Tax-deferred retirement saving always seems like a good idea.
But maybe it isn’t, at least for some people.
Skeptics should consider Texas teachers. Today, thanks to the Texas legislature, saving in a Roth IRA is a better choice than most of the products offered in the 403(b) plans available to Texas teachers.
Voted into law — No limit on investment product expenses
The new reason is HB2820. It went into effect September 1. The bill eliminates the need for financial firms to register products with the Teachers Retirement System. It also removes the expense caps that have provided some protection for teachers for nearly two decades.
Note the word “some.” The earlier protections provided a complete listing and database of investment products. The list has managed by the Teachers Retirement System of Texas. It is available on their website here.
Finding lower cost investment choices
Using the list, teachers could see lower-cost alternatives. Product expenses were also capped at a very high 2.75 percent a year. Sadly, while lower-cost mutual fund firms like American Century, American Funds, Fidelity and Vanguard are on the list, insurance firms with high expenses dominate it.
Now even the absurdly high 2.75 percent expense cap is eliminated. In an email, the head of communications for TRS told me that the database would be available for only another year.
So let’s consider what the Texas legislature didn’t.
The impact of high investment expenses
Think about what a 2.75 percent annual expense for an investment means. As I write this, yields on U.S. Treasury obligations are under 2 percent. Even the 30-year Treasury now yields less than 2 percent, according to Bloomberg. Stocks aren’t any better: The yield on the S&P 500 stock index is 1.92 percent.
So a retirement investment with a fee around 2 percent will be taking every dime of dividend and interest income. Anything over that will be taking some principal from your investment as well. Every year. Win or lose.
A fee scheme like that works fine for the insurance industry. But it makes saving an almost fruitless activity for teachers.
Talk about swimming against the tide. Basically the vendor gets the income. Texas teachers get the risk. Jerry Reed has a country and western song about that kind of thing.
So what can Texas teachers do to protect themselves from rapacious investment fees and friendly insurance agents? One good option is to use the TRS database to shop for lower-cost investments. Just do it now, while you can still find the alternatives.
The Roth IRA option
Another option is radical. Abandon 403(b) plans altogether. Instead, opt for a Roth IRA. If you stick with low-cost index mutual funds and exchange-traded index funds, you can retire with more money.
A lot more money.
You can understand this by considering a comparison. Imagine that you’ve got $100 a month to invest for 30 years in an investment that provides a compound annual return of 8 percent before fees. Your job is to decide whether to invest the money in a low-cost Roth IRA or a 403(b) account with 2.75 percent in annual expenses.
Which is the better choice?
— If you could invest your $36,000 in monthly payments in an imaginary zero-cost account with no tax burden, your contributions would grow to $149,036.
— If you invest in a 403(b) plan that costs 2.75 percent a year, you won’t pay taxes as you invest the money. It will accumulate to an $87,181 nest egg that you’ll need to pay taxes on as you withdraw the money. If you’re in the 15 percent tax bracket, that means you’ll have $74,104 in after-tax spending money.
In effect, the insurance company vendor takes $61,855 in fees and compounding losses off the top. That turns out to be more than 11 timesas much as the $5,400 you’ll need to pay to the IRS before investing in the Roth IRA if you’re in the 15 percent tax bracket.
— But if you choose a Roth IRA, you’ll need to pay taxes up front and invest the rest. That’s $85 a month if you are in the 15 percent tax bracket. After a 0.10 percent annual fee, your investment will accumulate to $124,138. Tax-free. Go this way and you get to keep and spend $124,138.
Similarly, if you are in the 22 percent tax bracket, you’ll invest $78 a month and accumulate $113,915. Again, tax-free.
Either way, you’re better off than with the $74,104 you’d have in an expensive 403(b) plan.
But what if the gross return is lower than 8 percent? What happens then? Big fees make the high-cost 403(b) plans look even worse.
Don’t bet your retirement on rare events
What about brilliant investment managers and magic? What about the managers who beat the market? It could happen. But it’s rare. You don’t bet your retirement on it.
What decades of data tells us is that the odds against beating the market rise directly with fee levels. Managers with far lower fees routinely fail to beat market returns. As I’ve shown in other columns, even the TRS pension fund hasn’t been able to beat a dirt-simple, dirt-cheap Couch Potato approach.
Unfortunately, there is a limit to following the Roth IRA path: The limit on annual Roth IRA contributions is $6,000 a year if you are under age 50, $7,000 after age 50. Also, what you can contribute is phased out beginning at $122,000 for single tax filers, $193,000 for joint returns. With typical teacher salaries in Texas around $50,000 a year, I doubt contribution limits will affect many teachers.
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Using the TRS database.
Want to find out how much your investment costs you? Or compare one investment company with another? Here’s how:
— To access the database go to: https://oapi.trs.state.tx.us/FOTB/do/memberWebListByCompany?
— To find all investment products offered by a particular company, scroll down the list of companies and click on the name of the company. That will give you a list of all their offerings and related expenses.
— To rank order the expenses in any individual vendors products go to the searchable database: https://oapi.trs.state.tx.us/FOTB/do/memberWebListSearchSetup
Then click on the headings to get ascending/descending lists of different expenses. This includes items such as “maximum asset based fees,” “maximum front end loads,” “maximum surrender/withdrawal charge,” etc.
Related columns:
Scott Burns, “Couch Potato Investing Beats TRS Pension Fund, Again,” 6/22/2019
https://scottburns.com/couch-potato-investing-beats-trs-pension-fund-again/
Scott Burns, “Couch Potato Investing versus Texas state pension funds,” 10/6/2018 https://scottburns.com/couch-potato-investing-versus-texas-state-pension-funds/
Scott Burns, “Local pension fund performance: All the Wrong Monkeys,” 11/26/2018 https://scottburns.com/local-pension-fund-performance-all-the-wrong-monkeys/
Sources and References:
Bloomberg Treasury yields: https://www.bloomberg.com/markets/rates-bonds/government-bonds/us
Yield on S&P 500 Index: https://ycharts.com/indicators/sp_500_dividend_yield
403(b) Certification and Product Registration changes announcement on TRS website: https://www.trs.texas.gov/Pages/403b_cert_product_registration.aspx
List of 403(b) Certified Companies on TRS website: https://www.trs.texas.gov/TRS%20Documents/certified_companies_list.pdf
Searchable database of 403(b) products https://oapi.trs.state.tx.us/FOTB/do/memberWebListSearchSetup
Database of companies and products: https://oapi.trs.state.tx.us/FOTB/do/memberWebListByCompanySetup
Jerry Reed, “She Got the Goldmine” (with lyrics), on YouTube https://www.youtube.com/watch?v=kHvIcHbEHSU
Eve-Marie Ayala, “How much do Texas teachers get paid? Depends on where the classroom is,” Dallas Morning News, 01/18/19 https://www.dallasnews.com/news/education/2019/01/18/much-texas-teachers-get-paid-depends-classroom
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo: Scott Burns, storm flags flying in Avalon( 2010)
(c) Scott Burns, 2019