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Saving for Retirement

Make the Most of a 403(b) Retirement Plan

Why teacher retirement plans often flunk -- and how to raise the grade.

We sometimes hear from teachers who complain that our retirement-planning advice, which often focuses on 401(k) plans, ignores their needs. That's because most teachers have 403(b) retirement plans, which have tax-deferral rules similar to 401(k)s -- and a similarly geeky label drawn from the tax code -- but are otherwise very different.

SEE ALSO: Special Report on Understanding Annuities

These teacher-retirement plans often limit their offerings to insurance products, such as annuities, and they charge much higher fees than 401(k)s. But the biggest difference is the way 403(b) plans are sold. Instead of a menu of funds -- with easy access to information about fees and perform­ance -- many school systems just hand out a list of sales reps. Scott Dauenhauer of Murrieta, Cal., discovered the differences in 1998, when he was a financial adviser and his wife, Shauna, started a new teaching job. "A guy walked into my wife's classroom and said he's from the state pension system and that the district sent him to talk about her retirement options," he says. "It turns out that he was not there representing the pension system or school district."

The Dauenhauers called the school district to find out more about the 403(b) options and were sent a list of about 30 company names and phone numbers. "There was no option of signing up for a low-cost product, and they were all either variable annuities or equity-indexed annuities or mutual funds sold by a broker," Scott says.


The precursor to the 403(b) plan was created in 1918 as a pension replacement for higher-education workers. Many such large plans still offer fixed annuities that can provide lifetime income, plus they include mutual funds from low-cost providers such as Fidelity, Vanguard and TIAA-CREF. Most are subject to the same fee-disclosure rules as 401(k)s.

But the 403(b) marketplace for elementary and high school teachers in public schools is frequently described as the "Wild West" because of the lack of oversight. That's partly because these plans were intended to supplement defined-benefit pensions. Most school systems with pension plans that promised retirement income didn't get involved in 403(b) offerings.

"It was very hands-off," says Alessandra Hobler, who is an analyst with Cerulli, an investment- and insurance-research firm that studies 403(b) plans. "But as employers have moved away from defined-benefit plans, they've been taking more control over 403(b) plans." And as teachers worry about pension cutbacks, they've become concerned about having better options in their 403(b)s -- which they may need to depend on for a larger portion of their retirement income.

Building a better 403(b)

Since the Dauenhauers discovered the paucity of good choices in Shauna's 403(b), Scott, a certified financial planner, has become an advocate for lower-cost options and more disclosure. He worked with the California State Teachers' Retirement System to reduce its 403(b) fees by 60% and help create the Web site to provide information about investments, performance, fees and surrender charges for the plans available in each California school district.


Regulations that took effect in 2009 require school systems to keep better records of the 403(b)s being offered to their teachers. Now that many have adjusted to the new rules, they're considering additional steps to improve disclosure and review product offerings. Several states are voting on laws this year that could make it easier for school systems to negotiate fees and take more control over their 403(b) choices -- which could help attract more low-cost providers.

"We have a major initiative to enter the public K-12 market," says Ed Moslander, senior managing director of TIAA-CREF, one of the largest providers of 403(b)s for colleges and hospitals. Vanguard and Fidelity are expanding into K-12 school systems, too.

Tracy Callard, a 48-year-old elementary school teacher in Wichita, Kan., is working on a grass-roots effort to try to get 403(b) options that are more like her other investments, which she has been carefully researching for years. She had been happy with a low-cost 403(b) from TIAA-CREF when she taught at a private school. But when she shifted to the public school system in 2009, she was disappointed that none of the familiar low-cost companies -- such as TIAA-CREF, Fidelity and Vanguard -- were on the list of available 403(b)s. Instead, the list of 14 approved vendors was dominated by insurance companies selling annuities.

"I think people have no idea what they're buying," she says. "A salesman will bring a big sandwich to the teachers' lounge and chat up the teachers, and the next thing they know, they are signing up for a direct investment from their paycheck with no understanding of the fee structure."


Callard has lobbied her school system to add more low-fee providers to its 403(b) list, and she serves as a representative for her school to the teachers' union. She's also working with Dan Otter, a former teacher and longtime 403(b) advocate who created, for advice on trying to attract lower-cost providers.

Until then, she and her husband, Mark Barfield, a public-school history teacher, max out their Roth IRAs instead of investing in the 403(b). Because their school system doesn't offer a 403(b) match, they're not missing out. They also invest in taxable accounts, buying and holding stocks to complement the guaranteed income they'll have in retirement from their pensions.

Maximize your benefits

Your 403(b) contributions lower your taxable income, then grow tax-deferred until retirement. Some employers also offer Roth 403(b)s, which offer tax-free withdrawals in retirement.

You can invest up to $17,000 in a 403(b) in 2012, plus an extra $5,500 in catch-up contributions starting in the year you turn age 50. If you have 15 years of service with one public-school system, you might qualify for extra catch-up contributions that let you boost your annual contributions by up to $20,000.


Some hospitals and colleges match 403(b) contributions, but most K-12 public schools do not. If your employer matches your 403(b) contributions, invest at least enough to get the full match -- that's free money. But before you put all your retirement money into a 403(b), do a little digging:

Compare investment choices and fees. The range can be huge. Some plans have fees as high as 2.42% per year -- for the investments and annuity charge -- and have a surrender charge if you cash out before eight years, says Otter. But others, such as Vanguard, may offer a target-date fund (a diversified portfolio that gradually gets more conservative as your retirement date draws near) with a 0.20% fee and no surrender charge. TIAA-CREF charges from 0.42% to 0.92% for its funds, and 50 cents on a $10,000 account for its annuity expenses, with no surrender charge.

More plans now let you invest directly in a large menu of mutual funds, including target-date funds. If you'd like more personalized help, some companies, such as Valic, also offer managed accounts for their 403(b)s. Ask about extra charges for these serv­ices; Valic's service starts at 0.60%.

Understand annuity guarantees and expenses. Some 403(b)s -- especially for K-12 teachers -- offer nothing but annuities. If you want to invest in mutual funds, you may have to do it through a variable annuity offered by your plan, which can add an extra layer of fees. Be sure to ask for the annuity fees, called the M&E charges, in addition to the fund fees. Some M&E charges are 1.25%; others, such as TIAA-CREF's, are as low as 0.05%. You can get helpful information from the tool at if the investments in its database are also available in your plan.

If you are paying extra for an annuity wrapper, ask what you're getting in return. Some merely promise that your heirs will inherit at least the amount you originally invested if your account loses value before you die. You may have to pay a fee beyond the M&E charge to provide a guaranteed level of lifetime income, which could be attractive if you're in your fifties or early sixties and worry that your investments could lose value right before you retire.

But these extra guarantees usually aren't worthwhile if you have more than a decade before retirement -- and can ride out the market's ups and downs -- or if you'll be receiving guaranteed income from a pension that will cover many of your regular expenses in retirement. In that case, you can generally afford to invest more in stock funds and don't need to pay extra for another guarantee. Some plans also offer fixed annuities.

Be careful before switching. If you do find better 403(b) investing options, don't automatically move money you've already invested. Many of the high-fee plans also have long surrender periods with high charges -- sometimes starting at 8% or more and gradually decreasing until they disappear after about eight years. Some plans even impose a new surrender period on each new contribution. "I've worked with teachers whose annuities never came out of the surrender period," says Matthew Jarvis, a financial planner in Seattle.

In that case, consider putting new contributions into the low-fee option and gradually shifting the rest of the money as the surrender period shrinks. "It can take some time for the money to get out of surrender jail," says Otter. After you leave your job, you can usually roll your 403(b) into an IRA, but be mindful of surrender charges before making any moves.

Consider a Roth IRA. If your choices are limited to high-fee 403(b) investments with no match, you could invest in a Roth IRA instead. You can put up to $5,000 in a Roth in 2012 ($6,000 if you'll be 50 or older this year), and you'll have more control over your investments and fees. You can choose from a huge range of brokerage firms, fund com­panies and banks and can invest the money in mutual funds, stocks, bonds and other investments.

You won't get a tax break now, but you can withdraw the money tax-free after age 59 1/2 (and can tap your contributions without penalties or taxes at any time). Even if you have good 403(b) options, a Roth IRA -- or Roth 403(b), if available -- can diversify your tax options in retirement. You'll have a pot of tax-free money to tap in addition to the 403(b), which will be taxed at your income-tax rate in retirement. To qualify for a Roth IRA, your adjusted gross income must be less than $125,000 if you're single in 2012, or $183,000 if married filing jointly.

Check out 457 options. If your school system offers both a 403(b) and a 457 plan, you can contribute up to $17,000 per year to each plan plus take advantage of any catch-up and matching contributions you qualify for. Consider maxing out the 457 first if the investments are better and the fees are lower.