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403(b) Plans: The Flaws Teachers Should Know

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403(b) Plans: The Flaws Teachers Should Know

As you may have seen, The New York Times has recently written a series of articles detailing the many issues with the retirement plans commonly used by teachers, known as 403(b) plans.
 

Their first piece, “Think Your Retirement Plan Is Bad? Talk to a Teacher” outlines many of the same points we had previously written about. As these articles already focus on the problems of how these accounts are managed, here we will summarize some of the main points and take a look at why it is so important for this to be corrected.

This Is Money Teachers Will Need
 

Unless you have been living under a rock, you are probably familiar with the fact that many teachers in our society are severely underpaid. As we mentioned in our previous article, my mom was a public school teacher and single mother so I know first-hand all about this. Unlike some individuals who may be fortunate enough that they don’t need to rely on their retirement savings entirely, that is usually not the case for teachers.

The NYT piece correctly points out some of the obstacles for teachers when it comes to securing a financially stable retirement: “Teachers in about a dozen states may not qualify for Social Security. And while public school teachers often are offered decent pensions, many of them do not work for the decades required to qualify for a full payout. And pension formulas are becoming less generous for newer recruits.”

Many teachers will rely primarily on 403(b) plans as a source of income once they retire. Unlike 401(k) plans that are overseen and regulated by federal law based on the Employee Retirement Income Security Act (ERISA) of 1974, many 403(b) plans fall outside of ERISA oversight and protection.

Who Can They Trust?
 

Instead of having access to a financial advisor who is a fiduciary, someone who always has the client’s best interests in mind, teachers are often exposed to salespeople from insurance brokers. As part two of the NYT series points out: “From the teacher’s standpoint, they really miss out getting quality advice,” said Mr. Bergeron, 27, who sold the plans for Axa Advisors’ retirement benefits group. “People who are in the schools pitching them and positioning themselves as retirement specialists are really there just to sell them one product.” (For more, see: An Investor’s Guide to the New Fiduciary Rule.)

Fee-only fiduciary advisors make investments that are the best for their clients, not themselves. Good financial advisors aren’t trying to hit a quota, working for sales commissions on the products they recommend to you. Fiduciaries strive to provide the best advice to investors looking to build a strong foundation, like teachers. These advisors grow with you, not at your expense by profiting off the products assembled for you.

Many of the millions of workers in this country have access to 401(k) plans through their employer that are approved and monitored by the employer in some way, ensuring at least some oversight of the plan itself. This isn’t to say 401(k) plans don’t have their issues, as we have pointed out before. Unfortunately, public school teachers who are working for nonprofits and religious institutions are easy prey for companies just trying to sell a high-cost product because their retirement plans often don’t have the same oversight. Given the loosely regulated industry, the insurance salespeople or “advisors” teachers are exposed to can buy investment products that are the best for their own pockets, not the plan owners’.

The Costs and Confusion
 

Most 401(k) plans, even if they have their own problems, are offering more traditional investment options, such as mutual funds or stocks and bonds, making it easier to understand how your money is invested. In contrast, 403(b) plans are often held inside annuities, which can be confusing even for the smartest people out there. The New York Times focuses on a broker, Axa Advisors, which often tries to sell annuities:

“The most popular version of the Equi-Vest annuity has a total annual cost that can range from 1.81 to 2.63%, according to an analysis from Morningstar. In contrast, large 401(k) plans usually charge an annual fee of less than half a percent of assets, according to a May report by BrightScope using 2013 data.”

Even when a teacher comes to realize the excessive cost they are paying for their retirement plan, they are often locked into these annuities and might have to pay a penalty if they want to make changes. If a teacher wants to transfer their assets out of the Axa Equi-Vest annuity into their own IRA, for example, they would have to pay a 5% penalty on the portion of that withdrawal that had been contributed within the last six years.

One of — if not the biggest — advantage of many retirement plans is the tax deferral, which allows these accounts to compound and grow over a long time horizon. Just like compound interest can work to your advantage, it can also work against you when you are paying excessive fees year over year.

In summary, not only are teachers not given access to solid, low-cost and efficient long-term investment options in their retirement plans. They also aren’t given access to a financial advisor who they can turn to with questions, knowing that they can trust the answers they are given. Teachers, we encourage you to spend some time finding out more about the practices of your retirement fund manager. It’s vital to find out whether they are a fiduciary, how they make money (fee-based or fee-only), and how personalized their investment strategy is. (For more, see: 6 Questions to Ask a Financial Advisor.)

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