If you work for a tax-exempt organization, then you may be eligible to participate in a 403(b) plan. This is the type of retirement plan offered to teachers, nurses, and clergy members. While the contribution limits and tax-deferral benefits of a 403(b) plan work very much like a 401(k), these plans are different in two ways, and those differences can present a significant risk to your savings.
Where a 401(k) typically invests in mutual funds, a 403(b) plan can invest in either mutual funds or an annuity. Many teachers have been approached by annuity salespeople who offer them bonus money or income guarantees if they buy an annuity. The mathematical equations behind these benefits, however, make it difficult to know what you’re really getting into. Here is what you need to know before you buy.
THE DIFFERENCES BETWEEN A 401(K) AND A 403(B)
Both a 401(k) and a 403(b) plan can give you a tax-sheltered place to grow your money for retirement, and there are contribution limits. The money comes out of your paycheck before you pay the taxes, and any returns you earn are not taxed until you pull the money out. This can help your money grow faster so that you can save more and earn higher returns.
TIP: If your money is in a retirement account such as an IRA, a 401(k), or a 403(b), then your money is already benefiting from tax-deferred growth and so there is no additional tax benefit to owning an annuity.
The way your money earns its returns depends on the type of investments inside the retirement plan. Perhaps the biggest difference between a 401(k) and a 403(b) is the annuity. While there has been talk of offering low-cost annuities inside 401(k) plans, they typically grow your money using mutual funds. In these cases, the private company is responsible for the menu of investment options offered inside the plan, and oftentimes a plan administrator will hold presentations to help explain these investment options to you.
A 403(b) plan can invest in either annuities or mutual funds, and these plans are typically less regulated. If you own this type of plan, then you may be targeted by an annuity salesperson hoping to earn a commission.
THE DIFFERENCE BETWEEN AN ANNUITY AND A MUTUAL FUND
If you have the option of investing in either a mutual fund or an annuity, you should understand the differences between these two types of investment products before you choose.
Mutual funds invest in the stock market and as such, they can go up or down in value. They do not give you income or death benefits. An annuity is designed to give you income.
TIP: Only one kind of annuity invests in mutual funds: the variable annuity.
Mutual funds are popular because they give investors an automatic layer of diversification, offering investors a choice of funds from among the categories of stocks, bonds, balanced funds, and money market funds. Mutual funds can earn you money when a stock earns dividends, or when a fund increases in price.
Mutual funds can also cost you money. If the fund decreases in price and you sell your shares, then you may lose money if you sell the fund for less than what you paid to get into the fund. Mutual funds also have underlying expenses. These charges are the fees and commissions you, the investor, pays to the broker or fund manager. Higher fees don’t necessarily mean better funds. Morningstar’s Director of Mutual Fund Research ran tests and found that low-cost mutual funds beat high-cost mutual funds, every time.
If you have a variable annuity inside of your 403(b) plan, then you are paying BOTH the fees for the mutual funds inside the annuity, and the fees for the income guarantees and death benefits. These fees can be anywhere from 1.25 to 2.45 percent in addition to the mutual fund expenses. Yikes!
THE DIFFERENT TYPES OF ANNUITIES
There are two main types of annuities: immediate and deferred. An immediate annuity gives you income right away. This type of annuity may be right for someone who has already saved their money for retirement, and now they want to roll over some of their money into an income-producing vehicle. An annuity is the only kind of investment that can structure your money to delivery pension-like payments.
TIP: An immediate annuity is one of the cheapest and fastest ways you can get an income, but if you haven’t saved enough money yet, then you may be interested in the benefits of a deferred annuity.
A deferred annuity has two phases: the growth phase and the payout phase. You might consider a deferred annuity if you are prepared to make a long-term commitment and if you know you want to use this money for income. A deferred annuity may not be right for someone who is more than 10 years away from retirement, or someone who is currently in retirement.
There are two main types of deferred annuities: the fixed and the variable.
Fixed annuities (such as the fixed-indexed annuity) can structure your money for regular income payments like an immediate annuity, but you may also get other benefits such as penalty-free withdrawals and protection from market loss. A variable annuity is invested directly in the market, and because of this, your account may lose money, even if you are paying extra for income guarantees.
Annuities are some of the most complicated financial products on the market, but that doesn’t mean they are all bad. You want to be very careful, however, before choosing an annuity to go inside your 403(b) plan because high fees and restrictions can greatly affect how much money you’re able to save for retirement. Obviously, the more you are able to save, the higher your income will be.
If you are spending your life serving others, you certainly deserve to receive the best retirement possible. If you have any questions about the investments options inside your retirement plan, we are happy to offer you retirement income planning feedback without any high-pressure sales tactics. At Annuity Gator, we offer 100 percent unbiased advice because we do not work for a brokerage firm, bank, or life insurance company. We work for you, the investor. To have your annuity tested for fees, risk, and underlying expenses, schedule your free appointment today.
