance 403(b) typically offer annuities. This is an insurance contract that has a long lock-in period (up to 12 years) where you can’t transfer your 403(b) to another vendor without paying a penalty.
What is an annuity? An annuity is an investment contract between you and the insurance company. With an annuity, you agree to invest your money in the plan, and the insurance company agrees to provide you with a specific income at the end of the contract term. As mentioned, annuities can have limited investment income, surrender charges, and a lack of investment options. But some teachers like annuities because of the guarantee of not losing money on their principal, but the possible upside potential is more limited.
High Costs of Annuities
With a 401(k) some of these plans are held by a major investment brokerage firm, you may be able to invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), and real estate investment trusts (REITs).
According to a study by Aon Hewitt, the fees charged on variable and fixed annuities and mutual funds included in a 403(b) plan are:5
-Variable annuities: 2.25%.
-Fixed annuities: 1.15%.
-Mutual funds: 0.97%.
By contrast, the average expense ratio of an ETF or passive exchange traded fund is just 0.44%. You can do even better than that by investing in low-cost index funds.
Other options: Self-directed IRA
There are options if you have a 403(b) plan and you are concerned about high fees and lack of investment choices. One option is to open an self directed IRA and you can invest in low-cost ETFs, instead of mutual funds and annuities that 403(b) plans offer. Also, since an IRA is completely self-directed, you will have a choice over what to hold in your account, not just the plan offered by your employer.
One problem with an IRA is that contributions will be either partially or entirely nondeductible depending upon your income. The IRS also limits IRA deductibility if you are covered by another retirement plan and your combined income exceeds certain income thresholds. Since you are participating in a 403(b) and may also be covered by an employer pension plan, you may be subject to these limits.
In Texas, teachers can take advantage of 403(b) plans to supplement their TRS. It is a good way to save additional money outside of TRS. Your TRS pension will not fully cover your wages while you were working, so participating in a 403(b) is a smart choice.
But teachers should be aware of the high costs in terms of fees for some of the 403(b) plans, also lack of choice in investments, and annuity contracts that lock your money away for many years. It is best to talk to a financial planner to make sure the choice of 403(b) plans fits into your retirement goals.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.