What Is a 403(b), Anyway?
It’s not just a “401(k) for non-profits.”
Earlier this month, I went through the process of deciding whether to roll my 403(b) into an IRA. I spent a full week going through the decision tree, and you can read Parts 1, 2, 3, 4, and 5 if you want, but after learning about the rollover process and looking up which states allow 403(b) and/or IRA funds to be protected from creditors and lawsuits, I finally decided that I would roll the funds in my 403(b) into a traditional IRA.
Then I tried to start the rollover process, and discovered that not everything in my 403(b) could be rolled over.
[…] TIAA told me that not all of my 403(b) was eligible to be rolled over. I would have to keep nearly $5K of my funds in something called “TIAA Traditional.”
So it was time to go learn what that was. Apparently, it’s an annuity.
My 403(b) was in fact full of annuities, and after grumbling a bit because I had heard that annuities were terrible investments, I got contacted by a TIAA representative who had seen the post and wanted to talk to me about what a 403(b) actually was.
Turns out it’s not just “a 401(k) for non-profits.” I’ve heard—and written—variations of that phrase so many times that I never thought to ask any more questions about it.
But I did ask TIAA several questions, and got extremely comprehensive answers. Here are some excerpts:
How is a 403(b) different from a 401(k)? A lot of us just hear “oh, a 403(b) is like a 401(k) but for nonprofits,” and it looks like it’s more complicated than that.
There are many differences between 403(b) and 401(k) plans, including that 403(b) plans are only available to individuals who work in the not for profit sector. One main distinction is that, generally speaking, many 403(b) plans are designed to be “core” or primary retirement plans, so ensuring income throughout retirement is a primary objective. When 401(k) plans were created they were intended to be a supplemental retirement savings plan that individuals could fund in addition to a defined benefit plan. Therefore, 401(k) plans were structured to accumulate assets and not designed to provide a guaranteed income stream in retirement.
- Most 401(k) plans primarily offer mutual funds, which are focused on generating investment returns, while 403(b) plans are designed to generate investment returns and provide a stream of income in retirement by utilizing annuities.
- Annuities in 403(b) plans provide a base of lifetime income, whereas the savings in a 401(k) could be depleted if market declines occurs while taking income, market declines that happen early in the income phase could increase the probability of running out of money. Taking income in retirement is thought of as Dollar-Cost-Averaging in reverse. Additionally lack of adequate savings could also impact the amount of income.
- Annuities are the only financial instruments available, other than Social Security, that provide a guaranteed stream of retirement income that lasts the participant’s lifetime.
How do TIAA’s annuities differ from those higher-cost annuities people are warned to stay away from?
- TIAA fixed and variable annuities are in-plan, low cost, and non-commissionable.
- TIAA’s variable annuities are fully liquid and do not have surrender charges.
- Investing in annuities within a retirement plan is often more cost effective than buying an annuity offered outside of plan because of institutional pricing and economies of scale.
- Our annuities offer flexibility — giving employees the choice, but not the obligation, to annuitize. Employees don’t have to convert all of their savings to lifetime income. Employees may change their asset allocation among different annuities even after lifetime income has begun.
- It’s important to note that in-plan annuities are not an “all or nothing” deal — TIAA’s annuities operate within a full, open-architecture investment menu. By annuitizing a portion of their savings, employees get a source of lifetime income to cover basic expenses in retirement.
What type of “lifetime income” does this represent? Is TIAA’s assumption that its long-term, best-case scenario users will have a retirement income similar to their pre-retirement income, possibly adjusting for a lower cost of living post-retirement?
Yes. Research released from TIAA’s Retirement Income Index shows not-for-profit sector plan participants are estimated to replace an average of more than 90 percent of their pre-retirement income in retirement. The index shows participants’ income replacement ratio, which is a person’s projected after-tax income after retirement divided by his or her after-tax salary before retirement. The methodology used to calculate the index assumes a retirement age of 67 and includes full benefits from Social Security.
I learned so much from getting to ask TIAA these questions. I now know the difference between the TIAA Traditional annuity and the CREF variable annuities, for example, and I can share more information on that if you’re interested, but I don’t want to make this sound like an ad for TIAA.
Instead, I want to focus on what I learned about a 403(b):
- That it is designed to be a core retirement savings vehicle
- That it is structured to ensure income during retirement
Most of the reading I’ve done about investing has been from what I might call the “401(k) perspective:” diversify, try to get your return as high as possible without taking on too much risk, take a multi-pronged approach to saving for retirement, etc. etc. etc.
We rarely discuss investing from the 403(b) perspective, though—even when we’re investing in them. When I opened my 403(b) account, I don’t remember going over fixed and variable annuities or what it meant to incorporate annuities into a core retirement plan. Yes, that was ten years ago and I might have forgotten some components of the TIAA onboarding system, but all I remember is 1) selecting the paycheck deduction option that allowed me to earn the highest company match and 2) choosing between a “low,” “medium,” and “high” risk portfolio.
The one thing I didn’t think to ask was what we should do with our 403(b)s if we leave the non-profit sector, as I did—because 403(b)s can’t be core retirement plans if we aren’t able to put the majority of our retirement savings into them. (Yes, I realize this puts me back at the beginning of my “should I roll over?” decision tree.)
Luckily, I have a TIAA contact who should be able to help me get this question answered.
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