Quick Crash Course on 403(b)s

I used to work for a higher educational institution, and 403(b)s were all the rage there. I happily invested in the college's 403(b) and stuck to it for 12 years. 

Then, when I left my job, I transferred my money from a 403(b) into a traditional IRA. I took another job (a corporate job) and started investing in a 401(k). So I've invested in practically every retirement vehicle on the planet because now I'm in an individual Roth 401(k). (It's just too fun not to play with them all.)

Take a look at this quick overview of 403(b)s in case you're not sure what you're getting yourself into when your organization offers you the option to invest in a 403(b).

What is a 403(b)?

Employees who work for nonprofit organizations and the government can tap into 403(b) plans. You may work for a public school, private college or university, for the government, or at a library. You can contribute pre-tax or post-tax money to your 403(b) through payroll deduction, just like with a 401(k). Unlike 401(k) plans, your 403(b) doesn't come from a for-profit company. 

You can choose from two types of 403(b) options, a traditional 403(b) and a Roth 403(b). Take a look at the difference between the two:

• Traditional 403(b): You fund traditional 403(b) accounts with pre-tax dollars and the money grows tax-deferred. In other words, you won't pay taxes on the money now but you will when you take it out in retirement.
• Roth 403(b): The money in your Roth 403(b) grows tax-free. In other words, you won’t pay any taxes when you take the money out in retirement. However, if your company offers to match the money you put in, the money grows tax-deferred, so you will have to pay money on your company's match down the road.

How to Invest in a 403(b)

Take these steps on how to invest a 403(b)!

Step 1: Visit your human resources office.

Did you know that for some people, that's all that's stopping them from becoming a millionaire? A simple walk down the hallway could hinder your lifetime of earnings. Go to your company's benefits meetings, webinars and free offerings. Sign up for your company's 403(b) the minute you get your job. 

If you've been in your job for years but have never signed up, never fear. Do it today. It's never too late to start investing for your future. You may have to wait a few months after you start a new job to start investing in your plan, and that's okay. Save the paperwork and get on the company plan the first day you can.

Why? You don't want to miss out on a single penny of free money, or the employer match. More on that in a second.

Step 2: Subtract your age from 110 to know how to invest. 

One of the other biggest hangups involves knowing what to invest in — many people don't know how to invest, so they just… don't. 

You want to diversify no matter what. This means choosing lots of different investments in order to spread your risk over several types of investments. You may want to choose to invest in all of these: U.S. large caps, U.S. small caps, international, emerging markets or real estate.

 So, subtract your age from 110 to know how to invest. Let's say you're 40. 

110 - 40 = 70

You should invest 70% in equities (examples involve the ones listed above) and 30% in bonds. Simple, huh?

Step 3: Check yer "extras."

By this, we simply want you to ask your company about low expense ratios. You don't want to pay any more than you need to. A fund with a high expense ratio could chew up a lot of your returns over the years. 

Since your expense ratio gets deducted from your assets, your returns change throughout the year and over the fund's lifetime. The higher your expense ratio, the more you'll lose out on throughout the year. You want to look for the lowest expense ratios possible.

Pros and Cons of a 403(b)

Before you dash off to the human resources department and sign up for a retirement fund, take note of the pros and cons of choosing this type of retirement plan. 

Pros

First, the good news — the pros of owning a 403(b): 

• Employer match: Many employers match your contributions, as we mentioned earlier. In other words, most employers will kick in money to match what you've put in. The company match has hit a record average 4.7%, according to Fidelity. The moral of the story: Don't leave money on the table.
• Tax advantages: You can't leave out the tax advantages of a 403(b). You see immediate tax benefits when you defer money into a traditional 403(b) account. You don't have to pay any tax at all when your accounts rise in value. (Though, again, remember that you do have to pay when you withdraw if you get the traditional account.)

Cons

Yes, you also want to consider a few cons: 

• Few investment choices: Much of the time, you don't get a lot of options when it comes to choosing between different investment types with your 403(b). Your company chooses a provider (in our case, TIAA-CREF offered our plans) and the number of funds you have to choose from depends on the provider.
• High fees: Many 403(b) plans include investments held inside annuities, which cost a lot and you must pay a surrender fee to extricate yourself (and your money) from an annuity. Does every 403(b) solution encourage you to invest in annuities? No. However, figure out how much the fund will cost you over time before you jump into it.
• Lack of ERISA protection: Many 403(b) plans don't have Employee Retirement Income Security Act (ERISA) protection. What's that? ERISA promotes minimum standards for retirement plans and an ERISA plan puts some helpful safeguards in place for savers.

Should You Invest in a 403(b)?

So, should you hop on your company's 403(b)? Or should the cons cause you to skip the Roth 403(b) in favor of a Roth IRA or another type of retirement fund?

Yes, you should invest in it, particularly because of the employer match. By the time I left, my employer was kicking in a whopping 10% match! Amazing! 

So, trot to your human resources office to pick up the paperwork and go from there. Your 65-year-old self will thank you for it.