SAVING FOR RETIREMENT
Table of Contents
This information is designed to be used as an overview and reference source on Tax-Sheltered Annuities (TSA). Its focus is on three major areas:
The importance of saving for retirement;
Government rules and tax regulations controlling TSA plans; and
Ways to distinguish between different types of investment funds and how they can be mixed and matched to help you achieve your investment goals.
This information will not include a discussion of the specific products
that are available under the TSA Program. That discussion will be
left to the individual company representatives. This material is
merely provided to focus your attention on some of the differences between
the products. You should obtain and read a current prospectus describing
the product before you actually decide to invest. Click
here for a list of University-approved vendors and their telephone numbers.
Anticipating Your Retirement Needs
Are you sure that you'll have all the money you'll need at retirement? If you're like many others, the answer may be "no." If you have just begun your career, you are probably not thinking about your retirement, since you will have plenty of time to plan and save at a later date. But financial experts encourage you to start planning and saving early to have the financial security important for the future needs of you and your family.
A widely used rule of thumb is that you will need to replace 80% of
your final earnings to maintain your standard of living after you retire.
This percentage may have to be even greater to take into account inflation,
the cost of post-retirement medical coverage and leisure activities.
Financial experts often speak of retirement income as a "three-legged stool." The legs of the stool are made up of:
Social Security;
Employer sponsored retirement plans in which you have earned a benefit during your working years; and
Individual savings.
In the past, many people have relied on Social Security and their employers' retirement plans to provide the bulk of their retirement income. However, as we move towards the 21st century, there are limits on how much each can provide. The benefits provided by Social Security and the Teachers' and State Employees' Retirement System (TSERS) or The University of North Carolina Optional Retirement Program (ORP) may not be enough to provide the replacement income you want for a comfortable retirement.
How can you supplement the Social Security and TSERS or ORP benefits to help insure your retirement security? Retirement income can be created from your personal savings and investments, Individual Retirement Accounts (IRAs), or from retirement benefits from your previous employer or employers. Even with adding all these sources together, you may still have a shortfall in meeting your retirement goals. A savings and investment plan that fits your individual needs might well be the next step.
An effective way to accomplish your retirement savings goal has been
made available by The University of North Carolina. The Tax-Sheltered
Annuity Program (TSA Program) is a benefit provided to you as an employee
of the University. It is not available to all employees of the State
of North Carolina, just those employed by an institution of higher education
or employees of a public school system. The TSA Program will allow
you to save for retirement on a pre-tax basis and defer the payment of
income taxes on any interest earnings, as well. All of these rules are
found under Internal Revenue Code (IRC) Section 403(b).
Is The TSA Program Appropriate For You?
In making your decision to invest in the TSA Program, you need to consider
your current financial condition, your ability to save on a regular and
ongoing basis, any large upcoming expenses such as college or other school
tuition, or other immediate needs that would interrupt the savings process.
The TSA Program should be considered a retirement program, not a short
term savings program. Making contributions and then taking withdrawals
over the short term could be more costly than saving on an after-tax basis
and using a bank or credit union, because certain distributions from the
TSA Program may be subject to income taxes and penalty fees, as well as
possibly being subject to surrender charges from the TSA products themselves.
How Much Will You Need For Retirement?
As discussed before, a general rule of thumb says that you will need approximately 80% of your income just prior to retirement to maintain your standard of living after retirement.
Although the level of your expenses will generally be lower after retirement,
you must plan for the effects of inflation on your retirement dollars.
The chart on the following page demonstrates the impact of inflation on
current earnings. Let's assume you need $30,000 a year to live on
in today's dollars. Assuming a modest 3% rate of inflation or a higher
6% inflation rate, you would need the amounts shown just to stay even.
The TSA Program offers a simple, tax-advantaged way to prepare for your retirement. If you decide to invest through the TSA Program, you will have to make some important decisions about how your money is invested. Essentially, they are:
How much should be invested?
What products best meet your needs?
Within the product you choose, what investments (measured by growth potential and risk) are best for you?
A basic dictionary of terms might be helpful in understanding your options.
The law only allows TSA contributions to be invested in two types of investment products. You may only invest in an annuity contract offered by an insurance company or a mutual fund with the shares held by a custodian bank.
Annuity Contract: A contract between you and an insurance company that generally provides for the accumulation of contributions during your working years and a guaranteed income for the remainder of your lifetime during retirement. These two phases of the contract should be viewed separately. The contract can be used to invest contributions during your working years with a lump sum payment at retirement or it can also be used as a payment mechanism at retirement. There are two types of annuity contracts generally offered for purposes of the TSA Program:
Fixed: A fixed annuity contract provides at least a minimum rate of return which is guaranteed by the insurance company. Your contributions are invested by the insurance company and become a part of the general assets of the insurance company. Thus, they are subject to the financial stability of the company.
Variable: A variable annuity contract provides various separate account funds in which you may invest your contributions. The separate accounts are not part of the general assets of the insurance company and there is no guaranteed minimum rate of return. Your money will be combined with the money of a large pool of other investors and the total amount is managed by a professional money manager. There can be many different investment funds, each with a different investment objective and a different level of risk.
Mutual Fund: Like the variable annuity, a mutual fund is an investment in which your money is combined with the money of a large pool of other investors and the total amount is managed by a professional money manager. Here, too, there are many different investment funds, each with a different investment objective and a different level of investment risk. The returns are not guaranteed by the investment company.
The general assets of an insurance company are usually invested in bonds issued by corporations or the federal and state governments. They could also be invested in real estate or stocks. Mutual fund assets are generally invested in stocks and/or bonds.
Stock: When you buy stock, you are actually buying an ownership interest in a company. Most often however, when you buy stock, the amount you pay does not go to the company directly, but rather, to someone else that owned the stock before you. If a company does well financially or is expected to do well, more people will want to own it and the price per share will increase. The price of a share of stock is often a reflection of what others expect the company to do in the future, rather than what may be happening today.
Bond: A bond is like a loan. The investor does not have an ownership interest in the company; he merely lends the company money in exchange for the promise of repayment, plus interest. The interest a company pays is often fixed for the term of the loan. When the loan period is over, the company will pay back the entire amount it borrowed to the owner of the bond. Assume a company issues a $1,000 bond for 20 years and agrees to pay 6% interest. For the next 20 years, the bond holder will receive $60 each year. At the end of the period, the investor will get back the $1,000. This is similar to the mortgage you may have on your house; however, with your mortgage, each month you pay back interest and a part of the principal you borrow so that the entire amount is paid back by the end of the term of the loan.
Like stocks, bonds are traded in the open market and their price can fluctuate. A bond's market value is dependent on current interest rates, as well as the probability that the company can continue to make interest payments or will pay the bond off at maturity. Two examples will illustrate this:
Assume a company is doing poorly and their credit ratings have been downgraded. At this higher level of credit risk, the going interest rate is 10%, meaning an investor can receive $100 per year on a $1,000 bond. In this situation, there would be no market to buy a bond for $1,000 to get $60 per year when the investor could get $100 per year from a bond issued by another company with a similar credit risk. However, if the investor could buy the $1,000 bond for $600, he could get the same 10% return as the $1,000 bond paying $100.
In the second example, the exact opposite happens. Assume interest rates go down to 4%. If you can only invest new money at 4%, having a bond that pays 6% would be more attractive and as such, would command a premium. The $1,000 bond could be worth $1,500 ($60/$1,500 = 4%).
In both of these examples, the closer the bond gets to maturity, the
closer the price will get to $1,000. This is because the company
only has an obligation to repay $1,000, regardless of current market conditions.
Retirement Savings Vehicles And The TSA Program
The TSA Program is a tax-advantaged retirement savings program designed primarily for employees of educational, religious and charitable organizations. Through the University program, you are able to help save for your retirement by investing pre-tax contributions in tax-deferred investments. Therefore, you save on taxes now and quite possibly in the future. Your taxable income for a given year is reduced by the amount you contribute to the Program and your investment earnings are sheltered from taxes until you receive a distribution. The program is strictly voluntary; that is, you are not required to participate. All contributions are made by salary reduction; the University does not make contributions to the program.
As mentioned earlier, the TSA rules require that, in order to obtain the tax deferral, you must invest in an annuity contract issued by an insurance company or a mutual fund, the shares of which are held by a custodian bank. We will take a closer look at both of these types of investments later.
Advantages of Investing in the TSA Program
In a nutshell, you can:
save with pre-tax dollars by payroll reduction; and
investment earnings are sheltered from tax until distributed.
In other words, your contributions are made before taxes are calculated. As a result, your wages subject to Federal and State income taxes for the year are lowered by the amount of your contributions. Depending on your tax bracket, this can mean a significant current tax savings on the money you contribute, as shown by the following example. Taxes will be due on these funds when they are withdrawn.
Further, the investment earnings in your account are also tax-deferred
until the year in which you withdraw them, which allows them to grow at
a faster rate. Also, if you postpone withdrawals until you reach
retirement age, you may be in a lower tax bracket and save on the tax rate
you pay on the distribution.
The most important decision you will make regarding the TSA Program is whether or not you should participate. Once you decide to participate, you must then determine:
How much money you want to save per pay period;
What product best meets your needs; and
What kinds of investment funds are appropriate for you.
The next step is to contact the UNCG Benefits Office at 334-4060. They will provide you with information about the approved TSA vendors and the process to enroll. Once all the forms are completed, and you have signed an application with one of the companies, your contributions should begin within two to six weeks, provided you have presented written notice to the Benefits Office at least 20 to 30 days in advance.
As with most everything else in life, when Congress provided this tax incentive to save for retirement, it also attached certain stipulations to the arrangement. There are rules relating to:
How much you can save;
Where you can save;
How often you can change the amount of your contribution;
Whether you can have access to your funds before retirement; and
When you must start taking a distribution.
We will review each of these rules to give you a sense of what the government requirements may be. There may be other rules imposed by the company with which you elect to invest.
How much can you save?
As a general summary, the following plans are applicable to employees
of The University of North Carolina: Teachers' and State Employees'
Retirement System, a qualified defined benefit plan, and The University
of North Carolina Optional Retirement Program, a qualified defined contribution
plan;
a State of North Carolina 457 Plan (Public Employee Deferred Compensation
Plan); a State of North Carolina 401(k) Plan (Supplemental Retirement Income
Plan of North Carolina); and, numerous TSA arrangements. Most employees
participate in one of the qualified retirement programs. All of these
programs as described below must be taken into consideration before a determination
can be made as to the annual maximum amount you can contribute to a TSA.
1. Teachers' and State Employees' Retirement System (TSERS): Permanent employees who work 30 hours or more (75% time or more) are eligible to participate in this defined qualified benefit plan. Cost of participation is shared between the employee and the University and set by the General Assembly. An eligible employee contributes 6% of gross salary on a tax-sheltered basis and the University contributes 10.46% (1997). The General Assembly also sets the formula for calculating the annual maximum benefit at retirement. This formula is based on a retirement factor of 1.80% (1997) multiplied by years of creditable service in TSERS multiplied by the Average Final Compensation (average of highest 48 months of compensation in a row).
2. Optional Retirement Program (ORP): Permanent employees who work 30 hours or more (75% time or more) who are faculty or administrators may elect the ORP in lieu of TSERS. This is a defined qualified contribution plan in which the employee contributes 6% of gross salary on a tax-sheltered basis and the University contributes 6.84% (1997). The employee's election is irrevocable and must be made upon employment in an eligible category. These rates are set by the General Assembly and subject to change.
3. State of North Carolina 457 Plan (Public Employee Deferred Compensation Plan): Permanent employees who pay FICA and Medicare taxes and who are paid on a regular basis are eligible to participate on a voluntary basis. This is a non-qualified plan in which the State of North Carolina has full ownership of the account.
4. State of North Carolina 401(k) Plan (Supplemental Retirement Income Plan of North Carolina): Permanent employees who participate in either TSERS or ORP are eligible to participate in this plan on a voluntary basis. (NOTE: Law Enforcement Officers receive an employer contribution of 5% of the officer's salary.) The 401(k) contributions are held in trust for the exclusive benefit of participants.
5. Tax-Sheltered Annuities [403(b)(1) and 403(b)(7)]: Each UNC institution makes available to employees 403(b)(1) insurance annuity plans and 403(b)(7) mutual funds. These plans are non-qualified and participation is voluntary. Each campus sets the policy for the selection and number of TSA companies (or vendors) that are available to employees.
IMPORTANT: There are actually THREE different tests that need to be taken into account before a determination can be made regarding how much you can contribute to the TSA Program. All three of these tests must be performed to determine your maximum annual contribution limit. The first two sets of tests identify the maximum amount that can be contributed to a TSA. The third test limits the amount that can be contributed by salary reduction to $10,000 (in 1998). In addition, the value of past employer contributions to a qualified retirement program must also be considered. A calculation must be performed to assure that you are in tax compliance. The representative of the investment company you select should perform this calculation for you.
TEST 1: Maximum Exclusion Allowance (MEA) - IRC Section 403(b))
The MEA limits your contributions to 20% of your adjusted pay (i.e., gross pay less certain amounts you contribute to either 1or 2 above) times years of service, minus past contributions made on your behalf to 1, 2, 3, 4, and 5 above, and any other qualified retirement programs.
Because this test is based on current pay and takes into account
past service, once you have two to three years of service, it generally
produces a contribution rate greater than the next two formulas.
If this is the case, the next two formulas will control the amount you
will be able to contribute.
TEST 2: Maximum Annual Addition - IRC Section 415(c)
The maximum annual addition limit is 25% of your adjusted pay (i.e., gross pay less amounts you contribute to either 1 or 2 above) or $30,000, whichever is less.
Due to the cumulative nature of the exclusion allowance, there are also special "catch-up" elections that are unique to 403(b) plans. If you have a pattern of low contributions in the early stages of your career, a catch-up rule may allow you to contribute at a relatively high level later. This limit has three special catch-up rules that could allow you to contribute a bit more to your TSA, but that ability may bring into play other rules that can limit your contributions in the future. Before we explain the catch-up rules, it is important to note that once one of these rules is used, either of the other two rules cannot be subsequently used. Further, your election of one rule over another is a passive election. This means even if you did not know the rules existed, if one of the rules is needed to support your tax deferral, you will have been deemed to have elected it. On the other hand, if you affirmatively elect one of the rules over another, but do not need it to support your tax deferral, you are not deemed to have elected it. This is one of the reasons why it is so important to have the entire calculation performed when you want to make TSA contributions.
The three catch-up rules under the IRC Section 415 tests will
be designated A, B and C. They are briefly described in the chart
on Page 11. Another important reason for performing the calculations
deals with these catch-up rules. Generally, if you are participating in
both a qualified plan and a 403(b) plan, the 415 limit for each of
the plans is calculated separately. However, there is an important
exception applicable to TSA arrangements that deals with catch-up election
"C". It is explained in the table below, but essentially, if this
catch-up rule is used, this separate limit is eliminated and a single aggregated
limit is used, which may be beneficial to some employees.
TEST 3: Maximum Elective Deferral Limit - IRC Section 402(g)
The maximum salary deferral is $10,000 per year. This amount is indexed and will increase in $500 increments every 2-3 years.
The tests are complicated and it is not expected that you will become an expert by way of this overview. Our objective is to make you more sensitive to the calculation and provide you with some insight into its workings.
There are five important things to remember:
First, the maximum TSA contribution from salary reductions and employer contributions is the lesser of Columns 1 and 2, but salary reduction contributions can never be greater than Column 3.
Second, if catch-up rule "C" is used (see Column 2), the 415 limits in Column 2 must be aggregated with any current year's contributions to a TSA plan or to any qualified retirement plan.
Third, once one of the Column 2 catch-up rules is used, it is irrevocable and another catch-up rule cannot be subsequently used. This does not mean that the rule has to be used every year. The employee can always revert back to the general limits [i.e., least of 403(b)(2), 415(c) or 402(g)]. However, the election is an employee election and will apply to any TSA purchased by any employer of the employee.
Fourth, the TSA must be aggregated with other qualified plans controlled by the employee. Control occurs if the employee controls more than 50% of the separate organization. For example, assume a physician earned extra cash outside of the University relationship doing medical exams for an insurance company and from that outside income created a qualified retirement plan. The contributions to that plan would have to be aggregated with the TSA for purposes of meeting the 415 limits.
Fifth, with respect to the time and method of making a Column 2 catch-up election, an employee is only considered to have made the election when the use of one of the catch-up rules is necessary to support the exclusion from gross income on the employee's tax return. This essentially means the election is a passive one in which the employee never really knows if a catch-up rule applies unless the calculation is performed each year.
The representative of the investment company you select can assist you in determining if you qualify for catch up.
Earlier, we mentioned that in order to receive the tax exclusion under a TSA, your contributions had to be invested in either an insurance annuity product or mutual fund held by a custodial bank. In fact, the regulations would allow the purchase of life insurance but the death benefit portion of the contract would have to be charged back to you as taxable income, so it is rare that life insurance is used. Let's take a closer look at the insurance and mutual fund products.
Fixed Annuities: When you invest in a Fixed Annuity, your contributions are invested by an insurance company in items such as bonds, mortgages and real estate. Fixed annuities are unlike mutual funds or variable annuities in two important respects. First, there is a minimum guaranteed investment return, although the actual rates credited by the company may be higher; and, second, your principal is guaranteed against loss by the insurance company. There is no federal guarantee of your principal.
Fixed annuities generally have a lower rate of return than other investments, but they are considered a lower risk, as well. The money you invest in a fixed annuity becomes part of the general assets of the insurance company; thus, the financial stability of the company can affect the performance and safety of fixed annuities.
Variable Annuities: When you invest in a variable annuity, your money is held in separate accounts and is not a part of the insurance company's general assets. This type of investment is similar to mutual funds, in that your money is pooled with that of other investors, and invested according to the established investment objective of the variable fund. The stability of the insurance company offering the annuity does not affect the performance or the safety of your investment, because your money is not made a part of the company's general assets, as is the case with a fixed annuity. The performance of the securities held by a fund determines the return and risk of the annuity; there is no guarantee on your rate of return.
Many "variable annuities" offer both fixed and separate accounts, thus giving the purchaser a choice between investment accounts supported by the general assets of the insurance company and ones that are not.
Mutual Funds: A mutual fund is marketed by an investment company in which an investor's money is combined with the money of many other investors. The total amount of money is invested by a professional manager according to the investment objective of the specific fund. Each investor holds a share of the total fund and is entitled to a proportional share of the profits (or losses) of the fund. There are many different types of mutual funds, each with a different objective and different potential for growth, as well as for risk. Each mutual fund invests in a number of securities, which means that the fund is diversified to help minimize risk. When you invest in a mutual fund, you are actually investing in the securities or other investments held by the fund. The investment company offering the funds does not guarantee the funds' performance.
How often can you change the amount of your contribution?
You may enter into a salary reduction agreement as often as once per month.
Can you have access to your funds before retirement?
While you are participating in the TSA Program, the time may come when you need to access the money in your account before retirement. There are several different circumstances under which you may access your account. Generally, however, when you do withdraw from your savings, the amount withdrawn will be taxable to you and, under some circumstances, there will be a 10% penalty tax imposed by the government. Further, there may be surrender charges or other restrictions imposed by the insurance company or mutual fund that is investing your money.
After age 59 1/2 You can withdraw money from the TSA Program while you are still working, as long as you are at least age 59 1/2. The 10% penalty tax does not apply but surrender charges may apply.
Hardship: If you
experience a financial
hardship, you can
withdraw and
Withdrawals amount necessary to meet that need, but not more.
These types of withdrawals are still subject to income taxes and may be
subject to the 10% penalty tax, as well. Under this exception, you
may withdraw your own contributions from the Program, but not investment
earnings on those contributions.
There are two sets of government rules to be eligible for this type
of distribution. First, the hardship withdrawal must be because of
an immediate and heavy financial need and, second, the funds withdrawn
must not be reasonably available from other resources.
The government has issued limited
guidance in this area, but there seems to be general agreement that
the following situations will be deemed hardships.
Post-secondary school educational expenses for you or your dependents,
Medical expenses not covered by insurance for you and your dependents,
Money for a down payment on your home or to prevent foreclosure on
or eviction from your residence.
Whether the requested withdrawal is available from other resources is a judgment that the approved vendor must make to meet these government rules and may require them to ask personal financial questions in order for them to make that judgment. Here, too, there are some guidelines that may make the process more understandable. The funds will be deemed not available from other resources (eligible for distribution) if:
The amount requested does not exceed the amount needed to meet the
hardship,
All other available distributions and loans from all plans have been
used first,
Salary reduction contributions to all plans will be suspended for
12 months after the distribution, and
Any salary reduction contributions made in the following taxable
year are limited by the $10,000 limit reduced by the amount of the hardship
distribution.
These hardship distribution rules apply to salary reduction contributions made in the past to mutual funds held by a custodial bank and any contributions to insurance annuity products made on or after January 1, 1989. They do not apply to amounts accumulated in insurance annuity products before January 1, 1989. Those funds are freely withdrawable under the law, subject, of course, to any contractual restrictions by the insurance company.
Termination: At some point
before your retirement, you may
leave employment at
the University. Termination of employment is a permissible distributable
event. However, if savings are withdrawn in a lump sum before termination
of employment at age 55, they may be subject to a 10% penalty tax.
They will also be subject to income taxes.
Options on termination of employment:
As mentioned above, receiving a cash distribution from your TSA is just one possible choice. Other choices will include:
Leaving the funds where they are and letting them grow with investment
earnings (no tax penalty);
Transferring your savings to another TSA underwriter (no tax penalty);
or
Rolling over the contributions to a TSA rollover IRA (no tax penalty).
These IRA accounts are the same ones you see advertised everyday; however,
TSA money needs to be kept separate from other kinds of IRA accounts.
Therefore, if this option is elected, a separate account needs to be established.
There are a couple of things to note about these choices:
Free Outs - Many insurance companies offer the opportunity
to withdraw a percentage of your savings without the imposition of the
usual surrender charge. This free-out percentage is generally about
10 - 15% of your account balance. Other contract restrictions may
apply.
Penalty Taxes - Withdrawals (but not loans) are generally taxable when you receive them, and there is usually an additional 10% early distribution tax applied by the IRS. The 10% penalty tax will not apply if:
You are over 59 1/2, regardless of whether you have terminated employment,
The payment is made to your beneficiary on your death,
You are disabled,
The payment is made over your life expectancy, or over the life
expectancy of you and your spouse, or
You are over 55 and have terminated employment.
Withholding Taxes - If there is a cash distribution from a TSA plan and the payment period is less than 10 years, the insurance company or mutual fund is required by law to withhold 20% of the distribution for income taxes. This withholding will not occur if you decide to leave your account balance where it is or you transfer your funds to another TSA or IRA. A direct transfer is a way of moving funds from one TSA to another TSA, and a direct rollover is a way to roll distributable amounts from a TSA to an IRA without actually taking possession of the distribution. This will preserve the tax-deferred status of your account.
Loans: You can borrow against contributions that are invested in an annuity contract while you are employed by the University (or after you have terminated employment if you leave your contributions in the contract). Contributions invested in any of the other investment options -- such as variable annuity separate accounts managed by an insurance company or funds managed by a mutual fund company -- are not available for loans. However, you may be able to transfer money out of these accounts into a fixed- account annuity and then take out a loan. This will depend on the product you choose.
Loans must meet the requirements of Internal Revenue Code 72(p). Loans which do not meet these requirements are treated as taxable distributions at the time the loans are made and included in the participant's gross income for taxation. If your plan permits loans, the amount of the loan must not exceed the lesser of (1) $50,000 (reduced by the excess, if any, of the highest outstanding loan balance during the prior 12-month period over the outstanding loan balance on the date the new loan is made), or (2) the greater of 50% of the employee's vested balance under the plan or $10,000. Vendors may have more restrictive limits to provide sufficient funds in the event of default.
Loans are not treated as a taxable distribution because you are just borrowing the money. However, you must pay it back in substantially level payments that are made at least quarterly over a period not longer than five years (longer if you are borrowing to purchase a home). If you don't pay it back in accordance with the loan terms, the insurance company will consider the arrangement a distribution and the outstanding balance will then become taxable.
When must you start taking a distribution?
The government, in allowing you to save with pre-tax dollars for retirement,
has placed certain restrictions on taking your savings out too soon.
That restriction comes in the form of a 10% penalty for early withdrawal.
Alternatively, they don't want you to keep your savings out of the income
stream too late in life. Therefore, the law requires you to start
taking a distribution from your TSA by April 1 following the year you attain
the age of 70 1/2 or April 1 following the calendar year of your retirement
from the University, whichever is later. The amount you must take
is an amount equal to an annuity payable over your life expectancy or your
life expectancy and that of your spouse. If you don't take out this
minimum amount, you will be subject to a penalty tax of 50% of the amount
you were required to receive.
Primary Differences Between The TSA Program And Other Retirement Plans
Tax-Sheltered Annuity Program A retirement plan in which contributions are eligible for tax-deferred treatment, created by a salary reduction agreement between the University and the employee. The University purchases annuity contracts with insurance companies or contributes to custodial accounts holding mutual fund shares for the employee. These types of arrangements are governed under the requirements of the Internal Revenue Code Section 403(b). Contributions are made on a voluntary basis by the employee through payroll reduction (before Federal and State taxes are withheld). The main tax benefit of a tax-sheltered annuity is that you are allowed to postpone paying tax on these contributions until you receive annuity payments, normally after your retirement. At that time, your income probably will be lower and may be taxed at lower rates.
Teachers' and State Employees': This type
of retirement plan is a defined benefit plan. Under
Retirement System (TSERS ) a defined benefit plan, there is a definite
formula by which a participant's benefits will be measured at his or her
attained age. The formula provides that the benefit will be a particular
percentage of the employee's final average pay. Benefits will then
be paid for the life of the employee. If an employee retires before
age 65 or with less than 30 years of creditable service, there are usually
two types of reductions that need to take place. First, the benefit
may be lower because the employee has not completed the anticipated years
of service to age 65. Second, the age 65 benefit that has been earned
is then reduced to reflect the fact that the plan has to pay those benefits
for a longer period of time.
Contributions to the plan are determined by an actuary based on assumptions regarding life expectancy, investment earnings of the fund and the number of employees expected to retire. An important point is that the Retirement System bears the risk of investment losses and gets the benefits of investment gains. This is not true of a defined contribution plan. Most State employees participate in TSERS.
Optional Retirement Program (ORP): Faculty and administrators can elect to forgo the TSERS and, instead, participate in the ORP. This plan is a defined contribution plan. A defined contribution plan promises no specific benefit at retirement. It does promise that a contribution will be made each year on behalf of an employee and whatever that contribution grows to is what the employee will receive. These types of plans usually give the employee one or more investment choices with the employee bearing the risk of investment gains or losses.
The ORP, the TSA Program, the State's Deferred Compensation Program,
and the State's 401(k) Program are all defined contribution plans.
How To Start Making Contributions To The TSA Program
If you have decided that participating in the TSA Program is for you,
you should contact your selected TSA carrier to begin the enrollment process.
The carrier must provide a calculation for you in order to determine the
annual maximum amount that you can contribute as allowed by law.
You should also contact the Benefits Office to tell them how much you want
to contribute and when you want to start. They can provide you with
information regarding those companies that have been authorized to sell
TSA products through the University.
How To Make Changes Under The TSA Program
Stopping your contribution: Once you have begun participating in the TSA Program, you may decide at a later date that you wish to stop contributing. In that event, you should notify both the Benefits Office and your annuity carrier in writing of your intention to stop contributions. This notice should be provided at least 20 to 30 days in advance of the date you want the contributions to stop.
Increasing or decreasing: Perhaps you
don't want to stop contributions,
but want to
your contribution increase or decrease the amount of your contributions.
Under these circumstances, you would need to notify the Benefits Office
and the carrier(s) in writing at least 20 to 30 days before you want the
change in amount to take effect. You must remember, however, that the number
of allowable salary reduction agreements in effect for any calendar year
is determined by your employer. A change in the amount you are contributing
would require you to sign a new salary reduction agreement with your employer
for the revised amount.
Changing the investment: Once you have
begun participation in the Program, you
may
account in the same product decide to change the way your money is
invested. If you decide to change investment funds within the same
company, the method for transfer should be spelled out in the materials
provided by the company's representative. Many companies allow you
to transfer within that company's funds by a toll-free telephone call.
You should be aware, however, that there may be restrictions or charges
associated with transfers. You should read your prospectus(es) carefully
or call your representative or the company directly for more information.
You may decide to
change your carrier completely: In
this event, the first step would be to have your future contributions changed
to the new company. You will need to contact the Benefits Office
for this, and present your request at least 20 to 30 days in advance.
Secondly, you must decide whether you want to transfer your account balance
to the new company or leave it "on account" with the old company.
If you decide to transfer the balance, you must determine whether the new
company will accept lump sum transfers. You should also be aware
that many companies impose a surrender charge or withdrawal fees on amounts
distributed from an account. For some companies, these charges may
be waived after a certain period of time has elapsed or under other circumstances.
You should read the materials provided by your representative for this
information, or call your representative or the company directly with any
questions.
Investment Opportunities and Risks
Once you've decided to save through the TSA Program, you'll need to decide how you want your contributions invested. The Program offers you many investment choices to meet different investment objectives. The following general investment concepts should help you think about your individual investment goals.
Everyone would like to get higher rates of return on their savings. The reality is that the types of investments that can grow fast enough to beat inflation also have some risk of investment loss. As a general rule, the greater an investment's potential is for growth, the greater its risk of potential loss.
The good news is that if you have a long time (ten years or more) before you will need your savings (a long "savings horizon"), experience shows that the actual risk of losing money in a higher-earning investment goes down. Although higher-earning investments usually experience short-term ups and downs in value in response to economic conditions, the chances are better that, over time, the higher rate of return should more than make up for short-term dips in market value. If you have only a short time to invest, you may want to choose investments with more stable, consistent rates of return.
A good way to minimize your risk of investment loss is diversification.
This means including a variety of investment alternatives in your savings
to offset the risk of any single
investment.
The old saying "don't put all your eggs in one basket" is a good, simple way to illustrate the value of diversification. To a certain extent, every time you invest in a TSA product there will be some diversification in that you will not invest in just one stock or bond. The mutual funds and separate accounts in the annuity contracts, by their nature, invest in a diversified portfolio of investments. In addition, by spreading your contributions among two or more different types of funds or annuity accounts, you're less likely to be hurt by the poor performance of a single investment or fund.
One way to help reduce some of the risk of up and down swings in market value is to invest regularly, regardless of what is happening to prices. Contributing through payroll reduction is a convenient way to do this.
This technique, called dollar-cost averaging, is widely regarded by investment professionals as a less risky way to invest than trying to time your investments to market swings. Using the dollar-cost averaging approach, you invest regularly and average the purchase price so that you lessen the risk of a large purchase when the price is high or a sale when the price is low.
After you've selected the investment choices that are right for you and for your current situation, be prepared to make changes when necessary. For example, as you get closer to the time when you will be withdrawing money from the Program, you may want to move your investments to a more conservative option. Always remember that the technique of dollar-cost averaging also works when changing investments: move smaller amounts over time instead of one large move to help minimize market value loss.
The different investment choices in the Program have varying potentials for risk and return. For purposes of illustration, we have chosen to equate risk with volatility. That is, the more a fund fluctuates up and down, the greater the risk. The products authorized to receive contributions have investment funds with many different investment objectives. When reviewing the returns of competing products, make sure you are comparing the returns and risks of funds with similar investment objectives. For example, an aggressive growth fund may have a high historical return and experienced substantial volatility in achieving that return. It would be unfair to compare that fund with a balanced fund whose objective might be to be less volatile and, as a consequence, achieve a lower return.
The following types of funds are typical of those offered by both insurance company variable annuities and mutual fund families.
Equity Fund: Your money is invested in the stocks of corporations. Equity investment funds differ in the types of companies in which they invest. These differences can be based on the size of each corporation and its potential for growth. Equity investments have a significant potential for short-term changes in value. This potential ranges from moderate to very high risk depending on the type of stock and diversity of stocks held in the fund. Funds that hold many different large, well-established companies, for example, have historically been less volatile than funds that hold stocks of smaller, newer companies. Long-term investment returns range from moderate to high, depending on the types of stocks held in the fund. Investment returns result from stock dividends as well as the growth in value of the stock itself. For example, emerging growth companies may issue no dividends, but may show a large increase in the value of the stock itself.
Balanced Fund: Money is invested in a combination of stocks and bonds. Balanced funds differ in the proportion of stocks and bonds they hold; they can also differ in the types of stocks and bonds that they hold. Balanced funds are considered to have moderate risk due primarily to short-term changes in stock and bond values. Since bonds are generally less volatile than stocks, they help to moderate the changes in stock values. Investment returns result from dividend and interest income as well as changes in the market value of the stocks and bonds. This type of investment is generally considered to have moderate to high potential long-term investment returns.
Bond Fund: Also known as fixed income funds; money is invested primarily in bonds. The funds differ in the types of bonds in which they invest (which may include government or corporate bonds), as well as the average maturity of the bonds (the length of the time until the bonds are repaid by the issuer). This type of investment is generally considered low to moderate risk, with the degree of risk dependent on the type of bonds in the fund and the average maturity. Some funds seek to minimize risk by investing only in bonds backed by the U. S. Government. Investment returns are generated primarily by interest earnings, but can include a change in the bond's value in response to a change in general interest rates. The potential long-term rate of return for this type of fund is moderate and, again, is dependent on the type of bonds held by the specific fund.
Money Market: Fund Money is invested in short-term securities, such as certificates of deposit (CDs), U. S. Treasury bills, and short-term corporate securities. Investment return from money market funds is due to interest. This type of investment is generally considered low risk, with little possibility of a short-term change in value. The long-term rate of return is generally expected to keep pace with inflation, but not to have significant growth possibilities.
Another factor to consider when deciding on an investment strategy through the TSA Program is the cost of investing in one company or fund versus another. There are a number of different fees and charges you need to be aware of in selecting the right product for you. It is important to note, however, that higher fees should not just be considered in a negative light. You need to equate those fees with what you get for your money. Paying for something you will not use rarely makes sense. However, if there is value received for the fees you pay, that should be acceptable.
The following are the types of fees and charges typically built into TSA products:
Sales charges: Sales charges are also known as "loads". These may be assessed when you buy a product (a "front-end load") or when you redeem a product (a "back-end load"). This is similar to a surrender charge. The purpose is generally to pay the sales representatives' commissions.
Administrative fees (Maintenance charges): These fees are assessed on a periodic basis, generally quarterly or annually, to assist in off-setting the company's costs in maintaining your accounts during the period.
Surrender charges: Surrender charges may be assessed when you take a distribution from your account. Surrender charges may be based on years of participation, which means that after you have made contributions for a specified period of time, the surrender charge will be removed, or contribution years, which means that each contribution must remain in the product for a specified period of time before the surrender charge is removed.
Mortality and expense charges: These charges are
assessed by most insurance
companies to offset their risk in paying annuities.
Investment advisory fees: These are
fees charged by an investment company and
paid to the investment manager of the separate fund or
account.
Annuity conversion rates: This is the cost involved
to pay for an annuity which
may extend for
a participant's lifetime.
All of these charges are explained more fully in the prospectuses that
must be distributed by the company in which you are investing. In
order for you to more accurately compare one company's expenses to another,
each prospectus has a similar example that assumes a $1,000 investment
earning 5% over periods of 1, 3, 5 and 10 years, with the expenses incurred
during each period. If expenses are a concern, this is a good way
to compare one company's product to another.
Administrative Fee The administrative cost of operating a fund. These fees are usually subtracted before calculating the fund performance.
Annuitant A person who receives an annuity.
Annuity A contract usually issued by an insurance company that generally provides for the accumulation of contributions and a guaranteed income for a specified period of time or for life.
Annuity Conversion Rate Cost involved to pay for an annuity which may extend for a participant's lifetime.
Back-End Load A sales charge levied to an investment when money is withdrawn from a fund.
Balanced Fund An investment company that spreads its investments among stocks and bonds. A fund that balances its portfolio to achieve both moderate income and moderate capital growth.
Bond A long-term promissory note. A promise by a corporation or government entity to repay money borrowed from investors.
Certificates of Deposit A receipt for a deposit of funds in a financial institution that permits the holder to receive interest plus the deposit at maturity.
Custodian A bank or other financial institution that holds or keeps custody of securities and cash by an investment company.
Defined Benefit Plan A pension plan in which retirement benefits rather than contributions into the plan are specified. A retired employee who has reached a certain age with a given number of years of service and who has earned certain income is entitled to a specific monthly pension payment.
Defined Contribution Plan A pension plan in which contributions into the plan, rather than eventual retirement benefits to employees, are specified.
Direct RolloverMovement of distributable amounts within an account from a tax-sheltered annuity to an IRA.
Direct TransferMovement of account assets from one tax-sheltered annuity to another. This is not considered a distribution.
Distribution Cash payments to stock, bond, or money market account holders by a corporation or financial institution.
Diversification Spreading of risk by putting assets in several categories of investments, such as stocks, bonds, money market instruments, or a mutual fund with its broad range of stocks in one portfolio.
Dividends A share of a company's net profits distributed by the company to a class of its stockholders.
Dollar-Cost Averaging Investment of an equal amount of money at regular intervals, usually each month.
Earnings Net income after all charges, divided by the number of shares outstanding.
Equity Investments Money invested in stocks, both common and preferred.
Fixed Annuity Investment contract sold by an insurance company that guarantees fixed payments, either for life or for a specified period to an annuitant.
Front-End Load Sales charge applied to an investment at the time of initial purchase.
Investment Advisory Fee Fee charged by an investment company and paid to the investment manager of the separate fund or account.
Loads Sales fee a buyer pays in order to acquire an asset.
Money Market Fund A mutual fund that sells shares of ownership and uses the proceeds to purchase short-term, high quality securities such as Treasury bills, negotiable certificates of deposit, and commercial paper.
Mutual Fund Fund operated by an investment company that raises money from shareholders and invests it in stocks, bonds, options, commodities, or money market securities.
Portfolio A group of investments the purpose of which is to reduce risk by diversification.
Prospectus A formal written document relating to a new securities offering that delineates the proposed business plan or the data relevant to an existing business plan.
Risk The variability of returns from an investment.
Rollover A non-taxable type of distribution from a tax-sheltered annuity, generally to an IRA or another tax-sheltered annuity.
Salary Reduction An amount of money taken from your salary before taxes are deducted from your pay.
Stock Ownership of a corporation represented by shares that are a claim on the corporation's earnings and assets.
Variable Annuity An annuity contract in which the earnings and payments fluctuate depending upon the investment performance of the portfolio.
Volatility The relative rate at which a security or fund share tends to move up or down in price.