Escape From a Bad Retirement Plan
Teachers and workers in the nonprofit world aren't locked in to lousy 403(b)s.
By Mary Beth Franklin, Senior Editor
From Kiplinger's Personal Finance magazine, October 2003
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While the average 401(k) investor can choose from more than a dozen mutual funds and money-market accounts, America's teachers, hospital workers and employees of charitable organizations are often limited to a few high-cost insurance products in their retirement plan -- known as a 403(b) because it's authorized under a different part of the tax code.
But it doesn't have to be that way. A special rule gives many 403(b) participants a chance to transfer money to investments they prefer. There's just one hitch: While the IRS allows this maneuver, known as a "90-24 transfer," it doesn't require plans to offer it.
"Teachers, particularly those in the K through 12 market, usually have very poor investment choices," says Dan Otter, a former California elementary school teacher who co-founded the Web site 403(b)wise (www.403bwise.com) three years ago to educate teachers about their 403(b) rights and to advocate for reform.
If your plan allows transfers, the money should go directly from your 403(b) to a special private account. If you take possession of the cash, it's treated like a taxable distribution. Participants who are invested in annuities -- the investment vehicle of choice for most school systems -- have to watch out for stiff surrender charges if they move their money. Such fees usually disappear after seven years, though.
Another strategy for 403(b) investors is to contribute to a money-market account or mutual fund (if available) because these vehicles don't impose a surrender charge. Then you can periodically transfer money out of the plan.
That's what Doug Taylor, a teacher with the Los Angeles school district, does. The 45-year-old computer instructor started contributing to his 403(b) about ten years ago. After reading about the impact of high fees, he began investigating ways to switch to a lower-cost provider. Although the nation's largest school district lists more than 150 choices for its 403(b) plan, most are insurance companies offering annuities. Taylor directs his salary deferrals to a stock mutual fund on the list and then transfers his money to his private 403(b) account at Vanguard where he diversifies among an index fund, bond funds and sector funds.
If you want to transfer money to a mutual fund company or a brokerage firm, first ask your plan sponsor if switches are allowed. Then ask a fund representative or broker for forms to open a 403(b)(7) custodial account. If you want to move to a lower-cost annuity not offered in your plan, you'll need to open an annuity account.
While it may seem like a paperwork hassle, a 403(b)(7) custodial account can pay off handsomely. Mike Beczkowski, who audits school retirement plans for the Bolton Partners Investment Consulting Group in Baltimore, says fees can have an astounding impact on returns in these plans, which are also known as "tax-sheltered annuities" or TSAs. For example, if you contribute $3,000 a year to a low-cost plan -- with a $30 annual administrative fee -- that grows at an average annual rate of 8%, you would have about $365,000 after 30 years. Contrast that with a plan that has similar returns but which extracts 2.5% a year for annuity and investment advisory fees. After three decades, the high-cost nest egg would hold just under $240,000--35% less.
--Reporter: Katy Marquardt