Welcome to this week’s edition of Your Financial Weekly Reader. Each week, we try to bring you a few articles that we’ve found from various sources that might be helpful to you and your financial situation. This week I’m changing it up a bit by discussing just one article, but it’s an important one.
The article is from InvestmentNews and is meant more for advisors like me than the general public, but it’s such an important issue that I want to share it with you. It’s especially important if you are a teacher or public school employee, or if you work for a nonprofit. If you aren’t a teacher or you don’t work for a nonprofit, you probably know someone who is. Please share this important information with them.
For as long as I’ve been in the financial planning and investment management business (which is a l-o-n-g time!), I’ve been frustrated with the retirement plans that school boards and nonprofit organizations offer to teachers and other employees. For a long time, I thought it was just a local problem, but over the years, I’ve learned that it is happening in school districts and nonprofits across the country.
So, what’s the problem with these plans? First, a little explanation for those not familiar. A 403(b) plan is the public-sector version of the more well-known 401(k) plans that many of us are offered through our employers. A 401(k) plan is subject to the Employee Retirement Income Security Act (ERISA) of 1974, a federal law that sets minimum standards for retirement plans. I didn’t realize it until I read the article that the 403(b) plans offered through school districts are not subject to the same rules. A topic for a separate conversation would be ... why not?
If you participate in a corporate 401(k) plan, the ERISA rules offer a fairly high degree of protection, including that your plan sponsor or provider acts as a fiduciary and keeps investment and other costs as low as possible. Not so in the 403(b) market. The plans offered by public schools and non-profits are subject to the much-more-lax state fiduciary laws. As the article states, this inevitably leads to shady sales practices and high fees.
The article addresses the announcement that the U.S. Securities and Exchange Commission (SEC) is investigating the compensation and sales practices in school districts and nonprofits across the country. The SEC investigation is focusing on “producing TPAs (third-party administrators),” which provide brokerage services and investment advice to these plans. The SEC is looking into how these providers are paid and what is disclosed to plan participants, the teachers and other employees.
The article also reports that about 76% of assets in 403(b) plans are held in annuities. That is shocking! Annuities are the highest-cost investment vehicles on the market, with fees and expenses often in the 3–4% range. A good argument can be made that annuities are not investment vehicles; they are insurance products, and the fees and expenses are to pay for the insurance benefits in the plan. Typically, annuities are also the highest-commissionable investment product, giving an incentive for the salespeople to put them in the plans. But 76%? While there are times when the insurance benefits in a retirement plan can make sense, it is not very often—and certainly not for three-quarters of the teaching and nonprofit population.
The SEC has begun fact-finding on the problem and has requested information on a wide variety of topics in the 403(b) marketplace. They are asking questions that need to be answered. For example, what is the organization’s role in selecting the approved vendors in a plan? I’ve often thought that the process resembled a “good old boys” network and suspected that it was not a level playing field. They are also looking at gifts and compensation received from a school district or vendor, and policies regarding conflicts of interest.
Hopefully, the investigation will begin to shed some light on this very dark segment of the retirement plan market. Our teachers and employees of nonprofit organizations are very good at what they do but usually do not understand the retirement plan and investment world. They put their trust in these “approved vendors” and are often steered into plans that are not appropriate. The plans are so bad that, for my clients who are teachers or are members of a nonprofit, I often suggest that unless they are given a matching contribution by the employer, which is rare, they do not participate in the plan. They can do much better contributing to a low-cost IRA or Roth IRA outside of their plan.