457(b)s: The solution to bad K-12 403(b) plans?

The majority of K-12 403(b) plans are a disaster for most teachers. Too many are stuck in high-cost investments that were sold to them by commission-based sales agents trawling staff lounges and teacher email inboxes.

Even for teachers wise to the impact of costs, the 403(b) can be an enormously frustrating plan. Too many school districts don't make any low-cost investment options available. Efforts to add even one low-cost vendor are often met with resistance by benefits officials, unions and the third-party administrators overseeing plans.

But there's a simple solution hiding in plain sight.

Teachers are eligible for a second supplemental plan. It’s called the 457(b), and it has several key advantages over the 403(b):

• Upon separation of service, it can be accessed tax-penalty free at any age. 
• It has a provision that allows regular contributions to be doubled for three years prior to retirement, if the employer permits it. For 2021 that would be an annual contribution of $39,000!
• More employer oversight is required, generally resulting in lower-cost vendors and investment choices than the 403(b) has. 
• Finally, more than 40 states have plans that teachers and school employees are eligible to participate in. The size and scope of some of these plans allows investments to be offered for as low as 0.0084%. That is not a misprint.  

Traditionally, the 457(b) has been the retirement plan of choice for state employees (government workers, municipal workers, firefighters and police). Teachers have long been eligible to contribute to this plan, but until 2001, contribution limits were coordinated with the 403(b). That meant that if the maximum allowed to each plan was $8,000, as it was in 2000, a teacher could only contribute a total of $8,000 to both plans.

The Economic Growth and Tax Reconciliation Relief Act of 2001 repealed that. In 2021, a teacher could contribute $19,500 to the 403(b) and $19,500 to the 457(b). Catch-up provisions allow even more to be contributed. 

Recently, a key shortcoming of the 457(b) — the inability to access money until age 70½ if still employed — was addressed via the passage of the obscurely named Miner’s Act of 2019. Now, those who are still working can access 457(b) money at the same age they can access 403(b) money, which is 59½. 

Access to low-cost state-based plans is the cherry on top. That investment charging 0.0084% mentioned earlier is an S&P 500 fund available through The New York State Deferred Compensation 457(b) Plan. Why can New York offer such pricing? Its plan has 250,000 participants, as it is open to more groups than just teachers, and it has more than $31 billion of assets under management. It also helped that this plan utilizes low-cost collective investment trusts, which are permitted in 457(b)s but uncommon in 403(b)s.

The solution to bad K-12 403(b) plans is obvious, if only employers would open their eyes.

More information on the 457(b):

• Participants may contribute up to $19,500 in 2021.
• Participants who are age 50 and older at any time during the calendar year are permitted to contribute an additional $6,500 in 2021.
• Employees who are three years from the normal retirement age (as defined by the plan) are permitted the lesser of: two times the current year’s normal retirement contribution limit, or underutilized limits from past years. Note: Not all employers make this additional catch-up option available, nor are they required to do so. Check with your employer for details.

We at 403bwise.org will continue to support teachers' efforts to gain access to better 403(b) vendors. But short of new legislation requiring employer fiduciary oversight of K-12 403(b)s similar to that for 401(k) plans, significant change in the short term is doubtful.

[More: How 403bwise.org provides financial education to K-12 employees]

Dan Otter is executive director at 403bwise.org.