April 3rd (4/03) is 403(b) day for teachers in America! So, today we will learn a little about what is a 403(b), how does it work, and the advantages and disadvantages of putting retirement money away in your school district’s 403(b) plan.
Let’s start out by me saying that I dislike 403(b)’s! I first started teaching in 2005 and in 2006 I started investing for my retirement in a 403(b) $125 a month. My first 403(b) was a terrible AXA plan with high fees, maintenance fees, and surrender charges. After 4 years of contributions, I finally researched retirement and began contributing to a Roth IRA instead of the AXA 403(b). AXA wouldn’t let me roll my account into my Roth without a huge surrender charge unless I had the account for 10 years, so I waited 6 more years and finally rolled it over. I do still contribute to a little bit lower fee 403(b) at my new school district, but its only because I max out my Roth IRA, my wife’s Roth IRA, and then I put $300 a month away into my new 403(b) with American Funds, which I actually do outside of my school district with my finance guy.
What is a 403(b)?
It is a tax deferred retirement account for people who work in education or certain types of non profits. Teachers fall into this category, and can use this account to supplement their state pensions, or if you have no pension it can be your retirement account. Much like a corporate 401(k) you get to pick how you invest your money. You usually have a choice of annuities, variable annuities, and mutual funds, but not individual stocks. Some companies provide more options than others, but I recommend something like Warren Buffett would do, and just follow the S&P 500 for the long-term in a low fee mutual fund. Another thing is that to get into a 403(b) you need to contact your Human Resources department, because you will be having the money you set up taken out of your check each month, or whenever you want it occur on a regular basis. You can’t set up a 403(b) by yourself, so you must go through your employer or a company they use.
Advantages of a 403(b)
- You are saving the easy way by making your retirement automatic. Once you get it set up you can just sit back and saving for retirement is happening behind the scenes. You don’t need to be disciplined and move money each month, it just happens and after a while you forget about it and check your account years later to find a huge fund.
- All contributions reduce your taxable income with a 403(b). If you want to pay less taxes just put more money into your 403(b). You get $1 off your taxable income for each dollar you put into it. You can only put in $19,000 a year starting in 2019. $19,000 is a lot for a lone teacher to contribute, but you also lower your taxes if you max it out in a dual income household. Also, if you are age 50 or over, you can contribute another $6,000 a year if you are behind on your retirement for an added tax bonus.
- You get free tax growth with a 403(b). The account is actually tax- deferred, so you don’t pay taxes on the money until you take it out later in retirement, but it grows tax free in the account in your younger years. So, as long as you keep your money in the account until you are 59 1/2 years old, you don’t have to pay taxes on the free compound growth in the account. This can be huge especially, with a pension that is tax-free, and added Roth IRA that is tax free as well. It’s a triple threat to tax free growth!
Disadvantages of a 403(b)
- You have to be careful of your options. Most school districts haven’t put much or anytime into searching for a great 403(b) product for their employees. School districts just outsource this to another person or company, and don’t know anything about their choices at all. My district outsources their 403(b) to the Omni Group, and they won’t budge on a change, even after some emails and meetings with HR, and they don’t know anything about what Omni offers. That is why I researched after my first go around with 403(b)’s, and use a compatible plan outside my district and had it approved by my HR. Research all your options and talk to everyone you can to get all of your options. The choices aren’t great…
- Lots of fees are another issue you find with many 403(b)’s. Most are designed for the financial advisor or company to get rich instead of the hard-working teachers of America. Read everything, learn that the fees are higher on must 403(b)’s, than if you just opened a Vanguard account and bought some mutual funds on your own. Know what fees, surrender charges, and how your account will be structured. If you think that your financial advisor for the fund is just a sales man…RUN!! They should be a teacher and walk you through everything before you sign up for their product. Open and honest should be the vibe, so you know about every fee and how they get paid too.
- Sometimes you can’t get out of your pay check contributions until the end of the school year. This hasn’t been my experience, but I have heard of nightmare scenarios where a district won’t let a teacher stop paying into their 403(b) until the school year is up. So, for example if you sign up in August you can’t stop paying your set amount until next August. I’m not even sure if this is legal, and I have never seen this, but I have been told horror stories that some places do this as a way to help teachers by locking them into retirement plans. Forced savings doesn’t feel great when someone else is doing the forcing with your money.
What if I Change School Districts?
Well, if you get out of teaching, change jobs, or change districts you have a few options.
- Move the money to a new plan. When you start your new job, in your new school district, you can open a new plan with them. You can also have your old 403(b) money moved into the new plan without penalty most of the time, unless you get a weird clause like I had that wouldn’t allow the move without 10% lost.
- Roll it over into an IRA. If you leave teaching, change districts, or just want to a different direction by starting a Roth IRA instead of using a 403(b), then you can just roll the money into an IRA. This should also be without a penalty in most situations.
- Leave the money where it is. You can always just leave it alone and move on with your life by leaving it alone. You also might be able to just leave it and continue to contribute into the same account with your new school district. When I left my 403(b) with AXA for 6 years it did continue to grow by thousands of dollars without my doing anything.
- Withdraw the money. This is the worst option and will get you hit with fees, taxes, and lose your money to surrender charges too. This isn’t advised unless it’s an emergency, and even then try to only remove the principle and not the interest earned. You can take a hardship loan too, but this is another topic and you must prove you have no other financial options to reduce your tax hit, or not have added taxes at all.
What do I do with my 403(b) when I retire?
Once you retire you have some options. You can of course withdraw from your 403(b) account once you are age 59 1/2, or at least 55 if you qualify (Another story too), and it is taxed as ordinary income. It grows tax-free and now you pay income taxes on withdraws at this point. You can just leave the balance in the account untouched to continue to grow until you need it as you get older, or to combat future inflation that your state’s pension can’t cover. You can also roll it over into an IRA, and this will help delay taxes longer (ask a tax planner on how to do this and why you might need to do this).
I use my 403(b) as a future inflation account. Since I have a teacher pension that I can start receiving at age 52, a maxed out Roth IRA, and a smaller funded 403(b) I feel secure that my needs in old age can be met with my three different accounts working over the long-term, and growing tax-free until I’m 59 1/2 or 70, when I can or have to make withdrawals.
Your Homework for This Month
Week 1- Find out what options you have at your school district for retirement and 403(b)s. Check with human resources, the district website, and with outside sources. Gather as much information and options as you can.
Week 2- Read everything, talk to everyone you work with to find out what they do with their 403(b) options, start to put together a plan that you can afford each month to be withdrawn from your pay check. Also, talk to HR to see if they know of a better way to invest for your future.
Week 3- Call and set up an appointment with the district finance/ 403(b) person, or who ever they have outsourced their retirement options too. Have all your fee questions ready, have your research done, and come to the appointment filled with knowledge from your research. If the advisor is not a teacher to you and tries to sell products, then leave and find someone else. You should walk away feeling great about who is helping you with your money and your dreams of retirement one day.
Week 4- Set up an automatic withdraw plan with HR, sit back and save worry free for your best retirement. Check your account quarterly and meet with you advisor once a year to make sure your goals are being met.
Bonus- Start maxing out a Roth IRA, and have this automatically withdrawn each month from your checking account to further your automatic retirement safety net.
In the end, I feel most teachers in America who live modest lifestyles, pay off their debts, live debt free, and have a paid off house, can retire on their teacher pensions alone, if their state pension is funded properly for them. If you are maxing out an IRA on top of that, and playing with some stocks or funds on your own with Robinhood, Vanguard or Fidelity, then you should be able to stay retired and maintain your modest lifestyle throughout retirement. Most school districts do make it easy to sign up at the beginning of each school year for a 403(b), and according to what I have seen online only 2 out 5 teachers are saving for retirement outside their state’s teacher pensions. Relying too much on cash strapped state pension plans is not a great idea, and you must save to combat this shortfall. If your district does a 403(b) match, you have better be getting that match, and if they don’t, I would fully fund a Roth IRA and if you have money left over, fund your 403b. I hope this was helpful, and don’t forget to share your 403(b) experiences and tips for others in the comments below.