The 403(b): Does the Company You Invest With Matter?

1. The 403(b):Does the Company You Invest With Matter?

2. Disclaimer • Everything I am going to tell you is to the best of my knowledge true. • You are responsible for verifying any information I present. • You are responsible for any investment decisions you make. • This presentation is designed to be informational only and should not be interpreted as investment advice.

3. Check With the Pros • All the content in this presentation should be validated with your current provider as to it’s accuracy with respect to that particular company.

4. Risk vs. Reward • Long term investing reward does not come without risk. They can’t be one without the other. Your risk tolerance refers to how much fluctuation in price over time you are willing to endure.

5. What Is a 403(b)? • A government program to relieve the financial stresses placed on the Federal Government by retirees. • Established in 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.”

6. What Makes a 403(b) Great? • Tax Deductible Contributions • Tax Deferred Growth p.s. It’s those same things that make an IRA or a 401(k) great.

7. 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 $10,000 to your account $70,000-$10,000=$60,000*.25=$15,000 in taxes • You save $2,500 simply by investing. This is fact.

8. 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 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 are a few.

9. So What’s Bad (Good) About Them • You can’t get your money without penalty until you turn 59 ½ years old. • When you take out the money you WILL PAY TAXES on the original contributions, the capital gains and the dividends.

10. 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!

11. 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 • Vanguard only offers a 403(b)(7) Custodial Account

12. 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)

13. The Difference: What a 403(b) Has, That a 403(b)(7) Does Not • In a 403(b), you sign into a “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. • Variable Annuities are available to anyone • AVariable Annuity is not included in a 403(b)(7)

14. 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.

15. 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 • There are cases in which an annuity may be a sound investment. • The annuity most of you have is probably a deferred variable annuity which is a type of insurance policy typically packaged within a 403(b).

16. 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. • 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,” or start taking payments until long after you actually signed 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.

17. 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 at 141

18. 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.

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

20. Who is Vanguard? • Who we are • 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. • Our 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. Taken from www.vanguard.com

21. Who is Vanguard?

28. 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 cares about you, and who typically earns at least a portion of his salary through commissions.

29. 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

30. 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?

31. 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.

32. 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?

33. Historical U.S. Stock Market Returns

34. 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.”

35. 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.

36. 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

37. Industry Quote • VA stands for Variable Annuity • “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 VA, investors should generally contribute the maximum allowable amount to qualified retirement plans prior to contributing to a non-qualified VA. Moreover, it is generally not appropriate to purchase a VA within a qualified (tax-deferred) retirement plan (such as a 403(b)).”

38. 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.”  

39. 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.

40. 403(b) Expenses Continued • 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.

41. How the Expense Ratio Effects your Net Worth • The Expense Ratio effects your Net Worth in 2 Ways • They take money that would be yours. • The money they take can not continue to grow over time. This is called “forgone earnings.”

42. How Expenses Effect Returns • Consider a standard S&P 500 Fund

43. How Expenses Effect Returns : Some Examples Assume an Initial Investment of $50,000 with no additional contributions, earning 8% for 20 years. Info from www.sec.gov/investor/tools/mfcc/mfcc-calculate.htm

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

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

47. 1.75% in Expenses No Expenses .21% in Expenses 8% Return: $304,943 $295,432 $234,965

48. Industry Quote • “Do not invest in a variable annuity within a tax-deferred qualified plan; you incur extra expenses for few benefits.” • The author is a fee-only insurance adviser in New York City. • Glenn Daily, “Investing In Variable Annuities: The Selection Process,” AAII JOURNAL, November 1991 at 11

49. My Advice • If you are going to invest in Mutual Funds, all other thing being equal, invest in the least expensive one! • Trust me, I’m a math teacher!

50. The Caveat • If you go with Vanguard, you will not be able to meet with anyone face-to-face. • You will have to choose your funds on your own or with the help of someone else. • You may want to consider paying a fee-only financial adviser to help you with this decision.