1st Step in Teacher’s Lesson Plan: Crash Course in Investing

When they first met in 1991 as marketing students, Brian and Susie Smyth found they shared many interests, including camping, bicycling and spending time outdoors.

Over time, they also learned that neither of them wanted a marketing career.

After adjusting insurance claims for several years, Brian, 29, became a police officer in 1997. Susie, 27, spent an extra year at Cal State Fullerton to get a teaching credential and now instructs sixth-graders.

As public servants, the Orange County couple expect significant pensions from their employers. Brian would receive about 75% of his salary if he were to retire at 55, and Susie would collect about half her salary if she were to quit teaching at 60.

After raising children, the Smyths envision themselves as carefree retirees playing golf and traveling, so they want a large nest egg to add income beyond their pensions and Social Security.

The couple can afford to put money aside, and they know that the best place to save is in their respective employers’ tax-deferred, voluntary retirement-savings plans, variations of the private sector’s 401(k). But their experiences in getting information about these plans have been as different as night and day.

For Brian, it was clear.

As soon as he was hired, the police department gave him information about its 457 retirement-savings plan. Because the plan’s only offering is a Hartford Insurance Co. variable annuity, all Brian had to do was contact an agent and discuss how the annuity should be invested. Brian looked over a list of 30 mutual fund families and asked about the better performers. In 1999, he began saving the maximum amount allowed from his pretax salary--about $8,000 a year--in Janus 20, a fund that invests primarily in large, fast-growing companies.

By contrast, Susie remained in the dark.

Because neither the elementary school nor the school district distributed any retirement-savings information, Susie asked her fellow teachers what was offered, and they advised her to get the list from the payroll department.

But that sheet of paper didn’t explain how the 403(b) retirement-savings plan worked; it merely listed more than 100 financial institutions, nearly all insurance companies, where she could get help. The list lacked addresses and telephone numbers, and the accompanying forms were unintelligible, so Susie gave up in exasperation. “I had no clue.”

Susie’s frustrating experience is all too common among teachers with 403(b) plans, said Marjorie Stanford Wray, a certified financial planner for Aragon Financial Services Inc. in Fountain Valley, who reviewed the Smyths’ finances at The Times’ request. Wray knows firsthand, because she taught for 17 years in the Garden Grove Unified School District--where Susie works.

Reviewing Brian’s situation was relatively simple. Wray endorsed his selection of Janus 20, which has outperformed the Standard & Poor’s 500 in recent years, but she suggested that he diversify by adding an international stock fund and an index fund to the mix. Brian is fortunate, Wray said, that Hartford’s fee for his 457 plan is less than one percentage point a year. Many insurers charge more.

Brian said he is intent on squirreling away as much money as possible, especially after reading about the power of compound interest and tax deferral to make savings grow. The son of Irish immigrants, Brian said he appreciates having the opportunity to save money toward retirement so he can spend his senior years playing golf. “Almost all my relatives are farmers in Ireland, and they basically work until they die.”

Susie is the daughter of immigrants from the former Yugoslavia who grew up under a Communist government that promised complete retirement and other benefits. Unlike her parents, she has the chance to start saving early in life. Susie wants to invest in stock mutual funds, but feels stumped.

Wray said financial planners are themselves frustrated by the paperwork involved in setting up a 403(b), the mathematical formulas for determining maximum contributions and the different rules at each school district, which sometimes conflict with the financial services companies’ rules.

The process is especially difficult for those teachers who want to invest directly--and usually more cheaply--with a mutual fund family, rather than investing the 403(b) through an insurance company. Indeed, many teachers are unaware that such an option exists.

The Institute of Certified Financial Planners in Denver says that only two of every five public school teachers contribute to 403(b)s. (Nonprofits with 403(b)s have a better record than school districts.) Wray attributes that low participation to the lack of information--starting with schools’ reluctance to distribute the lists and refusal to offer help.

Wray said she has learned that the lack of guidance stems from public schools’ fears of getting sued. Because the lists of eligible financial institutions are quite long, school districts are worried about showing favoritism or making referrals, Wray said.

Many teachers use the term “TSA,” or tax-sheltered annuity, to refer to the 403(b) because that was the precursor to the 403(b). Insurance agents have sold them for decades, developing a clientele among teachers. About half of all 403(b) funds are invested in fixed annuities that currently pay about 6%. A key selling point for annuities is that the principal and at least some portion of the interest are guaranteed, which appeals to those who are conservative about investing.

But most financial experts think it’s redundant to invest one’s 403(b), which is already tax-deferred, into any type of annuity, which is also tax-deferred. Most annuities also charge high fees, which reduce investment returns.

Though Wray agrees that annuities are usually not the best investment option, she says they can have a place in some portfolios, especially for people who have exhausted other tax-deferred options.

Especially because Brian’s 457 plan is in a variable annuity, Wray said Susie’s 403(b) should not be in an annuity. But how does she pick a mutual fund company?

It isn’t easy. Of more than 100 financial institutions listed as 403(b) providers by the Garden Grove district, only a handful are immediately recognizable as mutual fund companies: Franklin, GT Global, Kemper, Massachusetts Financial and Oppenheimer, which charge loads; as well as Invesco and Fidelity, which are families of mostly no-load funds. Several brokerages on the list--American Express, Lincoln Investment, Merrill Lynch, Waddell & Reed--also offer mutual funds, but those institutions typically charge commissions, wrap fees or a percentage of assets. Lutheran Brotherhood and Sun Life, both insurers, also have mutual funds.

The lowest-cost option is normally a no-load mutual fund. If a teacher is willing to do all the paperwork, it is possible to call a no-load fund family on the district list and get the forms, which usually must be returned with verification, certification and salary reduction forms obtained from the district.

An alternative is to use a financial planner associated with a fund family that has sales charges, or “loads,” but who would handle most of the paperwork. For some teachers, that help may be worth paying loads.

If the challenge of picking a provider and then an investment wasn’t enough, teachers must themselves calculate how much of their pretax salary they are allowed to save. That amount, called the “maximum exclusion allowance” is the lowest of three numbers:

* An overall $10,000 limit, which is rising to $10,500 in 2000.

* The “402(g) limit,” which is 25% of “includable income,” the result of subtracting the employee’s contributions to the California State Teachers Retirement System from gross income.

* The “403(b) limit,” which is the most complex, requiring the teacher to multiply includable income by years of service and by 20%, and factor in inflation. All the formulas have variables such as years of service, prior contributions to retirement savings, special exceptions and “catch-up” options enabling teachers to set aside extra money for years when they did not save.

Figuring Susie’s maximum exclusion allowance at $9,108 a year, Wray recommended that Susie put about $400 a month in her 403(b) plan. And she also recommended that Susie invest in a stock fund, possibly an aggressive and riskier one. Why? Because public school teachers can take more risk with their voluntary retirement savings when their pensions already provide a strong safety net if stocks falter.

That Susie obtained a list without getting the runaround gives her a head start. Now all she has to do is take a crash course on investments.

Wray said there is a movement afoot to simplify 403(b) saving (See accompanying story). One provision would eliminate the three formulas and establish $10,000 as the maximum limit for annual contributions. Any major changes are at least two years away, however, and teachers like Susie must navigate their way through a maze of complexity.

*

Suzy Hagstrom is a regular contributor to The Times. To be considered for a published Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053 or to money@latimes.com. You can save a step and print or download the questionnaire at https://www.latimes.com/makeoverform.

Information on choosing a financial planner is available at The Times’ Web site at https://www.latimes.com/finplan. The site offers stories, phone numbers, addresses and links to related sites.

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This Week’s Make-Over

* Investors: Brian Smyth, 29, and Susie Smyth, 27

* Gross annual income: About $100,000

Goals

Learn how to invest in Susie’s 403(b) retirement-savings plan to improve chances of early retirement.

Current Portfolio

* Cash and savings: About $9,500

* Real estate: Home equity of about $100,000, home mortgage of $247,000

* Debts: $5,000 left on a car loan.

* Retirement accounts: About $8,000 in Brian’s 457 plan. As public servants, both are likely to receive pensions.

Recommendations

* Stop making extra principal payments toward the mortgage.

* Apply Brian’s overtime earnings toward paying off car loan.

* Set aside $450 a month in a money-market fund to prepare for having children.

* Drop Brian’s whole life policy and replace it with term life insurance, which costs less and offers more coverage. Buy term policies with $300,000 coverage each for Brian and Susie.

* Consider tax deductions for Susie’s unreimbursed business expenses and teacher training.

* Think about a second career if Brian retires at age 55.

* Draft a will.

* Brian should diversify his 457 retirement-savings plan by splitting his contribution among several stock mutual funds.

* Susie should invest $400 a month in her 403(b), choosing stock mutual fund investments.

Meet the Planner

Marjorie Stanford Wray, a former schoolteacher, is a certified financial planner with expertise in 403(b) retirement-savings plans and the California State Teachers Retirement System. As a manager at Aragon Financial Services Inc. in Fountain Valley, Wray charges client commissions.