Understanding Your 403(b) Retirement Options: A Tale of Three Investments

Welcome to the world of retirement investing. When you're just starting your teaching career, the options can seem overwhelming, but at their core, they often come down to a single, fundamental choice of philosophy: Is your primary goal to maximize the growth of your 403(b) account, or is it to obtain guarantees, like a protected principal or a lifetime income stream? There is no single "right" answer; the best path is unique to your personal goals and comfort with risk.

This guide will explore three common 403(b) investment products available to public school educators to help you understand the trade-offs between growth and guarantees. We will break down how each one works, examine a real-world historical scenario, and even look at a hybrid strategy that seeks to combine the best of both worlds.

Let's meet the contenders that represent these different paths to retirement.

Meet the Contenders: Three Paths to Retirement

To understand the core differences in investment philosophy, we will break down the fundamental characteristics of three distinct options: a low-cost mutual fund, a variable annuity, and an equity index annuity.

The Low-Cost S&P 500 Mutual Fund: The Growth Engine

The primary goal of this investment is straightforward: to achieve maximum growth by directly mirroring the performance of the stock market, specifically the S&P 500 index.

• Market Exposure: It provides full exposure to the market, meaning the account value directly mirrors the S&P 500's gains and losses.

• Costs: Its costs are extremely low. The annual expense ratio is typically around ~0.10%, meaning very little of your money is lost to fees.

• Key Benefit: Its main advantage is the highest potential for growth. This is a direct result of its low fees and full participation in all market gains.

The Variable Annuity: The Guarantee Seeker

A variable annuity also invests directly in market-based accounts, but it does so with higher built-in costs in exchange for the option to purchase powerful guarantees.

• Market Exposure: Like the mutual fund, it offers full exposure to market gains and losses.

• Costs: Base fees for a variable annuity can be around 2.5%, but adding an optional income rider typically adds another 0.5% to 1.5%, bringing total annual fees into the 3% to over 4% range.

The most powerful optional feature is a Guaranteed Lifetime Income Rider. Its function is to provide a protected income stream you can never outlive, even if poor market performance causes your actual account balance to drop to zero. This is possible because the income isn't based on your fluctuating cash value. Instead, it's calculated from a separate, protected "bookkeeping number" called the benefit base. The significantly higher fees are the direct cost for this insurance; the insurance company takes on the risk of paying you for life, and the fees are its compensation for that powerful guarantee.

The Equity Index Annuity (EIA): The Safety Net

The Equity Index Annuity (EIA) is an insurance product designed for investors who prioritize safety and the protection of their principal investment above all else.

• Market Exposure: It offers limited, or capped, exposure to market gains. Crucially, it provides full protection from market losses, often referred to as a "0% floor." If the market goes down, your principal does not.

• The "Cost" of Safety: Unlike products with direct annual fees, the primary cost of an EIA is an opportunity cost. The insurance company limits your upside potential through features like caps (a maximum return you can earn in a year) and participation rates (the percentage of the market's gain you receive). Furthermore, returns are typically calculated without including stock dividends, which are a major driver of long-term market growth.

• Key Benefit: Its main advantage is the absolute protection of your principal from any market downturns.

• Now that we understand the theory behind each option, let's see how they would have performed in a real-world historical scenario.

A Real-World Test: The 1988-2008 Investment Scenario

Imagine an investor who contributes $10,000 per year for 20 years, from the beginning of 1988 to the end of 2007. They contribute a total of $200,000 over this period. At the end of 2007, their account has grown significantly, but they are then faced with the historic market crash of 2008, where the S&P 500 lost approximately 37% of its value.

Performance Before and After the Crash

The table below shows how each of our three investment options would have performed in this exact scenario.