Giving 403(b) Plan Participants Their Due
Part I: A Call for 403(b) Plan “Higher Education”
When seeking financial advice for managing your retirement plan assets, it seems the 401(k) receives a lot more press than the similar, but different 403(b) plans used by government and tax-exempt groups such as schools, hospitals and churches. Some sound advice does cover all retirement plan ground – and all investing, for that matter. But if anyone in your family participates in a 403(b) plan, it’s worth undergoing a bit of higher education, so you know where the similarities end, and how to best manage key differences.
Like a 401(k) plan, 403(b) plans allow participants to set aside money from their paychecks on a tax-favored basis – either as pre-tax contributions with tax-deferred growth; or, when Roth 403(b)s are available, tax-deferred growth and tax-free withdrawals in retirement.
The biggest disadvantages we often see in 403(b) plans have to do with excessive costs and lower liquidity compared with their 401(k) counterparts. Interestingly, we believe this has more to do with historical perception and entrenched interests than any inherent limitations in the offering. It may be an uphill climb, but there’s no time like the present to begin changing perceptions and challenging conflicting interests.
Trapped by Tradition
403(b) plans have been around since the 1950s – a quarter-century before the Internal Revenue Code (IRC) Sec. 401(k) was named in 1978. As vestiges of their roots, 403(b) plans have been shaped by at least two characteristics that help explain the challenges they still face today:
- They were – and often still are – based on insurance products.
- They were initially expected to serve as supplemental versus primary retirement income.
These points may sound relatively benign, but at a closer look, they can result in potentially debilitating effects on participants’ wealth.
The Impact of Insurance Investing
As described in The Wall Street Journal article, “Teachers’ 403(b) Plans See Big Changes,” federal law initially restricted 403(b) plans to using only insurance products (annuities) in their line-ups. This restriction was subsequently removed, but old habits die hard; insurance products remain the prevalent offering within 403(b) plans to this day.
While not all insurance products are de facto inappropriate, it does mean that plan participants often face:
- M&E costs – The typical 403(b) plan offering includes the added cost of an annuity wrapper (“M&E” or mortality & expense fees).
- High fund costs – The annuity wrapper costs are on top of underlying mutual funds that can be pricey themselves.
- Surrender charges – An insurance-based solution also may include long surrender periods, during which you incur additional charges if you want to switch out to a lower-cost or otherwise preferred alternative.
- Comparative Confusion – With the complex, often opaque structure, it can be difficult for the average investor to accurately assess the true, all-in costs of any one offering, let alone compare the various offerings in an informed, apples-to-apples way.
This brings us to another fall-out from the formative years of the 403(b) plan – the plan’s original intent as supplemental. We’ll cover that in next week’s blog post: “The 403(b) Plan: Pocket Change or Life’s Savings?”
Sage Serendipity: If you’re in the public sector (and even if you’re not), chances are you’ve participated in plenty of long-distance teleconferences during your career. You’ll get a kick out of this spoof: “A Conference Call in Real Life.”