How new 403(b) laws will effect Texas teachers, and why ever teacher NEEDS a 403(b)!
Hi everyone! Welcome back to Melissa Making Cents!
One of the things I love most about being a CERTIFIED FINANCIAL PLANNER™ is the variety of clients I have! It's always interesting getting to design customized financial plans for each client and their families. Attorneys, doctors, accountants, and teachers all have the same end goal of retiring, but planning for each profession may require a different path to reach the goal.
This week started off with a bang! Before my first glorious cup of coffee on Monday morning, I got an alarming text from a good friend who is a teacher, with a screenshot of the picture below.
Now, if you know anything about me, you know the respect I have for teachers is at the very tip top of my pedestal. I’ve been blessed in my life to have wonderful teachers from the very beginning and I truly believe I wouldn’t be where I am today without every single one of them. You should also know that I will do almost anything in my power to help my friends and clients that are teachers.
After receiving the text, contacting my friend, and explaining the situation to her, I logged in to Facebook. My feed was FULL of comments about this topic, an rightfully so! Teachers seem to get the short end of the stick when it comes to retirement, so it’s no surprise that seeing the words “403(B)” and “Riskier”, would put everyone up in arms!
So today, I’m going to break it down for you. Everyone truly deserves to understand how a teacher’s retirement works. In order to understand why so many people are upset over the changes to the 403(b) regulations, we need to start at the very beginning.
The Teacher Retirement System was established in 1937 to provide retirement benefits for teachers.
In 1916 a 20 year process began to provide teachers retirement benefits in the state of Texas. This effort was lead by the Texas State Teachers Association (TSTA). TSTA was the only major organization for Texas teachers in that era. The Teachers Retirement System (TRS) was voted into law in 1936 and was established in 1937. The new Defined Benefit Plan had more than 38,000 eligible teachers participating during the TRS's first year of existence. Its original responsibility was to provide service and disability retirement benefits to teachers and administrators of the public school systems of Texas, including institutions of higher education. As the years have progressed, so has the responsibilities of TRS, expanding into healthcare benefits for active and retired participants.
The Social Security System was established in 1935 by President Roosevelt.
Around the same time that the TRS was being setup, our country was also working towards establishing a retirement system of its own. At this point in our country it’s needless to say we had a lot going on! We had wrapped up World War I, we were still establishing workers rights, more and more people were moving to the cities and away from the agricultural jobs, and in 1929 we had our first really severe stock market crash. That crash was so severe they named it “The Great Crash”. Roosevelt had his hands full. As part of his New Deal, he signed into law the ability to setup a system for social welfare. As such, our modern Social Security System was founded. The Texas State Teachers Association wasn’t going to wait around for something to be done, so they had started setting up their own retirement system years before.
Teachers are often not eligible for Social Security.
Part of the law setting up the Teacher Retirement System, was that the teachers would not pay into social security or receive benefits. This is dependent on the school district, and the position held in the district. Of the nearly 1,227 school districts in Texas, only 17 districts have elected to pay into the social security system. Higher education employees, such as university professors, often pay both into social security and the TRS. Otherwise, as a teacher and recipient of TRS benefits, you are subject to a Social Security Windfall elimination. The elimination rules say that if you have less that 30 years of “substantial earnings” in to the system, your benefits will be reduced based on a formula provided by the social security administration.
A Defined Benefit Plan provides benefits based on age and years of service.
A Defined Benefit plan, also called a pension plan, is an employer based plan that provides a retirement benefit based on a defined formula. In most cases the formula is your off your length of service provided and the age in which you retire. The longer the service the more benefit you receive. The investment risk solely relies on the employer or governing board. Defined benefit plans get into trouble… A LOT. The reason for this is there can be huge grey areas in pension accounting. Companies often can alter contributions to their plan based on things like investment returns, inflation, and payouts and services to employees. The “higher” the returns, the less they have to fund. Seems simple enough..right? Except a great way for companies to save money for themselves is to under fund their pension obligation.
There is a great article in Forbes magazine by John Mauldin, The Coming Pension Crisis Is So Big That It's A Problem For Everyone, that is worth reading to understand the huge impending mess.
A pension from the Teacher Retirement System will likely NOT be enough to live on in retirement.
Let me say something loud and clear… The TRS pension system will not likely be enough to live on in retirement. It was never designed to fully support you! It was designed to be a portion of your retirement. So if you are not setting aside extra money for retirement…. Start NOW!
To calculate your TRS retirement benefits, use the following formula:
- Multiply your years of service credit by 2.3 percent. (Example: if you have 30 years of service credit in TRS, 30 x 2.3% = 0.69%.)
- Determine the average of your five highest years of salary.
- Multiply your average salary from step 2 by the number from step 1. This is your annual TRS standard annuity. (Example: $50,000 x 69 percent= $34,500 per year.)
So let’s look at an example: Melissa was a teacher for 25 years, and is ready to retire. Her average highest salary was $50,000. So her approximate TRS pension payments would be $28,750 per year before taxes! Take out 15% in taxes.Also don't forget healthcare expenses. After that, what’s left? Take a look at the chart from the Teacher Retirement System's Healthcare plan.
Continuing with the example above: If the healthcare cost is $200 a month for just oe person, Melissa would have approximately $1,836 a month to live on. If she is paying healthcare for the whole family the premiums will be higher. In fact, the chart show it approximately $1,000 a month! This would leave her with $1,036 a month to live on. Could you live on that much?
A 403(b) is a supplemental retirement account to help save money tax-free
A 403(b), also called a tax-sheltered annuity, is a retirement plan established for teachers, government employees, and other non-profit employees. Although it's called a tax-sheltered annuity, participants have the option of investing in annuities or mutual funds. In 2019 you may defer, tax free, up to $19,000 from your paychecks to save for retirement. Since the TRS was never intended to fully fund a teacher’s retirement, the 403(b)s were created to help fill the gap. Your money continues to grow tax free until you take out money. At that point you pay income tax on the distributions. They are a lot like 401ks for employees in the private company world.
403(b)s offer stability to those that see problems with the Teacher Retirement System
Many teachers have grown weary of the benefits provided by the TRS. The news often points out the shortcomings of the system, and many find the future frightening. There is not a day that goes by without hearing about various pension plans that are underfunded and having to cut benefits to their participants. It’s terrifying to know you have contributed to something your entire life that isn't a guarantee after all. So there is a great deal of comfort in being able to save in a 403(b). It’s a great way for teachers to take their retirement into their own hands.
The 403(b) market was the Wild West until 2001
From 1958, when 403(b)s were created, until 2001, there was an influx of investment products being offered thou 403(b)s. The lack of regulation caused various issue. So in 2001, the State of Texas legislature passed SB 273. This landmark legislation was a reaction to what many in the legislature and industry groups believed were abusive marketing practices by 403(b) companies, third party administrators, and other organizations in local school district 403(b) plans.
SB 273 gave the responsibility to regulate companies and products to the Teacher Retirement System of Texas. TRS created a program to regulate 403(b) companies and products. Part of the program was the creation of a website to display the fees and other features of every 403(b)s products allowed to be sold in Texas. Eventually, in 2017, the TRS added in a cap on the amount of fees that the 403(b) companies could charge participants. For some investment companies and politicians that was one step too far.
With the passing of the new laws, 403(b) could become more risky.
Just as the article my friend sent my says, it is quite possible that 403(b)s could become more risky. In short, certain organizations felt that the TRS had overstepped their bounds in instituting price caps ion 403(b) service and fees. It was also likely that a lot of investment companies and representatives were unhappy that there products could not be sold due to previous regulations. So now that the laws have passed removing the caps, you very well might see things changing.
So how would this make a 403(b) potentially risky? Well now there is the potential for riskier products,and increased risk of fraudulent vendors. Some of the things I have seen and heard about in my 15 years of practice would really make your head spin. There are definitely a few bad apples that give the rest of us a very bad name. Do your homework here! Visit FINRA’s BrokerCheck to get background on a potential representative’s history. Finally, there is an increased risk of very high fees that could eat most of your earnings.
Fees are important when saving for your future.
Right now fees are a huge hot button in the investment world. There is pressure from investors and investment companies in a huge race to reduce expenses. You see, nearly everything you invest in comes at some cost. Most mutual funds charge a management fee for managing your of money. This is a basic cost of doing business, but you should look to see how much their expenses are in relation to what their returns have been. It’s going to cost you something! Annuities have charges of their own. Depending on the annuity you purchase you may also pay a surrender charge for taking your money out before their required time period. Finally, you may very well pay a commission to purchase your investment. It will all depend on the company you select and the relationship you have with your financial representative. The bottom line here is that fees and expenses are a cost of doing business. Everyone deserves to make a living, but it’s important to measure your fees against your performance. High fees does not always equate to high returns.
The bulk of the risk now belongs to the school districts and third party administrators.
According to the new laws, the school districts are now responsible for allowing investment companies to sell their products to their employees. Districts have the opportunity to open their doors to a variety of 403(b) providers. The following points will need to be considered by districts when considering new vendors or providers:
The new law still has requirements that a company selling 403(b) products must meet in order to offer products to your employees. How will you be sure that companies on your vendor list meet these requirements?
Anyone can claim they represent a 403(b) company. How will you be sure they are actually licensed with the company and have had proper background checks performed if they come on your campus? (Note: This problem already exists and is not directly affected by HB 2820.)
Will your district be liable if a rogue company or representative sells 403(b) products that turn out to be fraudulent?
The law left a penalty for violation of the 403(b) rules that can be imposed on a district official that violates these rules. Section 10A. (a) of the statute states:
“A person who violates this Act is subject to a civil penalty in an amount that does not exceed:
(1) $10,000 for a single violation; or
(2) $1,000,000 for multiple violations.”
If you have created a financial plan, and started saving early, the changes should have little or no effect on you. When you start saving early for retirement, you have the magic of compound interest on your side. You can invest without trying to “hit home runs” your entire life. Being too aggressive with your investments can cause you a lot of heartache in the long run. Especially when a market correction hits, and we experience something like in 2008 when the markets were down 30%.
If you have not already, create a financial plan that balances saving for your future, paying off student loan debts and current living expenses. You have no doubt heard the saying “Pay Yourself First”. Set money aside out of every paycheck for your future. In fact, if you have student loans and are qualified for the Public Service Loan Forgiveness program, a great thing you can do is stash money in your 403(b). It reduces your taxable income and can lower your monthly loan payments. (Check out my blog post on the Public Service Loan Forgiveness Program, and my blog post on the Temporary Expanded Public Service Loan Forgiveness).
Just because the 403(b) laws changed doesn’t mean you have to!
The bottom line here is that just because the laws have changed with the 403(b)s, it doesn’t mean you have to change your retirement saving strategy! The people that are going to face the most risk are the people that are starting to save later in life. They often feel that have to invest more aggressively since they missed out on a lot of compounding. These individuals will be more likely to fall for a smooth talking salesman with an ill fitting suit. If you are happy with your current course of investments, stick with it! The grass is not always greener on the other side.
If you have questions or concerns, please give me a call. As a CERTIFIED FINANCIAL PLANNER™, I work with teachers (as well as of course other professionals)to help create custom financial plans to meet your personal needs and family’s circumstances. We can work together to decide how these changing 403(b) laws can help your financial future. Visit our Client Service Experience Page to see how we can help!
Until next time, this is Melissa Making Cents.
Melissa Anne Cox CERTIFIED FINANCIAL PLANNER™ is also a College Planning and Student Loan Advisor in Dallas, Texas