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.
• I DO NOT know every rule at every company

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Required Knowledgeto Move Forward
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Mutual Funds

• A Mutual Fund is an investment in the stock (or
  bond) market that invests in a number of
  companies (or bonds) at one time.
• Example The SP 500 Fund invests in the 500
  largest companies in the United States

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Expense Ratio

• 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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The Qualified Plan403(b)/401(k)/457

• Designed by the Federal Government to encourage
  people to invest for their retirement
• Tax Deductible Contributions
• Tax Deferred Growth

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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 4,000 to your account
• 70,000-4,00066,000.2516,500 in taxes
• You save 1,000 of your income simply by
  investing or the 4000 you saved only cost you
  3000.

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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 (defer) 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 and Variable Annuities are a few.

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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.
  It is a type of insurance policy.
• There are cases in which an annuity may be a
  sound investment.
• There are MANY different types of annuities.
• If you currently have a 403(b) with an Insurance
  Company, the annuity you probably have is a
  deferred variable annuity which is a type of
  insurance policy often 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 and the money grows tax
  deferred.
• 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, (start taking
  payments) until long after you actually sign 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.

Who typically buys variable annuities?
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Important

• Deferred Variable Annuities give you Tax
  Deferred Growth!!!!!!!!!!!!!

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How Does Money Grow?andHow Much is ½ ?
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http//www.bloomberg.com/invest/calculators/401k.h
tml
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Who is Vanguard?

• Who are we?
• 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.
• Their 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.
• Vanguard is a non-profit corporation.

Taken from www.vanguard.com
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Who is Vanguard?
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The Presentation
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What Is a 403(b)?

• A government program to relieve the financial
  stresses placed on the Federal Government by
  retirees.
• The term 403(b) refers to the section of the tax
  law explaining the rules of this type of
  investment
• Established in 1958 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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Why Are 403(b)s So Great?

• Tax Deferred Growth
• Tax Deductible Contributions

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So Whats Bad (Good) About Them

• You cant get your money out of a 403(b) without
  penalty until you turn 59½ years old. At 70½ you
  must start taking out the money.
• 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 (Met Life, an additional .6
  fee applies) (TIAA-CREF should offer one soon)
• Vanguard only offers the 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 Deferred 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.
• A Variable Annuity is not included in a 403(b)(7)

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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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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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401(k) vs 403(b)

• Approximately 21 of 403(b)s are invested in
  Mutual Funds, 79 are in Fixed and Variable
  Annuities source Spectrem Group
• Approximately 82 of 401(k)s are invested in
  Mutual Funds. Less than 20 are in Annuities.
  source Investment Company Institute
• Why the Difference?

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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, p.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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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 you can meet face-to-face.

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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

• 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 Variable
  Annuity, investors should generally contribute
  the maximum allowable amount to qualified
  retirement plans prior to contributing to a
  non-qualified Variable Annuity . 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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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 Affect 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!

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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.
• New regulations have made it harder to transfer
  money from one provider to another (90-24)
• 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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Web Resources

• www.403bwise.com The Mother of 403(b) sites
• http//www.403bwise.com/wisemoves/annuities.html
  (this is a must read)
• 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.