As a teacher, you are able to supplement your retirement savings by using a 403(b). In addition to your pension, and possible Social Security benefits, this money is designed to be used to fund your lifestyle when you retire from teaching.
But there are some choices that need to be made when choosing what type of 403(b) to use, and how to use it to its fullest effect.
How to choose a vendor
Depending on your school’s location and the approach your district has taken with selecting vendors, you may have one vendor available or over twenty.
If you have one available, you don’t have much choice but to hope your district has done its due diligence and the option is a good one. However, if you have a variety of choices, you’ll need to do some homework.
403(b)s are offered in two different ways. One option is to have an insurance company provide the 403(b), and these are sometimes called Tax-Sheltered Annuities (TSAs). The other option is to use an investment company’s option.
In 99% of the cases, it’s better to go with an investment company’s offering, as you will save a lot in fees, have better investment choices, and have more flexibility should you decide you want to move your money at some point.
Without naming names, any company that has “insurance” in their company’s full name is going to be a more expensive and restrictive option. Avoid those!
Explore a self-directed option
An option which has not been widely publicized, but is becoming more popular amongst astute investors, is the self-directed 403(b).
When opening a 403(b) in the regular way, you are assigned a representative (rep) of that company who will open accounts, transfer other 403(b)s to that account and choose investment options for you. The cost for choosing a company, holding an account and having a rep assigned to you can be an annual fee anywhere from 0.5%–1.5% of your account balance.
But the self-directed route bypasses all of this. It’s only available from a few investment company platforms (Fidelity, Lincoln Investment Planning and Aspire are the ones that are most prominent), the self-directed option will allow you to fill out paperwork, transfer existing 403(b)s and choose investment options all by yourself.
You’ll do away with the fees that you would pay for a rep and only have to pay a nominal amount to hold an account with the company. It should be noted that this is for teachers confident in their investing ability so may not be suited for everyone.
Understand your tax situation and how that impacts what type of 403(b) to choose
When using a Traditional 403(b), your contributions are avoiding taxation at this time and will be taxed, along with the account growth, when you make withdrawals in retirement. Given your tax bracket, this could have you avoiding paying taxes on this money at a 10-39.6% rate, and that’s not including state taxes.
Should you find yourself in a high tax bracket (28% and above), it can make sense to make tax-deferred contributions by using a Traditional 403(b). However, for teachers in the 10-25% brackets, they may actually find that if they pay taxes on their contributions now, they may be paying a lower tax rate than what it might be in the future.
To accomplish this, you will have to use a Roth 403(b). This will allow you to pay taxes on your contributions now, but when you withdraw them in retirement, the contributions and growth will be tax free. If you currently pay taxes at a 15% level, but can see yourself in a 25% bracket in retirement, you just got away with not paying taxes on the 10% difference. Big win!
One caveat—I’m not an accountant, so double check all tax projections and decisions with an accountant first before making any decisions.
Choosing your investments
So, you’ve chosen your account and you’re happy (or if you’re switching to a new account, then you’re unhappy but getting better!). Now comes the task of choosing the investments that your money will be invested in. This part of the process, if you’re using a rep, requires you to be on full alert.
Inside some 403(b)s, the company who owns the 403(b) will also own some of the investment choices. Because they are proprietary to the company itself, it’s hard to know what they’re investing in, even though it may seem obvious. (Even I can’t tell through my hours of research as they may not publicly tell you what is inside their products.)
To counteract this problem, ask to use investments that can be verified and researched on an investment research platform like Morningstar.
If available, ask to use passive investments that track the stock market versus active funds which try to second-guess and react to market movements. By doing this, you’ll be keeping more of your money for yourself versus paying investment managers to try and time the market.
Leaving your district
There may come a time when you leave your district, either for another one or to retire.
At this point, you can either move your 403(b) to a new one in your new district or leave it where it is. I would do neither of these options!
When you terminate employment with a district, you have the option of rolling your 403(b) to a Traditional IRA. This is an account that is not tied to your job, but does the exact same thing as a 403(b)—tax-deferred growth of contributions for retirement income.
You can open a Traditional (or Roth) IRA at major custodians like Charles Schwab, Vanguard, and Fidelity and then roll your 403(b) into that account. Holding an account with these companies is far cheaper than a 403(b), you get a vast array of investment choices, and you have more choice as to what to do with your money.
While choosing a 403(b) is important for all teachers, everyone’s situation is different. If you have questions, find an independent financial advisor (not your 403(b) rep) to ask about your situation and what option(s) might be right for you.