The hidden problems in your nonprofit 403(b)

In 1993, before the commercialization of the internet, there were the ‘big three’ dial-up services, Prodigy, CompuServe, and of course America Online which was busy sending out a billion CDs.  Alongside those big names were hundreds of little bulletin board systems hosting virtual online communities. The biggest was the West-coast based ‘The Well.’   

I was not a member of the Well, but I did join EchoNYC, a similar and smaller ‘internet salon’ out of New York. Every night (and most daytimes) I would use my 14.4 baud modem to connect to a UNIX computer running in Stacy Horn’s little Greenwich Village apartment. We would discuss everything from music to politics to sex. I’m no longer a member but it still exists! 

That began a lifetime of memberships in various online communities, that continues today. I am an active member of several communities including one about food fermentation, a Canadian-based one about academic research in planning and investing, and one about credit card points and miles.  In 2016, a few people from the travel and credit card Reddit /r/churning formed a group of 60 travel enthusiasts to share information.  It’s like a big family now and we talk about everything. 

Once, a pal (I’ll call him ‘Stewie’) on that board (which is now on a Slack) asked for help with his small nonprofit and their 403(b) retirement plan. The young organization chose a small, expensive custodian. Stewie noticed that the investment fees were very high. “They agreed to make some changes and suggested adding a ‘super-roth’ option, which looks good,” he posted.  

The hair rose on the back of my neck. Good for Stewie to advocate for better options in the plan!  But I knew his path would go uphill.  403(b) plans are often not well run or even understood by the nonprofits that choose them. 

403(b) plans are fine if set up correctly, but there are many bad ones with lousy investments and high fees sold to trusting nonprofits by consultants and brokers that are not fiduciary financial advisors.    

Step back a minute - what is a 403(b) and why does it exist?  If you’ve ever asked you were probably told ‘it’s the nonprofit version of a 401(k)’ and that’s true more or less. The 403(b) was indeed created by Congress in 1958 specifically for nonprofit organizations.  It is the grandparent of the 401(k).    

They are still the only plans allowed in state government and education systems. In 1978, Congress created the 401(k) and permitted nonprofits (known as 501(c)3s) to use either one, which is why today your nonprofit might have both a 401(k) and a 403(b).

What makes 403(b)s bad? Nothing inherently, it’s what they put in the plans that are lousy. Originally, the only investments allowed in a 403(b) were annuities. Annuities are Wall Street products that are packaged into life insurance and 403(b)s (and more rarely 401(k)s) and sold everywhere possible because the Insurance companies that make them profit handsomely.  Because of the history with 403(b)s, salespeople often tout the annuity as a ‘special’ option only available to nonprofits, as if it’s better or even required.  The ‘super-roth’ Stewie mentioned above is merely a form of annuity.    

Annuities are not required in 403(b) plans -- that changed in 1974 when they were permitted to add low-cost mutual funds. Don’t get me wrong, A 403(b) or 401(k) plan can still be bad even if it doesn’t have annuities, but a 403(b) with annuities is a red flag. Market-leader TIAA isn’t necessarily on your side, although they are hardly the worse offender in this space.    

403(b)s are an even bigger issue for school teachers, because they can only have 403(b) plans. There is a good mini-series podcast about this called ‘Learned by being burned’. Teacher 403(b)s aren’t even protected by ERISA, regulations that protect the retirement assets of workers.  Nonprofit versions of the 403(b) are at least ERISA protected.   

Are you in a 403(b)?  It might be time to check with Human Resources. Do you have access to low cost index mutual funds, ideally low-cost target-date index funds?  Those are typically a solid choice.  Anything labeled ‘variable annuity’ is rarely the best investment for a typical nonprofit manager.   

If you can, try to get them to convert to a lower cost 401(k) and add lower cost index target date funds. It's not an easy sell to an HR team that is probably under-resourced. So be understanding but persistent. 
 
Lifetime Financial consults with nonprofits that want to improve their retirement offerings.