“I just started working in employee benefits at a private university and am new to 403(b) plans. I understand that the only permissible investments un 403(b) plans are annuities and mutual funds, but can you explain the difference between the two?”
Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:
Certainly, and you are correct that, at present, 403(b) plan investments (with the exception of church 403(b)(9) retirement income accounts) are limited to fixed and variable annuity contracts under Code Section 403(b)(1) and custodial accounts for regulated investment company stock under Code Section 403(b)(7), more commonly known as mutual funds. From time to time, legislation is proposed in Congress that would add to the types of investments available to a 403(b) plan, but none has ever become law as of this writing.
The Experts defined an annuity contract in a previous Ask the Experts column as an insurance product, where the insurer provides a contractual promise to the contract holder (plan participant) to pay a specified amount at regular intervals over a specified period of time, which may be for the participant’s life or the joint life of the participant and a designated beneficiary, similar to a defined benefit plan (for example, X dollars a month over the participant’s lifetime). The insurance company is ensuring that the participant will be paid such a benefit, which is why it is an insurance product. There are two general types of annuities: fixed, or traditional, annuities, where the rate of return is fixed by the insurer, or variable annuities, where the rate of return can vary as it is tied to the performance of an underlying investment.
On the other hand, a mutual fund is a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce returns for the fund’s investors. Mutual funds are basically a way to give individuals access to professionally managed portfolios to which they might not otherwise have access. Unlike annuity contracts, however, there is no insurance component, and thus there is no contractual provision to pay a benefit to the account holder in the future—the account holder will simply receive the value of his/her interest in the fund upon distribution. However, a mutual fund holder could still opt to use the proceeds of the mutual fund to purchase an annuity contract at any time, subject to the terms of the 403(b) plan. 403(b) plans consisting of both annuities and mutual funds often allow transfers between the two investment types, subject to certain restrictions.
It should also be noted that there is generally no guarantee as to investment principal (the sum of all contributions and/or rollovers in the case of a 403(b) plan) in mutual funds and variable annuities; should the investments decline in value, the investor could lose at least some of what he/she invested in the contract (though, with variable annuities, should the investor die, a death benefit payable to the beneficiary would typically guarantee at least the amount of principal invested). The principal in fixed annuities, however, is insured against loss by the insurer, except possibly in the event of insurer insolvency.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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