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When I first started in the investment business, I did a lot of work with teachers. Some of the rules have changed but the products used in this marketplace are still the same old products that were offered 20 years ago. The world has changed and teachers, along with other non-profit employees, can now bring their investment program to the next level.

The 403b, sometimes referred to as a TSA or Tax Sheltered Annuity, can be very confusing. The following lays out the basics of the program, how we set up 403b accounts for our clients and then some background on the program. Although the teacher is discussed here, the 403b can also be used by hospital employees, clergy, and the employees of most other non-profit organizations.

  • The contribution is payroll deducted and is a forced savings plan.
  • The contribution reduces your current income and therefore reduces the federal and state taxes you pay.
  • The money grows or compounds on a tax-free basis.
  • Payroll deduction is set up with either a mutual fund company or an insurance annuity company.Maximum annual contribution is $15,500 (2008)
  • If over age 50, a $5,000 "catch up" is allowed.
  • There is also a "catch up" provision for employees with 15 years of service.
  • Employee can also contribute to a 457 plan if available.
  • Investments used are selected by the employer and its employees.
  • The employer may have its own set of rules as to how the plan is administered.
  • The IRS will impose a 10% penalty if money is withdrawn prior to age 591/2.
  • Upon withdrawal at any time, proceeds are subject to ordinary income taxes.
  • At age 70 1/2 the IRS requires a mandatory distribution based on a life expectancy table.
  • For convenience and estate planning reasons, upon retirement, it is best to convert the 403b to an IRA.
Using our services to set up the 403b
  • For small accounts or for those just starting to contribute, we would recommend a no load mutual fund through a company such as Vanguard, Fidelity or T. Rowe Price. For accounts over $100,000 we may suggest moving a block of money into a discount brokerage account to enhance the investment performance.
    • Discount brokerage firms only accept money transferred in from an existing 403b with another provider. They do not allow for a direct salary contribution from the employer.
  • We would review the list of companies that your employer will allow a payroll deduction to and try to find one that is a no load mutual fund such as Fidelity or Vanguard.
  • We will establish your current contribution into one of those. On an annual basis or every few years, assets can be transferred to the brokerage account. Therefore you would end up with two accounts. One that is receiving the payroll deduction and the other that would have more investment options.
  • Unless you have at least $100,000 in accumulated assets in a plan, it doesn't make much sense to get involved with a discount brokerage firm. A good no load mutual fund would serve you well.
  • If you want us to do the work to set up a no load payroll deducted program we will have to charge you for the time involved. If your account is over $100,000 you may want to consider our investment advisory services.



The 403b program is sometimes called a "Tax Sheltered Annuity".  This term originated from the time when the 403b program was funded only through insurance companies. Since insurance companies only offered annuity products, the term Tax sheltered annuity became common. Some time in the late 1970's, mutual funds were offered. It is important to understand both Annuities and Mutual funds. Technically the annuity falls under the IRS code 403b, and the mutual fund is under the code 403b7.

Fees and Expenses

A lot of investment products are differentiated only by the fees they charge. Since fees eat into returns, there has to be a value added to justify the cost. This could be advice, administrative support or superior management.  In many cases, fees get stacked up in order to pay a long line of intermediaries and there is little or no service provided. The investor's objective should be to eliminate as many intermediaries as possible, get to the source and buy services that will benefit him/her as the investor.  


There are two types of annuities sold. One is called a "fixed" annuity and the other, a "variable" annuity. These are also terms that are misused in the industry. First, it important to understand that there are two phases or stages of an annuity. Its accumulation phase is where dollar assets are built up and the payout phase is where an income stream is paid out. By definition, the word "annuity" refers to an income stream. So when you buy into an annuity you are actually buying a future income stream not necessarily a lump sum cash value. This is a very important concept to understand. In many cases, there is a rate of interest that determines the cash value and different rate of interest that determines the income stream. When you finally elect to take the income stream at retirement, you give up your rights to the cash value.

Fixed Annuity
  • The fixed annuity has a fixed interest rate during the accumulation phase. There can be redemption fees that last longer than the initial fixed rate. If you are going to use a fixed product, it is best to select one that has the interest rate fixed for the same duration as the surrender charge or one that simply pays a good rate of interest with no surrender charge.


Cautions on interest rates

  • Some annuity companies offer a rate that is only good if you annuitize the contract. That means you have to convert the value of your account to an income stream and take it over time. That is much different than taking it in a lump sum  - since you are losing control over the money and you are losing the interest earned over the time period that you are taking it. Keep in mind that actuaries write the programs to determine these income streams.  Actuaries are very highly trained. They take more mathematical exams than most NASA engineers! Their job is to create mathematical models that make money for the company, not you!
  • Interest rates in these contracts can also be "banded". This means that different blocks of money earn different rates of interest depending upon when it was put it. This is confusing. Sometimes the rate quoted is high in the first year and then declines over time. With a number of bands doing this, it is difficult to figure out what you are actually earning. This is tied in with various redemption schedules of the various bands which make the whole thing very complicated.
Variable Annuity
  • The variable annuity is a set of mutual funds under the wrapper of an annuity. Since you are paying the expenses of the wrapper and the expense of the funds, variable annuities are more expensive than buying the funds directly. There is little or no reason to pay for the annuity wrapper if you are going to buy mutual funds inside a tax shelter such as an IRA, 401k, 403b or any other pension vehicle. Some agents will argue that there is a loan privilege with an annuity and the annuity can offer some guarantees, but the expenses associated with these options can be excessive.  
Guarantees on returns


  • Many variable annuities inside and outside of the 403b offer guarantees. Initially this sounds like a way to earn market returns without the risk of losing money. The fact is that a lot of these guarantees are worthless. They are typically based on an income stream and not cash values. Before paying additional fees to obtain guarantees, it is best to examine them very carefully. In many cases, it is better to actually split a portfolio into an interest bearing portion that is guaranteed and a variable portion that moves with the market.
Mutual funds 

A "no load" mutual fund can be purchased directly without a sales agent. There are many available. Since no load funds are not sold through agents and do not pay commissions to agents, you have to seek them out yourself.  Obviously, as a fee only advisor, I work with these types of products for my clients. Fidelity is one of the largest mutual fund providers of 403b accounts for teachers. They have both load and no load funds, so you have to know what you are buying. Vanguard and T. Rowe Price are also no loads. But be careful that you are actually buying directly into these funds without an intermediary. Annuity companies sometimes offer these funds under their wrapper and tack on a number of unnecessary expenses.

Converting a 403b to an IRA at retirement

403b plans are a little more cumbersome to work with at retirement. It is best to convert these to IRA's. The only exception would be if you have significant contributions prior to 1985. Those contributions are not required to the minimum distribution requirements at age 70 1/2.

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