The 403(b): Does the Company You Invest With Matter?

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The 403(b)Does the Company You Invest With
Matter?
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Disclaimer

• Everything I am going to tell you is to the best
  of my knowledge true.
• You are responsible for verifying any information
  I present.
• You are responsible for any investment decisions
  you make.
• This presentation is designed to be informational
  only and should not be interpreted as investment
  advice.

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Check With the Pros

• All the content in this presentation should be
  validated with your current provider as to its
  accuracy with respect to that particular company.

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Risk vs. Reward

• Long term investing reward does not come without
  risk. They cant be one without the other. Your
  risk tolerance refers to how much fluctuation in
  price over time you are willing to endure.

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What Is a 403(b)?

• A government program to relieve the financial
  stresses placed on the Federal Government by
  retirees.
• Established in as a way to encourage employees
  at non-profit institutions to save for
  retirement. Only Tax Sheltered Annuities were
  allowed.
• In 1974 the Law was changed to allow mutual fund
  investing or Custodial Accounts.

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What Makes a 403(b) Great?

• Tax Deductible Contributions
• Tax Deferred Growth
• p.s. Its those same things that make an IRA or a
  401(k) great.

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Tax-Deductible Contributions

• Ex Suppose you earn 70,000 per year
• When you approximate your income taxes take 25
  of 70,000.
• .2570,000 17,500 in taxes
• If you contribute 10,000 to your account
• 70,000-10,00060,000.2515,000 in taxes
• You save 2,500 simply by investing. This is
  fact.

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Tax-Deferred Growth Capital Gains and
Dividends(Simplified)

• When you sell a stock for more than you pay you
  get taxed on the difference. This is called
  Capital Gains.
• When a stock pays dividends it pays out a portion
  of its profits to its shareholders.
• The rules can be complicated, but to simplify, at
  the end of the fiscal year, you must pay taxes on
  Capital Gains and Dividends.
• When investments grow tax-deferred, you do not
  pay the taxes on Capital Gains and dividends
  until you take the money out at retirement!!!
• This is a great thing! There are not a lot of
  ways to get tax-deferral. 403(b)s, IRAs and
  401(k)s are a few.

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So Whats Bad (Good) About Them

• You cant get your money without penalty until
  you turn 59 ½ years old.
• When you take out the money you WILL PAY TAXES on
  the original contributions, the capital gains and
  the dividends.

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The 403(b) vs. The 403(b)(7)

• There are 2 Types of 403(b)s
• 403(b) a.k.a. Tax Sheltered Annuity
• 403(b)(7) a.k.a. Custodial Account
• This is where it starts to get interesting!

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Who Offers What

• The Insurance Companies Major Offering is the
  403(b) Tax Sheltered Annuity
• Some Insurance Companies also offer a 403(b)(7)
  Custodial Account
• Vanguard only offers a 403(b)(7) Custodial Account

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The Similarities

• 403(b)s and 403(b)(7)s both offer
• Tax Deductible Contributions
• Tax Deferred Growth
• Access to the stock market
• Access to the bond market
• Automatic payroll deductions (dollar cost
  averaging)

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The Difference What a 403(b) Has, That a
403(b)(7) Does Not

• In a 403(b), you sign into a Variable Annuity,
  which is a financial product that has..
• Tax Deferred Growth
• A Death Benefit
• The opportunity to Annuitize your investment
• The opportunity to take out a loan against your
  account balance.
• Variable Annuities are available to anyone
• A Variable Annuity is not included in a 403(b)(7)

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Duh?

• The Question
• So why not just get a 403(b) rather than a
  403(b)(7) if in a 403(b) you get more?
• The Answer
• A 403(b) costs more, and you should only get one
  if the extras are worth the cost. Maybe they are,
  maybe they arent. Thats what you need to decide.

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Whats an Annuity?

• Typically, an Annuity is a contract with an
  Insurance Company in which you give a bunch of
  money to them, and they agree to pay you money
  back over time. Typically until you die. Once you
  die, they typically keep whatever money is left
• There are cases in which an annuity may be a
  sound investment.
• The annuity most of you have is probably a
  deferred variable annuity which is a type of
  insurance policy typically packaged within a
  403(b).

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How Does a Deferred Variable Annuity Work?

• During your working years you contribute to your
  403(b) TSA. This is called the accumulation
  phase of the annuity.
• The amount your money grows varies depending on
  how your investments do. Thats why its called
  variable
• After you stop contributing and you want to start
  getting payments back, they figure out how much
  you will get each year, month etc and they start
  paying you.
• The Deferred part refers to the fact that you
  dont actually Annuitize, or start taking
  payments until long after you actually signed the
  contract.
• Important Note You do not have to Annuitize. You
  may just take the money out when want it pursuant
  to the IRS regulations.

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The Problem

• One of the main reasons people purchase variable
  annuities is for the tax-deferral
• 403(b)s are already tax-deferred
• Its absurd to put a tax-sheltered investment
  like a variable annuity into an IRA, which is
  already tax sheltered. The only person who makes
  out on this deal is your broker.
• Lani Luciano, MONEY, January 1997 at 141

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The cost of a Variable Annuity inside a 403(b)

• Variable Annuities typically charge you in 3 ways
• Management Fees Around .25
• Expense Ratio Around .75
• ME Fees Around 1.25 (www.sec.gov)
• ME stands for Mortality and Expenses. This fee
  includes paying for the death benefit,
  advertising for the company and paying your rep.
• At Vanguard, you only pay the Expense Ratio and a
  yearly fee of 15 per year per fund.

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The 403(b)
403(b) TSA
403(b)(7) Custodial Account
Variable Annuity
Mutual Funds
Mutual Funds
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Who is Vanguard?

• Who we are
• Vanguard is one of the world's largest investment
  management companies. Whether you are an
  individual investor, institution, or financial
  professional, you can benefit from the size,
  stability, and experience that we offer.
• Our mission statement
• Vanguard's mission is to help clients reach their
  financial goals by being the world's
  highest-value provider of investment products and
  services.

Taken from www.vanguard.com
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Who is Vanguard?
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Variable Annuities It Costs More, So
What Do You Get?

• Tax sheltered growth. (Oops, you already have
  that)
• Loan Provisions You can take out a loan against
  your account
• A Death Benefit
• The opportunity to Annuitize your account at a
  later date.
• A representative who cares about you, and who
  typically earns at least a portion of his salary
  through commissions.

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The Death Benefit

• With variable annuities, if you die, your
  beneficiary will receive the greater of,
• a) the current value of your account
• b) a check for the total amount of money you
  have invested over time, also called your
  principal
• c) A step up benefit

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Possible Death Benefit Outcomes

• Assume for 10 years you have invested 10,000
  each year into your 403(b)
• Your Principal is therefore 100,000
• What happens if you die?

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Outcome 1

• If your 403(b) account is worth more than
  100,000, your beneficiary will inherit the
  entire amount
• This is the most likely outcome.
• Even if you had a 403(b)(7) rather than a 403(b),
  your beneficiary would still get the entire
  amount.

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Outcome 2

• If your account is worth less than 100,000, your
  beneficiary will receive a check for 100,000.
  This is not true in a 403(b)(7).
• What is the probability of different losses?

• Not only is it unlikely to have lost money, but
  at what cost?

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Historical U.S. Stock Market Returns
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Industry Quote Regarding Payouts

• Ron Panko, Can Annuities Pass Muster?, BESTS
  REVIEW, July 2000 at 103
• When Hartford Life was asked in the discovery
  process how much in death benefits the company
  had paid in the 17 years the San Diego and Los
  Angeles plans had existed, Hartford claimed it
  had paid a single death benefit totaling only
  119 in San Diego and no death benefits in Los
  Angeles.

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The Cost of The Death Benefit

• The average annuity death benefit, a portion of
  your ME expenses, costs about 1.25 of the total
  assets in your 403(b) account. (www.sec.gov)
• The cost of your annuity on your 100,000 is
  therefore, conservatively, around 600.
• I pay around 700 per year for a 1,000,000 life
  insurance policy!
• Compare term life rates to annuity costs to get
  an idea if you are getting a good deal.

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Annuity Conclusion

• You need to decide if a variable annuity is right
  for you!
• If you think it is a good deal then buy it!
• Read the next two quotes
• More Quotes at http//www.insurancelaw.com/bib6.ht
  m

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Industry Quote

• VA stands for Variable Annuity
• New Schwab Studies Shed Light On Variable
  Annuity Debate Studies Look At Suitability of
  Annuities, Business Wire, November 6, 2002 Two
  new studies from the Schwab Center for Investment
  Research provide objective analysis on the
  factors that investors should consider when
  considering a variable annuity purchase.   
• As qualified retirement plans offer tax
  advantages beyond those offered in a VA,
  investors should generally contribute the maximum
  allowable amount to qualified retirement plans
  prior to contributing to a non-qualified VA.
  Moreover, it is generally not appropriate to
  purchase a VA within a qualified (tax-deferred)
  retirement plan (such as a 403(b)).

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Industry Quote

• Making the Most Of Your Retirement, CNNfn, May
  13, 2003 at 500pm Attorney and financial
  planner Gary Schatsky is the guest. 
•  Host Ali Velshi asks You know. . . we dont
  have anybody who comes on this show, a good bunch
  of people, who recommend annuities.  Whats the
  problem?  Whos selling them and whos buying
  them if nobodys recommending them?   
• Mr. Schatsky responds that people are getting
  sold annuities, but annuities can make sense
  only for a very small subset. . . .  I am sure
  you do know 60 percent of annuities are sold in
  IRA accounts and other retirement accounts. 
  The absolute worst place for them to be.  Your
  putting a tax shelter in a tax shelter and your
  paying for it.  

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403(b) Expenses

• When you invest in a 403(b) you will generally
  select 1 or more Stock and/or Bond Funds to put
  your money in. These are called Mutual Funds
• For most people, Mutual Funds are considered a
  great way to diversify your assets.

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403(b) Expenses Continued

• Every Mutual Fund with every company has what is
  called an Expense Ratio
• The Expense Ratio is the percentage of your
  assets every year that the Company you invest
  with takes as payment for them to manage the
  Mutual Fund and hold your money.

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How the Expense Ratio Effects your Net Worth

• The Expense Ratio effects your Net Worth in 2
  Ways
• They take money that would be yours.
• The money they take can not continue to grow over
  time. This is called forgone earnings.

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How Expenses Effect Returns

• Consider a standard SP 500 Fund

Insurance 1 .30
Insurance 2 .34
Vanguard .18
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How Expenses Effect Returns Some Examples
Assume an Initial Investment of 50,000 with no
additional contributions, earning 8 for 20 years.
Expense Ratio Fees Forgone Earnings Total Loss Ending Value
.18 4353 3894 8247 224,800
.34 8295 7486 15,782 217,265
1.1 23,857 22,393 46,250 186,797
Info from www.sec.gov/investor/tools/mfcc/mfcc-cal
culate.htm
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Do Fees Matter?

• Do Fees and Expenses matter?
• YES!
• Are Fees and Expenses the only things that
  matter?
• NO!

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Value After 25 Years
Contribution per paycheck
Out of Pocket Expense
Value After 5 Years
Value After 15 Years
Tax Reduction
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8 Return
No Expenses
.21 in Expenses
1.75 in Expenses
304,943
295,432
234,965
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Industry Quote

• Do not invest in a variable annuity within a
  tax-deferred qualified plan you incur extra
  expenses for few benefits.
• The author is a fee-only insurance adviser in New
  York City.
• Glenn Daily, Investing In Variable Annuities
  The Selection Process, AAII JOURNAL, November
  1991 at 11

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My Advice

• If you are going to invest in Mutual Funds, all
  other thing being equal, invest in the least
  expensive one!
• Trust me, Im a math teacher!

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The Caveat

• If you go with Vanguard, you will not be able to
  meet with anyone face-to-face.
• You will have to choose your funds on your own or
  with the help of someone else.
• You may want to consider paying a fee-only
  financial adviser to help you with this decision.

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Can you switch 403(b) Providers?

• The answer is yes, but its hard to get the money
  you have already put in.
• One company allows you to transfer 10 of your
  total assets every year penalty free.
• Another company has a decreasing surrender charge
  depending on how long your money has been there.
• Every company has a policy for withdrawals. There
  are usually surrender fees. Call and find out
  your policy.

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My Advice

• Your knowledge is the only thing that will
  protect you.
• Dont be afraid to call your rep and ask the
  questions that need to be asked. They can not
  lie to you about facts regarding your account,
  nor would they want to.
• This is your money, protect it!
• Dont do anything you dont fully understand!!!

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Some Questions You May Want to Know the Answer To

• Link to The Questions
• Many of these questions come from the SEC website
  
• http//www.sec.gov/investor/pubs/varannty.htm

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Web Resources

• www.403bwise.com The Mother of 403(b) sites
• http//www.403bwise.com/wisemoves/annuities.html
  (this is a must read)
• www.mcnuttmath.com
• http//www.insurancelaw.com/bib-qualified-annuitie
  s.htm (an absolute must read)

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Web Resources

• The following website is run by the Securities
  and Exchange Commission
• Part of their site is specifically for teachers
  and is completely unbiased.
• It is a great place to learn this stuff
• http//www.sec.gov/investor/teachers.shtml

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Web Resources Calculators

• These web sites allow you to calculate the effect
  of expenses on your investments
• http//www.sec.gov/investor/tools/mfcc/mfcc-calcul
  ate.htm
• http//flagship2.vanguard.com/VGApp/hnw/FundsCostC
  ompare
• http//www.assetbuilder.com/wp-content/calcs/TheLo
  ngTermCostofExpensiveManagement.htm
• http//www.ipers.org/sub/calcs/Retire403b.html
• http//www.bloomsberg.com/invest/calculators/index
  .html

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Print Resources

• Teach and Retire Rich
• Available through the 403bwise website
• If you want to understand your financial choices
  and take control of your financial future this
  book is a must read.
• It is basically my presentation, in book form,
  with more examples and more information.

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Parting Words

• Dont be afraid of investing.
• Investing is confusing until it isnt.
• It is not that difficult to gain a basic
  understanding of investing and develop a well
  balanced portfolio.
• The most important part of investing is doing it
  as early and often as you can.
• It is never too late to start. And never to late
  to start doing it right.