When I started writing, I wanted this article to be about what teachers should consider when beginning (or revising) their investing careers. My train of thought and my research starting going other places. I realized I needed to fully inform myself and other teachers about the atrocious investment programs promoted in our teachers’ lounges.
I first opened a 403b with a district partner in April of 2017, after my mom convinced me I needed to be saving separately for retirement. A clerical error had caused me to underpay my taxes for a year without knowing it and at tax time a bill of $525 really took me by surprise. Her thought was that if I was contributing to a retirement account, I wouldn’t have gotten that bill because my taxable income would be reduced. So anyway, I opened a 403b with a representative I had seen in my building several times before. Late in 2017 I started learning from financial podcasts that 403b’s are usually annuities which have additional fees and taxes that standard retirement or investment accounts don’t have. I started to get concerned, but wasn’t really sure what to do about it. I’ve been thinking about it more and more.
Your “District Representative” is Just Another Salesman
Two weeks ago, my principal asked me if a certain colleague new to our district had asked me any questions about opening a 403b with one of the district partners. He had told her to talk with me since I would be straight with her; I am not trying to sell her anything. We got into this conversation in which I learned there are dozens of district approved companies offering 403b’s to teachers. I had originally thought there were 3. He has a practice of inviting one representative a year to do a presentation to teachers, and doesn’t just let anyone walk in our building to try to sell their product. He tries to protect teachers by not allowing shady salesmen in the door, but at the same time knows they all are salesmen trying to earn their commission rather than truly help us understand investing. I had no clue there were so many vendors vying for our business and this just added to my growing knowledge base that teachers are taken advantage of by the financial industry.
I thought about it and said “yeah, I know now that all of those guys that come in to the teacher’s lounges are salesmen and make a lot of money off of us. The New York Times did a series on how bad many 403b’s offered to teachers are. I wish more people knew about the 457.” My principal, of course, had not heard of the 457 retirement account either. I surmised that the office managing the 457 is probably a very small office down in Columbus with like 4 people working there. “They offer low fees and solid fund investments, so they can’t afford to send a rep out to the different school districts. You just have to know about it.” My principal then said “Damn, maybe I need to just invite you to present to staff about this stuff instead of trying to pick one good guy from the district list.”
A 457 is most likely a better option for you
If you haven’t heard of the 457 or Deferred Compensation plan it is basically this…
- Same tax advantage as 401k, 403b, or IRA
- Same contribution limits as above ($18,500 in 2018)
- You an access the funds when you separate from service from your employer
- You don’t have to wait until you are 59.5 to access funds
- In Ohio, the plan is excellent – research your options now – with low fee Vanguard index funds available
- You can have a 457 and 403b and contribute the maximum to each*
- There is no additional cost other than the fund’s expense ratio
*keep reading to see if you want to actually open a 403b or not.
403b’s for Teachers Are Problematic at Best
I first became suspicious of my 403b when the information came in the mail. The beautiful, glossy booklet of information said “Welcome to your Tax Sheltered Annuity.” I thought “wait, what’s an annuity? I didn’t sign up for that? I signed up for a 403b! Isn’t an annuity something day time television commercials talk about when you win a settlement over botched medical care?” I was very confused and did my best to understand the information. It seemed OK enough to keep using the account. I was still getting the tax benefit of reducing my taxable income, and I could just worry about getting the money out when I got older. I can’t access it until I am 59.5, anyways.
Wake Up! 1.24% in fees is a lot of freaking money
As I learned more about investing and investment fees, one day I thought back to that conversation with my “Financial Advisor.” I looked up the notes from our conversation and there it was plain as day:
The fees are only about 1.24% and most people don’t even notice that come out of their account.Notes from my conversation with the “District Representative” for a 403b Provider
And then running through my mind were the multiple articles I’d read, which describe the detriment a 1% fee can have on an investment portfolio. A fee of 1% taken every year can cost a person tens or even hundreds of thousands of dollars over a lifetime.
“To examine the effect of fees on a millennial investor, we looked at different investing scenarios for a 25-year-old who has $25,000 in a retirement account, adds $10,000 to the account every year, earns a 7% average annual return and plans to retire in 40 years.
Nerdwallet, How a 1% Fee Could Cost Millennials $590,000 in Retirement Savings
In one of the scenarios analyzed, paying just 1% in fees would cost a millennial more than $590,000 in sacrificed returns over 40 years of saving.”
I was 26 when I opened my account. And I had agreed to pay 1.24% ?!?!?!?!? Oooooh, nooo. What have I done? Swindled.
Less Regulation, More Deception
Then I heard on the Choose FI podcast that annuities are really bad products. There are surrender fees and lots of taxes involved. I remember thinking, “I don’t know exactly what a surrender fees are but it sounds like I am going to have to pay money just to get my money back.” I got really concerned and eventually stopped contributing. I had opened my 457 account and fallen in love with the low fee index fund options I got there.
I eventually found the website 403bwise and read the articles the New York Times published investigating the poor quality of investment options teachers have access to with these various 403b plans. Simply because of different IRS rules, the 403b is more likely to be a bad investing option, which is often what is available to public servants like teachers, nurses, firefighters, and the like. In the private sector, 401k plans have more regulation and therefore protect the consumer better.
A few quotes from these articles:
On excessive fees in 403b’s…
“…In fact, millions of people who save in 403(b) plans may be losing nearly $10 billion each year in excessive investment fees, according to a recent analysis by Aon, a retirement consultant.
Named for a section of the tax code, many 403(b) accounts are riddled with complicated, expensive investment products that can cost their owners tens of thousands of dollars, if not more, over their careers. The 403(b) accounts that many workers contribute to are not subject to the more stringent federal rules and consumer protections that apply to 401(k) plans. In fact, of the $879 billion in total 403(b) assets, more than half is not subject to federal retirement plan rules, according to Cerulli Associates, a research firm.”Think Your Retirement Plan Is Bad? Talk to a Teacher
That is, we are being swindled, teacher friends.
And it doesn’t come cheap. The most popular version of the Equi-Vest annuity [at AXA] has a total annual cost that can range from 1.81 to 2.63 percent, 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. Large, federally regulated 403(b) plans charge a bit more.An Annuity for the Teacher — and the Broker
The Math of Investment Fees Explained
You might be wondering how the math of this works. So say the blend of stocks and bonds you are invested gains an average of 8% a year and you contribute $200 every month consistently. And say your management fee is 1%. Now your average returns drops from 8% to 7%. So let’s compare this over 35 years because that is how long you’re supposed to work as a teacher in Ohio in order to retire.
The Dave Ramsey Investment Calculator shows us that your retirement portfolio would grow to be $446,685.
Now when you have to pay that 1% fee, every single year, your return drops to 7% and your portfolio grows to merely $354,992. That’s not a terrible portfolio size, if you have a guaranteed pension to also use. But you’ve lost $91,693 to fees!
If you want to build more wealth, fees hurt you more. If you contribute $300 a month consistently for 35 years, your portfolio could grow to be $669,967 at an 8% return. Pay those 1% fees and you’re only at $532,488 at the end. Now you’ve paid $137,479 in fees. Did you get $137,479 worth of value for those fees? Would you have written checks worth $137,479 directly to the fund manager? Then why would you let them skim off 1% every year from your portfolio?
If you remember Warren Buffet’s bet with the hedgefund managers, he proved what the research shows: index funds, over time, out perform actively managed funds. So there is truly no reason to be paying fees to other mutual funds. They aren’t going to make you more money than the index.
On the number of plans available causing confusion in itself…
“While some school districts and states have begun vetting plans for public school employees, most teachers must still sort through a bewildering list on their own. Instead of just one provider offering a selected range of low-cost mutual funds — which is typical in a 401(k) plan — teachers and other public school workers might see options from several large providers, each with a dizzying array of prospective investments.”Think Your Retirement Plan Is Bad? Talk to a Teacher
You have lessons to plan and papers to grade. You don’t have time to research 20+ companies to see who you can trust with your money.
On the hostage situation of an annuity…
“For instance, many teachers are encouraged to invest in high-cost variable annuities, typically explained in thick instruction manuals filled with jargon. Buyers who later decide they want to move money into a lower-cost investment vehicle often learn their savings are being held hostage: Pay a surrender fee or the money must remain in the annuity.
…a seventh-grade language arts teacher … decided to pay the fee, about 5 percent of his balance, just so that he could extricate himself from a variable annuity sold by AXA, which subtracted more than 2.34 percent of his balance each year.”Think Your Retirement Plan Is Bad? Talk to a Teacher
Still not totally sure what an annuity is but it will cost you to get out. It is some kind of insurance product. Why on earth should you have to pay money just to get your own money from one account to another? A 5% fee certainly shows that the industry is taking advantage of teachers who make modest incomes and don’t know enough about investing to avoid the situation.
On the salesmen mentality
“At Axa, for example, a broker can earn roughly 5 to 7 percent of the total amount teachers deposit in their 403(b)’s for the first year
Selling annuities also creates a continuing income stream for the brokers. Axa pays a commission of 1.5 percent to 2 percent on every future dollar an employee contributed to a 403(b) annuity. The annuity sold to the teacher, in a sense, becomes an annuity for the sales rep and the company’s managers.An Annuity for the Teacher — and the Broker
That “Financial Advisor” talking to you is just a salesmen trying to earn his own bread and butter.
Justin Victor, a certified financial planner who left Axa in 2008 after three years, recalls the intensity of that pressure. “I am not going to lie,” he said. “When you have your health insurance on the line in the commission-based financial advisory world, you will do whatever you can to get a commission.”An Annuity for the Teacher — and the Broker
My 403b Plan
I did a little digging and learned a few more things. I contacted the benefits department and requested the list of providers for retirement in our district. There are 21 distinct brokers that we can choose from. And several of those providers actually are middlemen for other companies. This doesn’t provide any value to have this many choices. How are you honestly supposed to have time to vet through all of them to find the best product? In the private sector the company does that for the employee. They create a partnership with a company and they use financial experts to know what is a good deal for their employees. But for public servants they leave it up to us. We don’t have the knowledge base or the time to sort through all of these before making a decision. By allowing so many providers, our school boards are just providing more opportunity for sales pitches and confusion.
In the list for my district, the very last broker is actually the 457. I opened a 457 and began contributing in January 2018. I chose a S&P 500 and A total bond market fund, just as Warren Buffet recommends. My expense ratio is 0.02%. This means the fees on my account are 98.4% less expensive than my 403b fees! It is 98.9% to 99.2% cheaper than the average Axa account expense cited in the NYT article above. You can’t do much better than a 99% discount.
I learned this week that while I am still working in this school district there is nothing I can do to move my money out of the 403b.You can only roll money out of any retirement plan to a traditional IRA after you stop working for a certain employer. I can’t roll it into the 457 because of the different tax laws. Since I contributed money to 403b under the assumption I wouldn’t access the money until I am 59.5, I cannot just move it to an account that allows you to access before that age. If, however, I were to move to a different employer then it could be possible to move the money out of the 403b and into my 457 plan. The catch is that the money maintains its status as post 59.5 year old money. I could move it to another 403b provider, but as I have already mentioned, I don’t have time to research all of those other companies. I am busy from now until winter break working. I make time for this website because I genuinely enjoy writing about money. But I don’t genuinely enjoy researching companies which aren’t trying to do what’s good for their customers.
To try to minimize loss while I am stuck in the 403b, I redid all of the investment allocations. I was originally put into a moderately aggressive portfolio designed by the company. I moved all of it into their S&P 500 index fund. Unfortunately their index fund, which is the cheapest mutual fund they offer, has an expense ratio of 0.59%. This is almost 30x what the same exact same fund costs in the 457. It is almost 20x as expensive as the same fund at Charles Schwab (which I have in my taxable and Roth accounts). It is almost 15x as expensive as Vanguard’s index fund offerings. Seriously, are you kidding me? How ridiculous is it that they can charge 30x for the same product? They’re getting away with some real theft. Stealing right from teachers’ pockets. But… It’s still less than 1%.
If you are contributing money to a 403b, look into what it is costing you. Consider switching to a 457 or a traditional IRA because it will cost you considerably less. Don’t let the ease and convenience of a sales rep in the teachers’ lounge cost you half a million in potential returns. It’s not a joke or an exaggeration. Don’t let another day go by without trying to understand who has your money and what it’s costing you. Make choices based on the math not on convenience.