Transcript Long Term Investing Options in Wayne

The 403(b)
What is it?
What’s wrong with it?
How can it be fixed?
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PART 1
Required Knowledge
to Move Forward
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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
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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.
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The Qualified Plan
403(b)/401(k)/457

Designed by the Federal
Government to encourage people
to invest for their retirement

Tax Deductible Contributions

Tax Deferred Growth
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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.
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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.
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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).
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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?
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Important
Deferred Variable Annuities
Grow Tax Deferred !!!!!!!!!!!!
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How Does Money Grow?
and
How Much is ½ %?
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http://www.bloomberg.com/invest/calculators/401k.html
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Who is Vanguard?

Who are we?


Their mission statement


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.
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
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Who is Vanguard?
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PART 2
What is a 403(b)?
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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 nonprofit 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.”
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Why Are 403(b)’s So Great?

Tax Deferred Growth

Tax Deductible
Contributions
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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.
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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!
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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
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The Similarities

403(b)’s and 403(b)(7)’s both offer…

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


Tax Deductible Contributions
Tax Deferred Growth
Access to the stock market
Access to the bond market
Automatic payroll deductions (dollar cost
averaging)
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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.
A Variable Annuity is not included in a 403(b)(7)
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The 403(b)
403(b) TSA
403(b)(7) Custodial
Account
Variable Annuity
Mutual Funds
Mutual Funds
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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.
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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?
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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
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The Cost of a Variable Annuity Inside a 403(b)
Variable Annuities typically charge you in 3 ways

1.
2.
3.
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.
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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.
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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
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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?
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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.
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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?

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Historical U.S. Stock Market Returns
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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.”
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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.
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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

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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).”
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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.”
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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.
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Do Fees Matter?

Do Fees and Expenses matter?


YES!
Are Fees and Expenses the only things that
matter?

NO!
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Contribution
per paycheck
Out of
Pocket
Expense
Tax
Reduction
Value After
5 Years
Value
After 25
Years
Value After
15 Years
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8% Return: 1.75%
No
.21%
Expenses
in
in Expenses
Expenses
$234,965
$295,432
$304,943
Web Resources

www.403bwise.com The Mother of 403(b) sites

http://www.403bwise.com/wisemoves/annuities.html
(this is a must read)

www.mcnuttmath.com

http://www.insurancelaw.com/bib-qualifiedannuities.htm (an absolute must read)
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Web Resources

The following website is run by the Securities
and Exchange Commission

Part of their site is specifically for teachers
and is completely unbiased.

It is a great place to learn this stuff

http://www.sec.gov/investor/teachers.shtml
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PART 3
The New Regulations
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The New Regs



Each district must create a Plan Document
outlining the “rules” of their 403(b) and
administer that document
Universal Availability: Employer must
regularly notify employees of their eligibility to
participate
90-24 Transfer Availability. New regs make it
more complicated to transfer assets from one
403(b) to another.
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PART 4
What can the NJEA do?
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Improve SACT

The NJEA could use it’s influence to
persuade the State of New Jersey to improve
upon SACT (Supplemental Annuity Collective
Trust).

SACT is a retirement program run by the NJ
Divisions of Pensions and Benefits as part of
the Department of the Treasury and is open
to any member of the TPAF.
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SACT

SACT was initiated in the 1960’s and is a
great program that was never adequately
advertised and never improved upon.

SACT offers dollar for dollar retirement
investing (no fees) in a single fund, a hybrid
S&P 500 Index Fund.
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How the NJEA can improve SACT


Educate the members of the NJEA that SACT
is available and teach them how to use it.
Lobby the Legislature to improve SACT by
offering a selection of Target Date type
Funds.
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Examples of GREAT “SACT” Type Plans


TSP “Thrift Savings
Plan”
Offered to Federal
Government
Employees
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Open to all New York City Employees
Offers 12 Pre-Arranged Portfolios (Target Date Funds)
and 7 General Mutual Funds and a 3rd option of 20% self
management.
Typical Expenses around .24%
They didn’t like the expenses they were getting at Vanguard
so they asked Vanguard to lower their fees. Vanguard said
that’s as low as we can go so they bid it out and got a lower
fee for a similar fund. i.e. Buyers Edge
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A new SACT is a Win, Win, Win.

TEACHERS WIN because they get low cost investments in
professionally manages funds at industry low costs without the
backbreaking fees of the insurance companies.

SCHOOL DISTRICTS WIN because they no longer have to offer
a 403(b) of their own and it would save them from the
management costs and fiduciary responsibility of offering a
403(b).

THE NJEA WINS because they create a great 403(b) program
for their members.
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