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Tax Deferred Accounts: 403(b)
Investing for retirement may seem like an issue to address far in the future. After all, you are likely coming straight out of medical school with no real income over the last four years and a few hundred thousand dollars worth of educational debt. Add to that the cost of living in New York City, and you may be wondering more about how you are going to feed yourself than how you can save money for when you are 65. That said, the time value of money principle and compounding interest make it so a dollar saved today for retirement is far more valuable than a dollar saved several years down the road. In plain terms, investing for retirement at a young age leads to too much greater personal wealth than investing later in life. Take the example of a person who starts investing at age 20 versus someone who begins at age 30. Assume that both people invest $3000 annually at a compounded rate of return of 8% (the historical average annual return of the stock market). At age 70, the individual who started at 20 will have a total of $2,010,977, while the person who waited until she was 30 will have $909,731. The power of those early years is clear, as an additional $30,000 invested led to an extra $1,000,000.
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403(b) refers to the section of the US federal tax code that describes tax deferred retirement accounts that are available to employees of not-for-profit organizations such as schools and hospitals. 403(b) accounts are essentially the same as 401(k) accounts offered by other employers. These accounts allow you to put pre-tax money away in an account that remains invested until you reach 59 years of age. By signing up for this plan you can reduce your current taxable income, let your investments grow tax-free, and you protect yourself from volatility in the market, maximizing return on your investment. In terms of lowering your taxable income, suppose you make $100 during a pay period. As an intern or resident at NYU you will most likely be in the 25% federal tax bracket. Therefore, for any given pay period, you would pay $25 of your $100 to the federal government. If you allocated 10% of every paycheck to go into your 403(b) account, $10 would automatically transfer pre-tax, leaving you with a taxable income of $90. You would then only pay $22.50 in federal income tax. In terms of what you take home from your original $100, if you do not enroll in the 403(b), you are left with $75 to spend on lunch, and nothing saved. If you allocate 10% to a tax-deferred account, you are left with $67.50 plus $10 in the bank. In a way, once taxes are figured into the equation, saving $10 now only cut your spending money by $7.50.
Saying that your investments grow tax-free is a bit of a misstatement as there is still no such thing as a free lunch (unless the drug reps are around). However, when it comes to investing money, there are infinite ways to skin a cat. The advantage of a 403(b) is that you can pay the taxes on your money at retirement, after you have allowed the interest to compound for many years. For example, if you put $1 into a tax-deferred account and let it sit for 30 years, you would be left with $10.06 (assuming a rate of 8% compounded annually). However, if you pay 25% income tax on that $1 and invest the rest, you have 75 cents to put into the market. Assuming the same 8% return, in 30 years you will have $7.55. Paying Uncle Sam 75 cents now costs you $2.51 in 30 years. Upon retirement, both these investments will be subject to tax, but at similar rates, so by deferring the taxes, you still end up ahead.
An in depth discussion of market volatility, risk, and maximizing your return is beyond the scope of this discussion. Briefly though, by constantly buying into a 403(b) account, you purchase more shares of a fund when the price is low, and fewer when the price is high, a concept referred to as dollar cost averaging. This has the effect of letting the market fluctuations work in your favor rather than trying to time your investments with swings in the market (a practice that is nearly impossible, even for those who get paid millions to try and accomplish it). Therefore, you benefit from the increased financial returns the stock market enjoys over bonds and savings accounts, and you minimized the increased risk inherent in the market.
How do I sign up?
Tax deferred accounts are a benefit managed through the office of human relations. The human relations people should be present at orientation with all the materials you need for enrollment. Otherwise, you can go to the office of human resources and pick up the material in person. As with the other benefits you are eligible for at NYU, the 403(b) options are different between the payrolls. So, the first step is to find out if you are on Bellevue or Tisch payroll. Next, go to human resources and ask for benefits. At Bellevue this is located on the 8 th floor in the old building (take the elevators across from the ER waiting room). For Tisch, human resources are located at 1 Park Ave., at the corner of 33 rd St. and Park Ave. Bring your NYU ID and ask the security guard for directions. Once you are there, you can pick up all the material you need and either fill it out while you wait or take it home and study it. I would recommend trying to get the material at orientation so you have time to review it as deciding where to put your money may take some time and research. For either program you can sign up at any time. However, during orientation is the best time because once intern year begins, enrolling in a 403(b) will likely be the last thing on your mind (unless you are one of those who can contemplate retirement savings while running an ABG).
What are my options for investment?
The retirement accounts at Bellevue and Tisch both offer a wide range of mutual funds that allow you to invest in stocks, bonds, money markets, and any combination of the above. When deciding where to invest your money, you first need to decide how much risk you are willing to accept, and what your overall investment goals are. Historically, higher returns are found in higher risk stock funds, while bonds and money funds offer lower returns, but are also less volatile. There are many resources online and in print to help you personalize your portfolio so that your distribution of investments meets your goals. One that I particularly like is smartmoney.com.
Bellevue Options
While on the Bellevue payroll you have the option of choosing from several funds provided by Prudential Financial, but only Prudential. The details of each fund are presented in the brochure available from human resources. Additionally, there is some helpful information about investing for retirement in general at the beginning of the Prudential brochure. In all, the Bellevue program offers 14 funds where you can allocate your money. You can choose any combination of funds, and you can put a different percentage of your savings into each. For example, a more conservative investor may decide to place 25% of savings in Money Mart Assets Z (essentially a money market fund), 50% in Eaton Vance Income Fund of Boston A (a high yield bond fund), and 25% in Vanguard Institutional Index (a stock fund that invests in a broad range of equities in an attempt to mimic the Standard & Poor’s 500 index). A more aggressive yet riskier strategy would include growth stock and small cap stock funds.
FICA Benefit at Bellevue
As housestaff on Bellevue payroll, you are eligible for an additional benefit not offered at Tisch. FICA (Federal Income Contributions Act) is payroll tax deducted directly from your paycheck every cycle that then go to social security. If you have been following the recent news from Washington, you may know that the manner in which we pay social security may change soon. Until that happens, 6.2% of your income will be withheld automatically and placed in the Social Security and Medicare trust funds. If you enroll in a 403(b) plan at Bellevue, and you pay 7.5% of your adjusted gross income into that account, then you will not have FICA tax withheld. This also does not lower your Social Security benefit when you retire. However, one thing to keep in mind is that as housestaff you receive an additional food allowance that is not considered part of your regular pay. Therefore, if you elect to contribute 7.5% of your regular pay, it will end up being less than 7.5% of your adjusted gross income (which includes the meal allowance). What the Bellevue human resources people recommend is that you allocate 10% of your regular pay to a 403(b), leaving yourself a margin of error to account for any extra money that my be included in your adjusted gross income. Otherwise you may lose the FICA benefit and end up with much less take-home pay every two weeks. If you are working in the U.S. for the first time, and you want to be eligible for Social Security benefits, then you must pay FICA this year. Therefore, you will not want to contribute more than 7.5% to a 403(b). For further clarification, you should discuss your plans with human resources.
Tisch Options
NYU/Tisch benefits offer a wider range of investment options. They too have a similar family of funds offered through Prudential Financial. This time around you will have 17 funds to choose from, with a similarly diverse field that includes everything from money markets to small cap growth stocks. In addition to Prudential, Tisch benefits also offer funds from Vanguard, one of the largest mutual fund houses in the world. Here you will find a choice of 28 different funds, all of which you can allocate savings to. Like Prudential, you also have the choice of money funds, bond funds, and stock funds. The choice of where to put your money is a daunting one, especially with so many choices. A true discussion of investment allocation is beyond the scope of this paper, and should be addressed with an investment advisor. However, in the following section I will attempt to outline some basic details to look for in mutual funds, and references you can turn to for further questions.
A third option you will have when on Tisch payroll is TIAA-CREF. They offer a range of actively managed funds that allow you to be a little more hands-off in your retirement planning. With CREF you can choose to allocate savings to one or many of their individual funds (they offer only 10, but they range from money markets to stocks), or you can choose a sample portfolio—a strategy unique to CREF. With the latter option, their fund managers automatically distribute your savings into a given percentage of money markets, bonds, stocks, and real estate. All you have to decide is how aggressive you want to be.
Another thing to keep in mind while on Tisch payroll is that you are not limited to just one of the fund groups listed above. You can allocate a little to CREF, some more to Prudential, and whatever is left to Vanguard.
Choosing a Mutual Fund
Picking the correct mutual fund can be a daunting task. Fortunately, human resources have already narrowed the number of choices down. However, you will still need to choose funds that fit your investment strategy. Some details to take into consideration include the fund’s past performance. As a benchmark, most funds are compared to the S&P 500 or a similar index that tracks the performance of the entire market. The goal for a mutual fund manager is outperform the S&P, otherwise their multimillion-dollar salaries would not be justified. When evaluating a fund’s performance, pay little attention to the 1 and 3 year returns listed, as these short-term returns may be based more on market volatility and luck than true value investing. However, a fund manager who is able to post consistent returns over 10 years most likely has more than just luck on her side. Finding a fund that meets these criteria is not easy, as historically fewer than 10% of US mutual funds are able to consistently outperform the S&P 500.
As I am sure you know, nothing comes free in life. This axiom holds true for mutual funds as well, as someone has to make sure the bankers don’t starve. Buried within the statistics for each fund you will find the expense ratio. The expense ratio represents the percentage of the fund’s total assets that go to pay the bills (i.e. the fund manager’s Ferrari). Therefore, if a fund’s expense ratio is 1.5% (the national average) then the funds you put in will be decreased by that percentage. Over the years, this can make a significant dent in the performance of your 403(b). Typically, index funds such as the Vanguard 500 (an S&P 500 index fund) have the lowest costs (0.18%). Actively managed funds are more expensive, and considering that only 10% of American mutual funds outperform the market, you have to be careful to make sure that you are not paying more but getting less.
In the long run, the most important decision you make is simply deciding that you want to set money aside for savings. Once that happens, you are on your way to retiring comfortably. Where you put your money will make a difference in terms of your long-term performance, but you first have to decide to save before you can think about where to save.
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