Retirement Plans: 401a, 403b, and 457b Plans
401a vs 403b vs 457b! Physicians are high income professionals who optimally defer income into retirement plans during peak earning years.
If you have access to a 401a vs 403b vs 457b then you either work for the government or a not-for-profit hospital system. Which account should you use and in which order?
Well, that depends on if you are a governmental or non-governmental employee! I’m gobsmacked by the poor quality of information on the internet on the topic. So, let’s discuss physician retirement accounts: 401a vs 403b vs 457b plans. Also, see below for how to invest in your 401a.
Governmental vs Non-Governmental Retirement Plans
As I mentioned in the introduction, there is a huge difference in the plans depending on if you are a governmental (local, state or non-VA federal) or non-governmental employee.
If you are a non-governmental employee (that is, you work in a not-for-profit hospital), then you have some unpacking to do. The rest of the blog is for you. But if you work for the government, your decision is pretty easy!
Let’s get the Governmental physicians out of the way first.
Governmental Physician Retirement Plans
The Thrift Savings Plan (TSP) is pretty awesome for accumulation but consider ditching it come de-accumulation. While there are only 5 offerings (Large Cap, Small Cap, International, Bonds, and a cool “G Fund”), they are inexpensive, and sometimes less is more (especially with passive funds and low costs). In addition, there are target-date funds which are fine for many in accumulation.
During de-accumulation, distributions from the TSP can be tricky. What I don’t like about the TSP is they sell your funds pro-rata for distributions. So, say you own stocks and the G fund and want to take a distribution while the market is down 50%. Optimally, you would sell just the G fund and leave your stocks alone. When you take a distribution from the TSP, however, they sell an equal amount of both. (Of course, since money is fungible, you can always re-balance after the distribution… but one point of a distribution is to rebalance your account.) They used to only allow one distribution a year and it had to come equally from Roth and non-Roth, but apparently this is now a resolved issue.
The TSP is a federally qualified defined contribution plan. Aside from a few quirks, you can consider it exactly like a 401k. Use it!
The TSP has a Roth option. It comes with a 1% free match, and a total of 5% match.
Max out your TSP if you are a VA physician. Do the Roth if you are making less than usual or if you are a supersaver. And for the love of god get the federal pension and health care!
Other Governmental Physicians
Non-VA governmental physicians might work for local, state, or federal healthcare facilities. This means you have a governmental 457 (as opposed to a non-governmental 457… you must know the difference).
The governmental 457 is awesome and should be maxed out after you get your match. It just might be the best retirement plan in existence! There is no penalty for early withdrawals once you separate from service, and the governmental 457 can just be rolled into an IRA if you want.
So, do this: get your match (usually by contributing to a 403b, but it could be the 401a). After you have your match, fill up your 457b. Next, if you still want more tax-deferral, go back and fill up the rest of your 403b or 401a. Remember the 457 limits are completely separate from the other retirement plan limits. That means 20.5k plus 20.5k plus the match.
There might be a Roth option somewhere in the mix.
And, as a bonus for Governmental plans, you may be able to put in an extra 15k in your 403b the 3 years prior to traditional retirement. This is just for governmental 403b plans! Here is what the IRS says about these plans. And Here as well.
Finally, for you governmental physicians of the world, please do not invest in TIAA or in annuities in your pre-tax retirement accounts! Avoid annuities in tax-sheltered accounts. There are very few exceptions to that rule. Avoid TIAA because it is chock full of hidden fees and screwed over teachers for generations (and sadly continues to do so to this day).
Physician Retirement Plans if You Work at a Not-For-Profit Hospital
The 401, 403, 457 dance gets more complicated when you work at a not-for-profit hospital. The first decision you need to make: should I invest in the non-governmental 457?
Should I Invest in the Non-Governmental 457?
In short, the NG457 is not your asset, may have bad distribution options, and you should only use one if you know what you are getting yourself into.
If you do use your 457, you can defer an additional $20,500 a year. Please understand that the 457 limits are entirely separate from the other retirement plan limits. A NG457 can be useful in early or traditional retirement, but a NG457 is generally not a good idea early in your career.
401a vs. 403b, 401k: Other Retirement Plans for Non-Profit Hospitals
After you figure out if you want to invest in your NG457, the next problem to tackle is how your retirement plan is set up. You might have a 403b that matches into a 401a, a stand-alone 401a (which both you and your employer fund), or a 401k that has the chassis of a 401a.
Yes, not-for-profit hospitals are starting or switching to 401k plans which were typically reserved for corporate for-profit entities. After some tax law changes in 2006, you can have a stand-alone 401k plan and the match goes right into that 401k.
Prior to this and still most commonly, hospitals set up a 403b plan for your employee contributions ($20,500 a year), and the match goes into a 401a. A 403b could take your employer’s match, but if they do it that way there is no vesting and the money is yours right away! Of course, they want you to have to vest so you stick around for at least 6 years after signing. Golden handcuffs lite.
If you have a 403b and a 401a, your hospital may switch you to a 401k in the near future. Let’s look next at this evolution.
Non-Profit Hospital Retirement Plan Evolution
F****** is a large retirement plan provider for the non-profit hospital space, and they are trying to “modernize” hospital retirement plans. Instead of a 401a and 403b, they are trying to get hospitals to go to a 401k plan.
To boot, this is slightly confusing because your plan will say “XYZ Hospital 401k Plan” but in the small print it will say 401a plan. This is why I say it is built on a 401a chassis, but now you can have vesting of employer contributions all in one single plan. These plans are just different subsections of IRS code in section 401, so it doesn’t really matter all that much.
F specifically recommends 403b/401a plan consolidation in the above document. They say these plans are at risk of non-compliance, more expensive, and are confusing. Instead, they suggest switching to a 401k or a safe harbor 401k.
If this happens to you, your 401a will be frozen or terminated. If frozen, you will still need to vest. And if terminated, they will vest all your money and you can transfer it into your 401k. Which option do you think most employer will take?
Comparing Retirement Plans 401a vs 403b vs 457b
Just to nail things down, let’s go over the most common comparisons. Remember, this is not applicable if you are a Governmental physician.
401a vs 401k
This is the account where you get your match. Of course, with the 401k, it is also where you do your contribution.
401a vs 457b
The non-governmental 457b plan is an entirely different beast and requires separate considerations. Do not confuse a NG457 with any other type of plan.
401a vs 403b
You might have both of these plans. This is where you will contribute your employee funds (403b) and get your employer match (401a).
401k vs 457b
These plans, aside from the independent $20,500 you can contribute each year, have almost nothing else in common.
401k vs 403b
See the discussion about the evolution of physician retirement plans, above.
If you work at a church, then don’t read this. There are blogs devoted to your plans.
If you are a teacher, then avoid TIAA and annuities inside retirement accounts and do your best to figure out the rest. Again, there are blogs devoted to helping teachers overcome the past abuses they have been put through by the retirement industry.
How to Invest in your Physician Retirement Plan
Next, let’s do a deep dive into how you actually invest in your physician retirement plan.
Let’s look at the brochure, the plan summary document, matching, vesting, contributions and which investments you might want to select.
How do you set up and invest in a 401a? Or your 401a vs 403b vs 457b physician retirement plan?
The Glossy Brochure
Most still get a 401a or 403b brochure during onboarding. Glance through it, but honestly there isn’t a ton of useful information. Notice the match and the vesting schedule if mentioned.
Vesting Schedule and Match in your Physician Retirement Plan
Now we are getting somewhere! You can see the vesting schedule and the match for a 401a. This is useful!
Vesting is either graded or a cliff. A cliff would be, say, 100% vested at year 3. If you leave before year three, you don’t get any of the match. Your contributions are always yours.
You can see the above vesting schedule is graded, which means the longer you work, the higher percentage of the match you get to keep.
And the match?
Matches are Free Money!
The match in an employer-sponsored retirement plan is important! Of course, with your own contributions you get an income tax deduction.
But if your employer matches say 3%, you get an instant 100% return on your 3% investment! The Match is part of your salary, don’t leave it on the table. Make sure you are always investing enough to get matching contributions.
How much do I need to invest to get the match? You can see above there is a basic contribution that every eligible employee gets which is 1% for my plan. Some plans (especially Safe Harbor ones) are more generous with the basic match, but most plans don’t have any basic contribution.
The matching contribution in my plan is 100% of the first 5%. So, this means if I put in 5% of my salary, I get 5% match plus 1% basic = 6% match. Again, plans can have different matches. Know your 401a plan matching contributions! This is essential for 401a plans!
Also note, there is a $280k salary limitation on matching contributions. If you make $400k a year, you will only get the match on the first $280k of your salary no matter how much you contribute.
So, how much should you contribute?
How Much Should You Contribute When You Open Up a 401a?
You can contribute a percentage of your biweekly salary up to your $20.5k maximum (in 2022) employee contribution limit. This can either be pre-tax or Roth (if your plan has a Roth option). The employer match is always pre-tax. They want the tax write-off for their matching contribution.
If you make $205k, you can contribute 10% and get your full (or “max out”) employee contribution of $20.5K.
Let’s do some quick math. Say you make $400k a year and contribute 10%. Well, that would be $40k, and you can only contribute $20.5k. So, by July you would have maxed out your 401a.
This is called front-loading. Some plans allow you to put up to $20.5k in your first pay period of the year (assuming you earn that much). Is that a good thing?
Front-loading Contributions 401a Essential
Be VERY CAREFUL Front-loading your 401a. You might not get your match!
Some plans will only match evenly throughout the year, so you have to be putting away money every pay period to get the whole match. Other plans will true you up.
What is a True-Up?
A true-up is when you plan makes sure you get all of the match that you are eligible for, even if there are monthly limits they match. So, say your company matches 6% but only will match 0.5% per month. If you max out your employee contribution at month 6, you will only get half of your match during the first six months. If your plan has a true-up, you will get the rest next year. If there is no true-up, you lose out on half of the match!
Summary Plan Description
So, to see if your 401a has a true-up or not, find the Summary Plan Description. Sometimes this can be found online, and sometimes, you will need to ask HR for a copy. By law, not all 403b plans will have a summary plan description but they should have something similar.
I found my 403b plan’s Summary Plan Description online and searched for “true.”
My plan does have a true-up. So, I can front-load my plan, but I might not get my full match until next year!
What Investments Should I make in my Physician Retirement Plan?
So, now that you know your contribution level, match, and vesting schedule, it is time to invest!
Please note that you have to set up your contribution investments in addition to the allocation for the funds that already exist in your account. You have to change both the contribution and the existing funds if that is your intention. Just changing the contribution investment doesn’t change your overall asset allocation.
What should you invest within your 401a? On-line, you get something like this:
Ok, so do you want to look at the 1, 3, 5, or 10-year results when you decide what to invest in?
None of the above!
This is, perhaps, the most common mistake people make when investing in their 401a. As they say, past performance does not predict future results! Don’t even look at the past performance. Ignore this screen!
You need to decide now if you are going to use a target-date fund or determine what your own asset allocation should be in your 401a.
To know what your options are, you need to understand what you examine when you are picking funds in your 401a.
Pay Attention to Fees!
Remember, the best correlation to future returns are current expenses—fees. You can tab over from average annual total returns to fees and find the Expense Ratio.
Here, you can see a S&P 500 index fund has an expense ratio of 0.015% whereas TRP MID CAP GROWTH is 0.75%. Doing the math, that fund is 50 times more expensive!
Remember, fees matter! You don’t know how two funds will perform in the next day or decade, but you do know how much they are going to cost you! Fees are the only real predictor of outcomes that you can control!
How about the target date funds? How much do they cost? The Gross expense ratio is 0.74%. Ouch, that’s high! Hold on to that number for a second, because the gross expense ratio can be misleading as we will see in a moment.
Do you want a Target Date Fund or will you create your own Asset Allocation?
I used Morningstar to pull the asset allocation from the 2050 target-date fund. Likely, you can find it when you click on the fund in your 401a online platform.
It is essentially a “three-fund” portfolio with 52.9% US, 34.5% international, and 12.4% fixed income and cash. Well, that’s not horrible.
Also, when you click on the link, you can see the “net expense ratio” is 0.37 compared to the gross expense ratio of 0.74%. This means that you are getting a discounted price on the price quoted in the prospectus.
How does 0.37% compare to national averages? Fees on target-date funds are coming down year after year. I still think 0.37% is expensive, though the recent national average is closer to 0.78%.
Can we do better choosing our own funds? Let’s look at equities (stock mutual funds) and fixed income (bond mutual funds) that are available and see what it would take to create a three-fund portfolio of 60% US, 30% International, and 10% fixed income.
Sometimes, when you are choosing your asset allocation, you decide to “tilt” to certain factors. This tilt actually increases your risk, which should increase your returns over the long haul. Small-Cap and value are common tilts. Neither are available to us. Explore the options for your 401a to see what passive index funds are available to let you decide on your US equity exposure. For me, it is 60% in the S&P 500.
You see there is a decent international fund with an expense ratio of 0.055%. This is the global ex-US index. “Ex” means except, so this is the world minus the US. Let’s put 30% in there.
So far, we have 60% at 0.015 plus 30% at 0.055. What about our 10% bonds?
Fixed Income Options in your 401a
Just for fun, I included in the “income” version of the target date fund on the very top. This has 80% fixed income and is for when your target date is “now.” Next is a very active long-short fund with an expense ratio of >1%. Ignore that.
So, the bottom three are our three fixed income options. On the very bottom is the money market account. You can see the expense ratio of 0.42% and its 1, 3, 5, and 10-year returns.
Yes, do look at returns on bonds. In fixed income, the expected return in the next 10 years are actually quite closely correlated with current yields. And there are some reasons to use active funds in the bond world. Bond mutual funds are complicated, and a complete discussion is beyond the scope of this blog. We are looking for 10% to make our asset allocation 90/10; which bond investment would you choose?
We have a total bond fund vs. an inflation-protected bond fund. Since we are young a let’s go total.
Cost of Asset Allocation
So, the final 10% fixed income costs us 0.37%. Cost of our 60/30/10 is 0.0625% vs. 0.37% for the target date fund.
The target date fund is almost 6x more expensive. If you have $10k invested, you will pay $6.25 or $37.00 per $10k per year.
This may not seem like a lot, but what if, with a match, you put in $34k a year over 20 years and earned 7% minus the above expense ratio? The difference is $45k over 20 years.
If you spend an hour a year managing your 401a (and why spend more?), you can save over $2000 a year in average costs despite even a fairly good target-date fund.
Investing in your 401a vs 403b and 457b
We have learned about vesting and employer matching. About contributions and front-loading.
To summarize how you should invest in your 401a: either pick a target-date fund or decide in advance your asset allocation given the available options.
Pick low cost, passive index funds for equities. Bonds are a little trickier. But you should have bonds.
Most importantly, understand that your 401a is just one asset location in your asset allocation.
As you have multiple investing accounts, you don’t need every fund in every location. Decide which good fund options you have in your new 401a, and then fit those options into your overall asset allocation.
Summary: Physician’s Retirement Plans: 401a, 403b, and 457b plans
These plans are all employer-sponsored retirement plans that allow you to defer income. 401a vs. 403b vs. 457b are all pretty much alike.
The 401a plans are particularly confusing, as they can be called money-purchase or profit-sharing retirement plans. The functionality of these plans depends on if the government or a not-for-profit hospital employs you.
The 403b plans were initially designed to house annuities, but then gained functionality to allow custodial investments in mutual funds. Now, they are a dying breed, and for the most part will be relegated to history.
The 401k plan (which may be built on a 401a chassis) is the future for not-for-profit hospitals.
Finally, 457 plans are to be treated with extreme care if non-governmental, and beloved if governmental. Remember, contribution limits for 457 plans and other employer retirement plans are separate, so consider filling up both!
Yes, all are tax-deferred. Which should you invest in and in what order? The answer depends on if you are a employee of the government or not.