So why are there some many annuities in 403(b) plans in the first place?

As advisors that specialize in helping teachers making smart financial decisions on saving, investing and retirement, we are constantly amazed at why so many teachers own high-cost annuities within their 403B plans.  (If you are reading this, do own an annuity and do you know why?)

In answering the above question, it may be helpful to go back to the very beginning and hear a little bit about the history of teacher’s retirement, 403(b)s and annuities to figure out exactly how we go to the place we are at right now, with 70% of teachers 403(b)’s in annuities. *

Before there was even a such a thing as a 403(b) there existed a basic plan where a tax-exempt employer (a school) could place funds into an annuity contract for an employee. These contracts were typically individual annuities, owned by the employees but funded by employers.  Remember, this is an era before IRA’s, 401(k)s and 403(b)s. Heck, Social Security was barely 20 years old.  All in all, not a bad arrangement for teachers.

Then, in 1958, section 403(b) of the Internal Revenue Code added some rules including defining contribution limits to such annuities and the term ‘403(b)’ was born!  However, the only investment options available for 403(b) participants were insurance-based annuity products, thus, the term ‘Tax Sheltered Annuity’ became almost synonymous with 403(b) plans.

Finally, 1974, Congress rectified this small issue by adding language to the law to allow participants to invest directly into mutual funds in addition to annuities.  Finally, teachers had true choice.

One would think that by allowing mutual funds into the plans, annuities would eventually suffer the same fate as the land-line phone.  However, the name tax-sheltered annuity remains pervasive.  For example, in an Investopedia article this year the author flatly states that a 403(b) plan is also another name of a tax-sheltered annuity plan. Given that we already know that a 403(b) does not need to own annuities to be considered a 403(b) (and probably shouldn’t) this is downright misleading. **

No wonder why teachers feel confused!

Let’s make it a little more confusing.  Today’s school districts are not only filled with one type of annuities, there filled with bunches.  How did this happen? According to a report by Arthur J. Gallagher and Co. published in 2017 entitled ‘The Perils of a Multi-Vendor 403(b) Plan” they contend…

From their introduction, 403(b) plans were prone to offering multiple providers. In 1958, 403(b) plans were introduced as tax-sheltered annuity plans for public sector and some nonprofit organizations. The purpose was to provide employees of these organizations a way to save for their retirement. At that time, 403(b) plans were limited to offering only annuities as investment options. Additionally, providers could only record keep their own annuities; so, if an organization wanted to offer more investment options, they had to offer more vendors. It wasn’t until 1974 that 403(b) plans were allowed to offer mutual funds (also known as

403(b)(7) custodial accounts). By that point many plans had presumably added multiple vendors to allow choice within the plan and a common practice had been established. ***

So, let’s bring it back to the present.  Since 1958, the universe of investments and the investor knowledge has changed and advanced dramatically.  We have tremendous evidence that investment fees have a dramatic impact on the ability of someone to accomplish their financial goals.  Investors have woken up to this reality and have voted with their feet.  Low cost, high value investment companies such as Vanguard are extremely popular with investors.  There not alone. Fidelity Investments, one of the largest providers of 401(k) plans (the private equivalent of 403(b) planned introduced ZERO fee index funds late in 2018. ****

Of course, there is nothing wrong with fees, as long as you are receiving VALUE for those fees.  But annuities, especially variable annuities, simply don’t stack up well versus the low-cost mutual fund options within 403b.

We often time see 403(b) Variable Annuities with fee’s as high as 2.5% for providing the same basic investment lineup that could be had for ½ that cost or even less with a Vanguard or Fidelity. That doesn’t even include the high surrender costs that are associated annuities.

Yes, you need to pay them if you want to move your account.  That’s the ‘surrender charge.’ During a set period of time from when you start contributing (typically 7-10 years) if you decide to move your account, you’ll have to pay % of the account charge.  Anywhere from 1-7% of the account balance.  Wow.

If private companies set up their 40k(k) plans like this, they would be sued.  I’m not kidding.  It’s because they have to comply with a law called ERISA.  Among many of the stipulations in ERISA there is an important one requiring the employer to act in a fiduciary capacity by monitoring the plans for cost and vale and always make decisions in the best interest of their employees.

Sadly, 403(b) plans are not covered by ERISA.

There is a tremendous interest for the financial and insurance companies to keep things as they are.  With the rest of the investment world experiencing fee compression, the 403(b) world not only remains tremendously large, but tremendously profitable.  That’s why the big players can afford to train, license and hire thousands of bagel toting young financial ‘salespeople’ to canvass schools and sign people up.

In the end, the reason you have 70% of the 403(b) in annuities* is because that’s how it started out, that’s how it’s been, and if it’s up to the insurance companies, that’s how it’s going to stay.   

There is simply too much money at stake.  Too much of your money.

 

 

There is another way.  Let us help you make an honest, fiduciary-based decision on what plan is best for you.  We offer no-fee cost and fund comparison through research powered by Morningstar, one of the largest providers of 3rd party, unbiased advice.  We also have an extensive history of helping teachers in Southeast Michigan navigate not only their 403(b) options, but their pension decision, college savings options and comprehensive retirement questions.

If you’re tired of the flavor of the month annuity salesperson and want honest, forthright advice.  We can help.

After all, while you’re looking out for your students, who’s looking out for you.?

 

Sources:

*https://403bwise.com/?/research/403bmarket.html

**https://www.investopedia.com/terms/1/403bplan.asp

***https://www.ajg.com/media/1701544/the-perils-of-a-multi-vendor-403-b-plan.pdf

****https://www.cnbc.com/2018/09/04/fidelity-offers-first-ever-free-index-funds-and-1-billion-follows.html

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Securities offered through Securities America, Inc. Member FINRA/SIPC. Check the background of your financial professional at FINRA's BrokerCheck. Advisory services offered through Securities America Advisors, Inc. Mission Point Planning and Retirement, and the Securities America Companies are unaffiliated.
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The Five Star Wealth Manager award, administered by Crescendo Business Services, LLC (dba Five Star Professional), is based on the following objective criteria: Credentialed as an investment advisory representative (IAR) or a registered investment adviser; Actively employed as a credentialed professional in the financial services industry for a minimum of five years; Favorable regulatory and complain history review; Fulfilled their firm review based on internal firm standards; Accepting new clients; One-year client retention rate; Five-year client retention rate; Non-institutionalized discretionary and/or non-discretionary client assets administered; Number of client households served; Educational and professional designations. Wealth managers do not pay a fee to be considered of awarded.


* Source: Pew Research Center
† Source: “Quantitative Analysis of Investor Behavior, 2014” Dalbar Inc. Most recent data available. An index is un-managed and one cannot invest directly into an index.

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