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Colorado public school employees are faced with a unique dilemma when it comes to retirement savings. The dilemma stems from the fact that all public school employees have access to a 401(k) plan offered by Colorado PERA, while most also have access to a 403(b) plan offered by their employers. Most public school employees in the United States don’t have this choice, and many are probably thankful.
The following is a conversation I have had many times with employees of public schools throughout Colorado.
What exactly are 401(k) and 403(b) plans?
Despite the confusing names, the answer is pretty simple. These types of plans are voluntary tax deferred retirement investment plans whose names (401[k] and 403[b]) simply refer to the section of the Internal Revenue Code (IRC) that governs them.
Different sections of the IRC must make these things pretty different. How different are they from each other?
Surprisingly, there is very little difference between 401(k) and 403(b) retirement plans. Each plan allows for tax deferred contributions of $18,000 in 2016 for those age 49 and under. For those age 50 or better, each plan allows for a $6,000 catch-up contribution on top of the original $18,000 contribution. Additionally, each plan has identical IRS rules governing distributions. The big difference comes from what type of employer can offer each plan.
A 403(b) plan is offered by non-profit organizations and certain governmental entities such as schools. Meanwhile, 401(k) plans are offered by private, for profit employers.
If only private companies offer 401(k) plans, why do I have access to one as a public employee?
Any employee of a PERA covered employer has access to the PERAPlus 401(k) Plan thanks to some heads up work by PERA and the Colorado General Assembly in the mid-1980s. There was a brief window of time when 401(k) types of plans were allowed for public plans. That window has since been closed for new plans while older plans, like the PERAPlus 401(k) Plan were grandfathered under the old rules.
What types of investments are offered by each plan?
Each plan typically is comprised of a range of mutual funds covering, at the very least, basic asset classes and their sub categories. In addition, a 403(b) can offer an annuity option that a 401(k) does not.
So these plans sound pretty similar, how do I decide which one to take part in?
The obvious answer here is to say that a participant should choose the plan with the best investments. However, there’s a problem with that line of thinking. First, mutual funds of identical assets classes perform about the same. Second, the average investor is simply not equipped to discern which investment line up is superior. That’s why good retirement plans have free advice tools built in to them.
Instead of simply assessing which investment lineup is best, maybe a simpler approach makes sense.
There are two major areas in which a 401(k) and a 403(b) might differentiate themselves from the other:
Administration expenses, compliance costs, management fees, and marketing expenses all eventually make their way to the plan participant. Typically, a 403(b) will have higher fees than a 401(k) but that isn’t always the case. You should always shop around and compare the fees.
See the example below for a comparison between a plan with 0.4 percent fees versus a plan with 0.8 percent fees:
Imagine how that total rises as fees, contributions, and returns are increased! There’s a great calculator that can help you see the outcome.
Note: Nobody invests your money for free. Just because the fees aren’t shown in a plan brochure doesn’t mean they don’t exist. Always ask about administrative and management fees.
Most retirement plans offer easy to use, DIY tools or managed accounts (for an extra fee of course). Yet, not everyone is comfortable managing their retirement account on their own.
Do you prefer to sit down with someone face-to-face to feel comfortable with your choice?
Is the face-to-face option worth $33,000? This level of service is unlikely to bring an investor a greater rate of return as those plan representatives probably use similar applications that the do-it-yourselfers get for free. However, the face-to-face might bring a more solid emotional experience and a better night’s sleep.
This is all much simpler than I thought. What’s my next step?
The next step is to act. By choosing a plan and taking the time to return enrollment forms to the employer, retirement savers are taking the single most important step they can in building their retirement security.
Sounds impossibly simple doesn’t it?
Don’t worry. We’ll get to some more complex issues in later conversations.