Savings Options

MA public employees have the opportunity to save some money for the future using plans sponsored by their employers and also individually. Some products aren't available to all public employees, so it is useful to understand no only what is available but also the advantages and disadvantages of each. I shall discuss three main investment options: 403(b) plans, 457 plans, and non-sponsored investments.

403(b) Plans (TSAs)

403(b) plans, also called Tax Sheltered Annuities (TSAs) are sponsored by your employer, usually a school district, educational institution, or health care facility. They are not usually accessible to public employees who work for general government, emergency services, police, fire, or public works. Each plan is established and maintained by an employer unit. Some employers allow multiple investment providers to each offer a 403(b) plan to the employees; others pick one provider that the employees must use if they want to use a 403(b) at all. Different employers, units, and districts will have made different choices about how many investment providers to allow, though most public school districts allow more than one. Thus a typical public employee of a school district faces not just one by three big choices:

1. Should I invest in a 403(b) plan?
2. What plans are available to me?
3. Which plan should I pick?

The first question can be answered with some confidence using financial planning techniques, while the second requires inquiring with your benefits manager. The third involves comparisons between different providers and evaluating how the features of their products fit in with your overall investment plan. Generally, there are two broad categories of 403(b) providers: Annuity companies and Mutual Fund companies. The annuity companies offer Fixed, Indexed, and Variable Annuities; the mutual fund companies offer a range of stock and bond pooled investments.

Annuities

Annuities are offered by insurance companies and were originally used to give those who purchase them a lifetime income that they cannot outlive (much like a pension earned by public employees). As time went on, many people used annuities not as lifetime income streams buy as savings vehicles with some insurance protections. The level of protection afforded by different products varies greatly; as a result there are many benefits for different objectives. If you are worried about losing your principal during choppy investment markets or recessions, there are products that guarantee against losing your principal. If you're interested in always making sure your account will grow, there are products that guarantee a certain interest rate floor on your principal, thus protecting both your principal and guaranteeing some growth. Other products are less focused on guaranteeing principal or interest but instead offer minimal guarantees that your beneficiary will get (at minimum) your principal even if you die during a market downturn. Such products allow you to invest in markets, so your account value with fluctuate but there is at least some protection for your beneficiary. Of course all guarantees made are subject to the claims-paying ability of the insurance company that offers the guarantee, so it is also important to look into the financial strength and security of the insurance company you're considering.

Annuities are generally offered through brokers. While each product should be investigated thoroughly and evaluated according to your objectives and circumstances, there are some general questions to ask about annuity products:

1a. What is the length of the contract being offered?
1b. Are there surrender charges if you leave the contract early?
1c. What is the surrender charge schedule?
2a. What guarantees are being offered by the insurance company?
2b. Will you be expected to pay for these guarantees through any expenses or fees that will be charged to your account?
2c. What are all the expenses and fees charged to the account?
3. How will you grow your principal in the product? Is it through a fixed interest rate, through variable investments offered inside the product, or some other formula?
4a. Is there a fixed interest rate being offered?
4b. Does this fixed interest rate last throughout the contract's lifetime, or can it change? If so, how often?
4c. Is there a guaranteed interest rate that the current rate can never be lower than, and if so, what is that guaranteed interest rate?
5. Who is the insurer, and how is their financial strength and claims-paying ability?

Annuities can be beneficial for many different types of investors, but each should be evaluated to make sure they fit your particular objectives and circumstances.

Mutual Funds

Mutual Funds are offered by money managers as pooled investments. You buy shares in a company (the mutual fund) that invests its money in stocks, bonds, or other securities or derivatives according to its mandate, which is published in a prospectus. The money managers charge a fee for their services and also to support the infrastructure of the company you're invested in. When their investments gain, the money managers return that gain to you, or the values of the shares you've purchased rise. When their investments lose money, however, the value of the shares you purchased usually falls. When you need to convert your shares to cash, you redeem them directly with the mutual fund. There are thousands of mutual funds, and there are hundreds of different investment mandates and processes that different money managers have.It is important to remember that almost no mutual fund offers a guarantee of principal or interest. Your investment will rise and fall generally with the underlying investments within the fund, which are subject to market prices. Mutual funds are often offered in "families", which can allow for easy transfer of shares from one fund to another. This can be beneficial as your objectives and circumstances change or to take advantage of changing market conditions. Mutual funds can be offered through brokers, but some companies sell them directly to the public without an intermediary. While each fund should be investigated thoroughly and evaluated according to your objectives and circumstances, there are some general questions to ask about mutual funds:

1. What is the mandate of the fund?
2a. Who are the money managers of the fund?
2b. How long have the money managers been at the fund?
3a. Is there a sales charge for you to buy or redeem the fund?
3b. What are the expenses charged to you on an annual basis?
3c. How do the expenses compare with the industry average?
4. How does the fund's performance compare fo an appropriate benchmark?
5. Can this fund be exchanged for other funds within the same family?

Mutual funds have been beneficial for many investors, but each should be evaluated to make sure they fit your particular objectives and circumstances.

457 Plans (Deferred Compensation)

457 Plans for public employees are different from those for other tax-exxempt organizations. Anyone who is an employee of the sponsoring goverment (state, city, town, or other government unit) should be able to participate. This is the primary method of employer-sponsored investing for general governemtn employees, emergency, police, fire, and most state employees. Employers often pick just one 457 provider to offer to employees, though within that offering will be numerous investment options. Still, there is a rather limited choice of investments, but that is usually balanced by lower investment and administration fees. What makes 457s different from many other types of employer-sponsored retirement plans, however, are the plan features:

-If you leave the employer at any time, you are eligible to withdraw your deferred compensation without paying a 10% penalty tax on the withdrawal. This can be useful if you do not plan to work in the public sector until the usual retirement age.

-Once you are in your 60s, if you are still employed by the sponsoring governmental unit, you cannot take withdrawals from your account. (You're still employed, so you're still "deferring" your compensation.) This limits flexibility in later working years. Many plans do allow for withdrawals if you are still working and you reach age 70&1/2, however.

-Because a 457 is technically not a "qualified plan" under the law, some public employees, specifically those employed in education of selected health care roles, can defer the maximum into both a 457 plan and also a 403(b). This allows for very large amounts of compensation to be invested pre-tax for larger tax savings.

-Some 457 plans will offer a "Roth provision", which allows for the contribution of after-tax compensation that, once certain rules are followed, allows for both the deferred amounts and the interest to be withdawan tax-free in later years.

-457 Plans have a variety of optional provisions, so looking into the plan provisions and assessing how they will align with your career and life goals is essential.

Annuity companies, trusts, or other custodians will generally by the providers for 457 plans. They often offer a limited selection of mutual fund-like investments (technically called "sub-accounts") at low cost, and a conservative account that is usually guaranteed by an insurance company. Such an account is designed never to lose money, and may even be guaranteed to do so by the insurer, subject to its claims-paying ability. Because of this, the interest offered in such an account can be low. Many of the options offered are either similar to those provided by a Variable Annuity, or they are actual Mutual Funds provided inside a custodial or trust account.

The 457 is the only option available for employer-sponsored investing for many public employees. Thus the decison is between a 457 plan and non-sponsored investments. For some public employees, specifically those who are educators or work in some health-care units, there will be a choice between the 457, the 403(b), both, or neither. Such decisions should be made as part of a comprehensive financial plan that accounts for not only for investment options but also life goals and choices.

Non-Sponsored Investments

For our purposes, a non-sponsored investment is simply an investment that is not related to or affiliated with your employer. 403(b) and 457 plans (as well as 401(k) and other retirement plans) are all plans that are offered through your employer's sponsorship. In many ways, it is a three-part relationship: you, your employer, and the investment provider (and, usually, a trustee or administrator ro make sure the plan follows the rules). Non-sponsored investments eliminate your employer from the relationship. This is often beneficial to you because you don't have to follow quirky rules about whether you can get access to your funds while you are still employed (457) or whether you have to get your employer's permission to withdraw your funds(403(b)). There are some drawbacks as well, such as potential tax treatment, loan provisions, and, sometimes, a difference in cost structure. Here are some of the more common non-sponsored investments:

-Roth IRA: This can be a good option for people trying to save for retirement buy also want to keep some ability to withdraw their contributions before then. It is useful for people who have limited funds to devote to investment. It is also good for people who pay low marginal taxes now, perhaps because they have children and are in the early years of a home mortgage. Mutual funds, annuities, and many other kinds of investments can be held within a Roth IRA.

-Traditional IRA: This can be good for people trying to maximize their tax deductions now and want a lot of flexibility in their investments. One strategy is to own a single Traditional IRA that is funded by rollovers from the retirement plans you had during previous employment. This keeps your invetments easy to track while also giving you access to thousands of investment options. Mutual funds, annuities, and many other kinds of investments can be held within a Traditional IRA.

-Brokerage Accounts and Investment Accounts: These are usualy used after all retirement account options have been considered, or for shorter-term goals. There are no tax benefits inherent to the structure of these kinds of accounts (though there may be tax benefits to the investments chosen). They will offer the most investment options of any non-sponsored investment. Generally, there are few government rules regarding the use or disposition of investment accounts, so you will have the most flexibility on how (and when) you use your funds.

The decision to use non-sponsored investments rather than employer-sponsored ones is part of the planning process for public employees. While employees in the private sector often will have a match applied to their contributions to an employer-sponsored plan, that is predominantly not the case for MA public employees. Thus the normal-- often default-- option of chosing the employer-sponsored plan as the primary source of retirement savings is not the same for MA public employees. The decision of how to save is also made in context of how much to save, which is often far less than workers in the private sector. Nevertheless, most public employees will need to have saved and invested during their working years to secure a comfortable retirement. Contact us to talk about the optimal way for you to save for the future.