Money Matters:
Retirement Plan Options for Charter Schools
by
Randall Bingham

One of the biggest problems with money is that it doesn't come with any instructions!

Retirement Plans

Take full advantage of tax-deferred savings plans. With tax-deferred savings vehicles... you pay no taxes on investments until you begin to withdraw the money at retirement. That means the amount you would ordinarily pay in taxes remains in your account to accrue even more dollars.
Source: Your Money magazine

Deferring the impact of income taxes is worthwhile because of the dramatic increases in investment returns you can achieve. Simple strategies for deferring taxes are available to everyone, although many people fail to take advantage of them. Perhaps they don't understand the bonanza that occurs when taxes are deferred on interest income & profits. Source: Terry Savage's New Money Strategies for the 90's by Terry Savage, HarperBusiness

While private industry offers its employees 401(k) plans, public employers offer similar plans under different names. Government employees may participate in 457 plans. School boards, hospitals and other non-profit entities offer 403(b) plans. They are all cousins... the names come from sections of the tax code.
Source: The Herald by Ted Reed, Herald Business Writer

Sometimes the TSA- 403(b) deposits from the monthly paycheck have little, if any, impact on take-home pay. Remember, what counts is not what you make, it's what you keep. By reducing your taxable income each month, you might slip into a lower bracket and not lose very much of your monthly cash allotment. Source: Financial Tips For Teachers by Jay Weiss & Larry Strauss, Lowell House

In the final synopsis, it's not how fast the runners start off the line, or how much bigger and stronger they are. The only thing that really matters is who crosses the finish line... “We don't worry as much about percentage of growth as much as dollars of growth. Put another way, if method "A" showed you a way you could get a 12% return and at the end of 5 years you were a thousand dollars better off and method "b" showed you a way you could get only a 6% return, but also showed you how to reposition and leverage your assets, and at the end of the same 5 years you were one thousand two hundred dollars better off, which method would you choose?” Mike Hodson, president of PRO Financial Group

There are two basic retirement plan types, and variations on those types. There is a “Defined Benefit” plan, which describes what the output of the plan will be and there is a “Defined Contribution” plan, which describes what the input of the plan will be.

Our mandatory government plans are “Defined Benefit” plans. The Social Security System and State Retirement Systems, where the guaranteed outcome of the plan is described in advance, but the cost of the plan is not, are examples of Defined Benefit plans. Market conditions and demographics will change the cost of the plan. For example, advances in health care that assist people in living longer, were not conceived of 30-50 years ago when monies were being put aside to eventually pay out the guaranteed benefit to retirees. Such expenses are required to be covered by today’s contributions. The state that I am most familiar with has raised its contribution rate over the past few years from 3.6% to 7.4% of the payroll of participating employers. We’ve all watched the changes to Social Security Tax costs over the past years. The current heated national debate over Social Security is an argument over which type of plan is better for the citizens, a defined benefit or a defined contribution plan.

In some states, the choice to participate in the state employees retirement system or not is left up to the qualifying organization. Just like the private sector, the public sector employers are starting to look very closely at the unknown future costs associated with a defined benefit plan. An organization that desires to have a guaranteed, defined benefit and at the same time wants to control the input costs, to a degree would be able to establish a 412 plan that uses life insurance and annuities to fund that specialized plan. However, in most cases, employers are turning to the Defined Contribution plans because it puts the investment risk and responsibility on the shoulders of the individual employee.

I am not going to even consider in this article the glorified IRA plans such as the SEP or Simple 401(k). While they are defined contribution plans, they are inferior to the alternatives that I will list. The names of the different plans are taken from the IRS Code Section that describes the plan and its provisions. Thus we end up with names like 401(k) plans and 457 plans and 403(b) plans. These are defined contribution plans that allow employer and employee contributions. In the matrix below, I’ve tried to point out some unique points about the various options.

There are many other differences and considerations between the options listed above. Any decision to establish a plan for your organization should be given careful thought and planning. The 401(k) option is very popular and easy to find, however, it could very well be the most expensive option. If you are a for profit organization, then it is your only choice. For those that have the non-profit status, consider the other options that have little or no cost and greater benefits for tax deferral.

There is a major point of consideration that I often see left out of the decision process of which plan to pick. The retirement plan is a financial tool that affects the financial well being of all the employees that will be offered the benefit. How are the employees going to be able to use the tool? I believe that everybody should plan to reduce their current tax costs as much as possible. Everyone has reasons to defer spending and if the spending is to be deferred, then taxes should also be deferred. The retirement plan has the capacity to help an employee defer taxes, but based on their current financial condition, some have less capacity to do so, unless the plan is created to help them. For those that are just beginning to save, full access to savings is very important as are guaranteed returns. As the employee progresses from being a saver to becoming an investor, the needs for access change, but the variety and composition of the investment choices become critical. Recent portfolio management studies show that over 75% of the rate of return is based on the correct asset allocation, not market timing, and not individual stock selections. How does the plan address that need? For those that are sophisticated investors, how is the plan going to support their need for tax savings and individual choices? All of these needs are in conflict with each other because it is difficult to have a simple plan and offer aggressive investment choices and have guaranteed choices at the same time. I reviewed one plan for a group of about 100 employees that was set up with a major wire house stock brokerage firm. The access to high end investments was what the decision makers wanted to have. They now have a plan with only 15 participants, even though they are offering a 3% matching contribution. The rank and file employee does not perceive the plan to be anything more than a opportunity to lose their money. It is well known throughout the organization that the participants (highest paid, smartest investors) lost money with their stocks, so who wants to be involved with that? The organization is spending a lot of administration fees on a plan that only helps 15% of the employees and the other 85% have one more reason to be angry at the organization.

I have worked with Charter Schools with as few as 4 employees and others with over 200 employees. Here’s what I try to do: