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A 403(b) plan is a type of tax-deferred retirement savings program available to employees of public schools, certain non-profits, and some members of the clergy. Because you do not have to pay taxes on the amount you contribute to a 403(b) plan for the year in which you contributed to the plan, investing in a 403(b) plan can lower your overall tax burden, at least in the present. You can defer income taxes on your contributions until you begin making withdrawals from your account, typically after you retire. The earnings on your account also grow tax-free until withdrawal.
If you are eligible to participate in a 403(b) plan, you may have to choose among different types of investments. It will be up to you to choose investments that best meet your financial objectives. Typically, 403(b) plans offer fixed annuities, variable annuities, and mutual funds.
Although you may be eligible to participate in a 403(b) plan, don't assume that your employer has approved any particular investment product offered or any firm or professional that sells potential 403(b) investments. That's why it's so important to do some homework on your own. For starters, be sure to ask at least the following three key questions:
- Will I have to pay any penalties if I change my investment choices? If so, how much?
- What annual fees will I pay?
- Does my financial professional make more money for selling one product over another?
Make sure you know the answer to this before you make your investment choices. For example, if you withdraw money from a variable annuity within the first few years, the insurance company usually will assess a "surrender" charge. A surrender charge compensates the financial professional who sold the variable annuity to you.
Generally, the surrender charge is a percentage of the amount you sell or exchange, and declines gradually over a period of several years, known as the "surrender period." Some variable annuity contracts will allow you to withdraw part of your account value each year — 10% or 15% of your account value, for example — without paying a surrender charge.
Some mutual funds have a back-end sales load known as a "contingent deferred sales load." Like a surrender charge for a variable annuity, the amount of this type of load will depend on how long the shares are held, and it typically decreases to zero if the investor holds the shares long enough. The rate at which this fee will decline is disclosed in the fund's prospectus.
A redemption fee is another type of fee that some funds charge their shareholders when the shareholders redeem their shares. Unlike a sales load, a redemption fee is typically used to defray fund costs associated with a shareholder's redemption and is paid directly to the fund, not to a broker. The SEC generally limits redemption fees to 2%.
The question of whether you must pay a penalty or other fee for switching among investment choices in your plan is different from whether you must pay a penalty for taking money out of your 403(b). You’ll usually have to pay a tax penalty for early (pre-retirement) withdrawals from tax-deferred retirement plans, so before you take money out of your 403(b) account, be sure to consult with a tax adviser.
Fees and expenses vary from product to product — and they can take a huge bite out of your returns. An investment with high costs must perform better than a low-cost investment to generate the same returns for you. Even small differences in fees can mean large differences in returns over time. For mutual funds and variable annuities, you can find information on costs and fees in the prospectuses. For fixed annuities, check the sales literature or the contract.
Regardless of how much you trust your financial professional, it is always legitimate to ask how -- and how much -- he or she receives for selling a particular product. For example, you could ask:
- Do you receive a commission for selling Product X to me? If so, how much?
- Do you get any other type of compensation for selling Product X? If so, what? (This could include a bonus or points toward some other reward, such as a trip or a cruise.)
- Are there any other products that can meet my financial objectives at a lower cost to me, even if you do not sell those products?
Determine which products best meet your financial objectives and identify a financial professional who sells those products. Different types of financial professionals sell different types of products, and some financial professionals only offer a limited number of choices.
When deciding what's best for you, shop around for the best fit. When brokers or insurance salespersons stand to earn more money for selling Product X over Product Y, they have a natural incentive to steer you toward Product X — even if Product Y might ultimately be a better choice for you.