The 403(b)

1. The 403(b) The 403(b) What is it? What’s wrong with it? How can it be fixed?

2. Required Knowledge to Move Forward PART 1

3. Mutual Funds • A Mutual Fund is an investment in the stock (or bond) market that invests in a number of companies (or bonds) at one time. • Example: The S&P 500 Fund invests in the 500 largest companies in the United States

4. Expense Ratio • Every Mutual Fund with every company has what is called an Expense Ratio • The Expense Ratio is the percentage of your assets every year that the Company you invest with takes as payment for them to “manage” the Mutual Fund and hold your money.

5. The Qualified Plan403(b)/401(k)/457 • Designed by the Federal Government to encourage people to invest for their retirement • Tax Deductible Contributions • Tax Deferred Growth

6. Tax-Deductible Contributions • Ex: Suppose you earn $70,000 per year • When you approximate your income taxes take 25% of 70,000. .25*$70,000 = $17,500 in taxes • If you contribute $4,000 to your account $70,000-$4,000=$66,000*.25=$16,500 in taxes • You save $1,000 of your income simply by investing or the $4000 you saved only cost you $3000.

7. Tax-Deferred Growth: Capital Gains and Dividends(Simplified) • When you sell a stock for more than you pay you get taxed on the difference. This is called Capital Gains. • When a stock pays dividends it pays out a portion of it’s profits to it’s shareholders. • The rules can be complicated, but to simplify, at the end of the fiscal year, you must pay taxes on Capital Gains and Dividends. • When investments grow tax-deferred, you do not pay (defer) the taxes on Capital Gains and Dividends until you take the money out at retirement!!! • This is a great thing! There are not a lot of ways to get tax-deferral. 403(b)’s, IRA’s and 401(k)’s and Variable Annuities are a few.

8. What’s an Annuity? • Typically, an Annuity is a contract with an Insurance Company in which you give a bunch of money to them, and they agree to pay you money back over time. Typically until you die. Once you die, they typically keep whatever money is left. It is a type of insurance policy. • There are cases in which an annuity may be a sound investment. • There are MANY different types of annuities. For example the Fixed Immediate Annuity. • If you currently have a 403(b) with an Insurance Company, the annuity you probably have is a deferred variable annuity which is a type of insurance policy often packaged within a 403(b).

9. How Does a Deferred Variable Annuity Work? • During your working years you contribute to your 403(b) TSA. This is called the “accumulation phase” of the annuity and the money grows tax deferred. • The amount your money grows varies depending on how your investments do. That’s why it’s called “variable” • After you stop contributing and you want to start getting payments back, they figure out how much you will get each year, month etc and they start paying you. • The “Deferred” part refers to the fact that you don’t actually “Annuitize,” (start taking payments) until long after you actually sign the contract. • Important Note: You do not have to “Annuitize”. You may just take the money out when want it pursuant to the IRS regulations. Who typically buys variable annuities?

10. Important Deferred Variable Annuities Grow Tax Deferred !!!!!!!!!!!!

11. How Does Money Grow?andHow Much is ½ %?

12. http://www.bloomberg.com/invest/calculators/401k.html

15. Who is Vanguard? • Who are we? • Vanguard is one of the world's largest investment management companies. Whether you are an individual investor, institution, or financial professional, you can benefit from the size, stability, and experience that we offer. • Their mission statement • Vanguard's mission is to help clients reach their financial goals by being the world's highest-value provider of investment products and services. • Vanguard is a non-profit corporation. Taken from www.vanguard.com

16. Who is Vanguard?

17. What is a 403(b)? PART 2

18. What Is a 403(b)? • A government program to relieve the financial stresses placed on the Federal Government by retirees. • The term 403(b) refers to the section of the tax law explaining the rules of this type of investment • Established in 1958 as a way to encourage employees at non-profit institutions to save for retirement. Only “Tax Sheltered Annuities” were allowed. • In 1974 the Law was changed to allow mutual fund investing or “Custodial Accounts.”

19. Why Are 403(b)’s So Great? • Tax Deferred Growth • Tax Deductible Contributions

20. So What’s Bad (Good) About Them • You can’t get your money out of a 403(b) without penalty until you turn 59½ years old. At 70½ you must start taking out the money. • When you take out the money you WILL PAY TAXES on the original contributions, the capital gains and the dividends as if it were ordinary income.

21. The 403(b) vs. The 403(b)(7) • There are 2 Types of 403(b)’s • 403(b) a.k.a. Tax Sheltered Annuity • 403(b)(7) a.k.a. Custodial Account This is where it starts to get interesting!

22. Who Offers What • The Insurance Companies Major Offering is the 403(b) Tax Sheltered Annuity • Some Insurance Companies also offer a 403(b)(7) Custodial Account (Met Life, an additional .6% fee applies) (TIAA-CREF should offer one soon) • Vanguard only offers the 403(b)(7) Custodial Account

23. The Similarities • 403(b)’s and 403(b)(7)’s both offer… • Tax Deductible Contributions • Tax Deferred Growth • Access to the stock market • Access to the bond market • Automatic payroll deductions (dollar cost averaging)

24. The Difference: What a 403(b) Has, That a 403(b)(7) Does Not • In a 403(b), you sign into a “Deferred Variable Annuity,” which is a financial product that has….. • Tax Deferred Growth • A Death Benefit • The opportunity to “Annuitize” your investment • The opportunity to take out a loan against your account balance. • AVariable Annuity is not included in a 403(b)(7)

25. The 403(b) 403(b) TSA 403(b)(7) Custodial Account Variable Annuity Mutual Funds Mutual Funds

26. Duh? • The Question: • So why not just get a 403(b) rather than a 403(b)(7) if in a 403(b) you get more? • The Answer: • A 403(b) costs more, and you should only get one if the extras are worth the cost. Maybe they are, maybe they aren’t. That’s what you need to decide.

27. 401(k) vs 403(b) • Approximately 21% of 403(b)’s are invested in Mutual Funds, 79% are in Fixed and Variable Annuities source: Spectrem Group • Approximately 82% of 401(k)’s are invested in Mutual Funds. Less than 20% are in Annuities. source: Investment Company Institute Why the Difference?

28. The Problem • One of the main reasons people purchase variable annuities is for the tax-deferral • 403(b)’s are already tax-deferred • “It’s absurd to put a tax-sheltered investment like a variable annuity into an IRA, which is already tax sheltered. The only person who makes out on this deal is your broker.” Lani Luciano, MONEY, January 1997, p.141

29. The Cost of a Variable Annuity Inside a 403(b) • Variable Annuities typically charge you in 3 ways • Management Fees : Around .25% • Expense Ratio: Around .75% • M&E Fees : Around 1.25% (www.sec.gov) M&E stands for Mortality and Expenses. This fee includes paying for the death benefit, advertising for the company and paying your rep. • At Vanguard, you only pay the Expense Ratio and a yearly fee of $15 per year per fund.

36. Variable Annuities : It Costs More, So What Do You Get? • Tax sheltered growth. (Oops, you already have that) • Loan Provisions : You can take out a loan against your account • A Death “Benefit” • The opportunity to Annuitize your account at a later date. • A representative who you can meet face-to-face.

37. The Death “Benefit” • With variable annuities, if you die, your beneficiary will receive the greater of, a) the current value of your account b) a check for the total amount of money you have invested over time, also called your principal c) A “step up” benefit

38. Possible Death Benefit Outcomes • Assume for 10 years you have invested $10,000 each year into your 403(b) • Your Principal is therefore $100,000 • What happens if you die?

39. Outcome 1 • If your 403(b) account is worth more than $100,000, your beneficiary will inherit the entire amount • This is the most likely outcome. • Even if you had a 403(b)(7) rather than a 403(b), your beneficiary would still get the entire amount.

40. Outcome 2 • If your account is worth less than $100,000, your beneficiary will receive a check for $100,000. This is not true in a 403(b)(7). • What is the probability of different losses? • Not only is it unlikely to have lost money, but at what cost?

41. Historical U.S. Stock Market Returns

42. Industry Quote Regarding Payouts • Ron Panko, “Can Annuities Pass Muster?,” BEST’S REVIEW, July 2000 at 103 • When Hartford Life was asked in the discovery process how much in death benefits the company had paid in the 17 years the San Diego and Los Angeles plans had existed, “Hartford claimed it had paid a single death benefit totaling only $119 in San Diego and no death benefits in Los Angeles.”

43. The Cost of The Death Benefit • The average annuity death benefit, a portion of your M&E expenses, costs about 1.25% of the total assets in your 403(b) account. (www.sec.gov) • The cost of your annuity on your $100,000 is therefore, conservatively, around $600. • I pay around $700 per year for a $1,000,000 life insurance policy! • Compare term life rates to annuity costs to get an idea if you are getting a good deal.

44. Annuity Conclusion • You need to decide if a variable annuity is right for you! • If you think it is a good deal then buy it! • Read the next two quotes • More Quotes at http://www.insurancelaw.com/bib6.htm

45. Industry Quote • “New Schwab Studies Shed Light On Variable Annuity Debate; Studies Look At Suitability of Annuities,” Business Wire, November 6, 2002 Two new studies from the Schwab Center for Investment Research provide “objective analysis on the factors that investors should consider when considering a variable annuity purchase.”    • “As qualified retirement plans offer tax advantages beyond those offered in a Variable Annuity, investors should generally contribute the maximum allowable amount to qualified retirement plans prior to contributing to a non-qualified Variable Annuity . Moreover,it is generally not appropriate to purchase a VA within a qualified (tax-deferred) retirement plan such as a 403(b).”

46. Industry Quote • “Making the Most Of Your Retirement,” CNNfn, May 13, 2003 at 5:00pm Attorney and financial planner Gary Schatsky is the guest.  •  Host Ali Velshi asks “You know. . . we don’t have anybody who comes on this show, a good bunch of people, who recommend annuities.  What’s the problem?  Who’s selling them and who’s buying them if nobody’s recommending them?”    • Mr. Schatsky responds that people are “getting sold” annuities, but annuities can make sense only for “a very small subset[.] . . .  I am sure you do know 60 percent of annuities are sold in IRA accounts [and other] retirement accounts.  The absolute worst place for them to be.  Your putting a tax shelter in a tax shelter and your paying for it.”  

47. 403(b) Expenses • When you invest in a 403(b) you will generally select 1 or more Stock and/or Bond Funds to put your money in. These are called Mutual Funds • For most people, Mutual Funds are considered a great way to diversify your assets.

48. Do Fees Matter? • Do Fees and Expenses matter? • YES! • Are Fees and Expenses the only things that matter? • NO!

50. Value After 25 Years Contribution per paycheck Out of Pocket Expense Value After 5 Years Value After 15 Years Tax Reduction