Updated: Jun 11, 2019
An overview of retirement savings for teachers in the Tri-Cities and Thumb
Private companies often implement a 401(k) plan for their employees so they can save for retirement. For public employees like teachers, the savings plan is labeled a 403(b) but is functionally the same as a 401(k).
Over the years, there has been a growing push from the department of labor to make sure fees for retirement plans are reasonable. The department of labor is working with the Securities and Exchange Commission to find the best way to hold advisors of retirement plans to the highest standards. However, this rule pertains to assets that are subject to the Employee Retirement Income Security Act of 1974 (ERISA). Public schools do not fall under the ERISA guidelines of retirement plans; and therefore, do not benefit from the higher standards. What this means for teachers is they are often subject to paying sales charges and annuity fees that greatly reduce their returns in their 403(b). Most schools have good low cost options available; however, they often get lost in the shuffle of a large list of vendors for participants to choose from.
Luckily, those vendor options are available online for someone like myself to sort through. If you are a teacher and would like me to look over your 403(b) options to see if you are in the best plan for you, click here to contact me and get an analysis free of charge. It is important to note when dealing with 403(b)s that YOU DO NOT NEED TO BE AFFILIATED WITH THE PLAN TO ADVISE ON IT. Do not accept the answer of “we have to use this plan or else I can’t manage it.” It simply is not true. Often the real reason is, “if you don’t use this plan, I can’t earn commissions on it.” I would be happy to go over all the options with you. After digging through a lot of this data, I can tell you the information isn’t exactly straight forward and you have to know where to dig. If your school is not listed, I can still do this analysis.
In the rest of this article I will go over in detail:
Why do teachers pay more investment fees?
What questions do you need to ask when enrolling?
What are some of the common plans in my area?
What are some of the low cost plan options?
What do I need to do if I am caught in a high fee retirement plan?
Why Teachers Pay More Investment Fees
Part of the issue why teachers pay more investment fees than the average worker is because schools are not required to follow the ERISA guidelines that other retirement plans do. There is no regulatory pressure to limit investment fees for teachers.
The other issue is the vendor model in which teachers are subject to. In 401(k) plans at private companies, the plan is set up for all employees. The plan sponsor or company selects the 401(k) provider and works with them to determine investment choices. As companies grow in size and participation grows, the balance within the 401(k) plan can become quite large. What this does is set up a very competitive environment for providers looking to earn that business. Often, businesses are approached by different 401(k) providers to bid on the plan. When they bid on the plan, they are looking to improve investment options and/or investment costs. This competition often benefits the participants as providers look for ways to add value to them. If their offering is not competitive, they risk losing out on millions of dollars to manage. As a result of this, the average fee for 401(k)s has been trending downward.
The 403(b) market for schools does not work this way. The retirement plan is, for lack of a better term, a free for all. There is a list of vendors that are authorized by the school. There are no real standards on the criteria or amount of vendors available across different schools. To give you an example of this: In Bay City Public Schools, there are 19 different vendors listed on the TSA consulting group’s website. In Ubly Community Schools, there are 6 different vendors. In Freeland Community Schools, there are 11 different vendors. The 35 schools in the Tri-City and Thumb Area listed on TSACG.com averaged just over 10 different vendors per school. Keep in mind once you select a vendor; they often have a menu of choices within the offering. In the total between the 35 schools, there were 47 different vendor choices. Here is the complete list of schools I was able to get data on:
This complicates the decision making process and leads to information overload. Comparing 2 different vendors is just easier than comparing 19 different vendors. This is also magnified when there is not a person in charge of vetting plans for participants. Every participant needs to do their own research every year. As a fiduciary financial advisor, this is my job, and I know what to look for. As a teacher, this is not your job nor should you know what to look for. Plus it takes time to do all of this because as I can attest, sometimes the information is not readily available or transparent. As a result of this, there is a lack of information and consensus among participants to improve 403(b) options for teachers.
Another factor as to why 403(b)’s for teachers are higher in fees is the majority of the vendors are annuity based. Of the 47 different vendors in the area, 64% were variable annuity options. The top 3 providers in the area, AXA Equitable, AIG/VALIC, and MEA Financial services, all have variable annuity options that are frequently recommended. Variable Annuity contracts charge extra expenses on their investments. There is a charge called an M&E expense that stands for mortality and expense. This charge reflects administration costs, selling costs and a death benefit if your account value is less than your purchase payments. These range from 0.85% up to 1.50%. The cost you may be paying in a variable annuity is dependent on what product you are in and will be listed in the prospectus. For example AXA Equi-Vest Series 100 has a 1.45% M&E + Admin cost while the AXA Equi-Vest Series 200 is 1.34%.
This extra cost can add up over the long run. For example, a new teacher saving $150 per paycheck into their 403(b) plan paying 1.35% M&E expenses and earning 6% annually on investments would pay an additional $64,000 in expenses over the course of 30 years. For most teachers, this means that you could be working over a full year of teaching just to pay for annuity expenses from your 403(b) over your teaching career. What did that $64,000 get you? It gets you a guarantee that if you pass away, your survivor gets at least your contributions as a death benefit. The only way you would get a payout is if you lost money. Over the long term you are not very likely to use that benefit. The worst 15 year period in the S&P 500 was from 1929 - 1943 and it still generated positive returns.
Without getting into specifics, it is pretty safe to assume that getting life insurance would be more cost effective then paying $64,000 in annuity expenses if you are looking for death benefit. There are reasons to purchase annuities on an individual basis as they often can bring benefits and guarantees that you can’t get in standard investments. It can also provide you the ability to defer taxes. However, the annuities I am speaking about in this situation already get tax deferred treatment by being a 403(b). Group annuities also don’t come with the guarantees and benefits individual annuities often come with. You could be paying an extra 1.35% every year for virtually no benefit.
The mutual fund options for 403(b)s can also have extra fees compared to private 401(k)s. Again, this has to do with working with individuals and not a collective group. There have been improvements in this area for individual investors as fund companies have been offering no-load mutual funds and lowering investment expenses. However, the majority of mutual funds in teacher retirement plans are still being offered as front end sales charge products. That charge can be as high as 5.75%. These front end sales charge mutual funds are known as A shares. Teachers usually have the option to pay no front end charges but higher internal expenses by selecting a C share. C shares usually have much higher internal expenses than A shares and can cost investors thousands of dollars over their working career. There are other mutual fund options that have no front end sales charges and lower internal expenses in the marketplace. Those options are just not the most common for teachers. For example American Funds, which is the most common mutual fund option in the area, offers a no load fund share class called F-shares. These F shares are often not offered in teacher 403(b) plans, thus leaving only A shares and C shares as your choices.
What questions do you need to ask when enrolling?
Here are the questions I would ask when enrolling in my 403(b) to help select the proper vendor:
1. Is this an annuity product? If yes, what are the M&E and surrender charges on the prospectus?
Understanding the fees you are paying is very important. It is also very important to ask SPECIFICALLY for M&E and surrender charges. When I asked a representative about the fees associated with an annuity account, they answered in respect to the annual maintenance fee which was $30 a year and completely glossed over the M&E charges. The M&E charges were left off the fact sheet in the fee section. You could only find this in the prospectus. That M&E charge was 1% annually which in larger accounts obviously is more than $30/year. I would have the advisor on the plan show you on the prospectus and not on a fact sheet as a result of this omission.
2. Is this mutual fund based? What are my share class options?
Along with question one, it is important to understand if the plan is an annuity or mutual fund based plan. If it is mutual fund based, you want to know if they are only recommending A shares or C shares. If they say that is all that is available, evaluate other options. The plan they represent might not offer other options, but others often do. If a representative says they don’t use A or C shares, ask again to make sure it is not a variable annuity.
3. Do you offer loan options?
This feature would allow you to take a loan out against your retirement savings if you needed money for something. This is not an essential feature, however you should know all options.
4. As the advisor, how often do you meet with participants?
This question will help you get an understanding of expectations you should have for your advisor. Some advisors like to meet on a scheduled basis, others will be available whenever you need them. Find an advisor that fits your needs.
5. Do I call you, the advisor, for help or is it an 800 number?
One of the best ways to figure out if there is a conflict of interest in your retirement plan is to find out if the person who signs you up actually advises you on it. If the person gives you an 800 number, more than likely their objective is just to get new participants. If that is the case, the primary objective might not be to help find you specifically the right plan.
6. How do you help make recommendations on the investments I choose?
You will want to learn what all factors someone takes into consideration when making investment recommendations. Some people only use risk tolerance, others rely only on age. The more information that is considered when making recommendations usually the more likely your investments will match your objectives.
7. How do you make recommendations on the amount I should contribute?
How much you should contribute can often be a more important decision than where to invest. The most common answer is, as much as you can. See if the representative can give you more insight then that.
8. Is there a Roth option available in the 403(b)?
Depending on your tax situation, utilizing a Roth 403(b) vs a Traditional 403(b) could make more sense. See if saving into a Roth 403(b) is even an option. Most plans in the area do not have the option, however it does not hurt to ask.
9. Should I be saving into a 403(b) or a Roth IRA?
This is an important question because saving into a 403(b) might not be the best option for teachers. There are pros and cons to saving outside of your 403(b). Ask a professional what they would recommend. Your tax situation should dictate this choice.
10. Do you offer non commission-able products?
Find out if the advisor offers products they don’t earn commissions on. A lot of times advisors earn commissions on their recommendations that can cause a conflict of interest.
11. Are you a fiduciary that has to act in my best interest?
There are 2 types of standards that most advisors adhere to. 1. I have to make suitable recommendations and 2. I have to act in your best interest. The Fiduciary standard is a higher standard.
12. Do you offer comprehensive financial planning?
If the advisor does, this is something you might want to explore more. The 403(b) choice is a small part of your overall financial situation. If the representative does not offer comprehensive planning, it can cause them to make sub-optimal recommendations due to not having your full financial picture. Full comprehensive planning does not just mean that person also sells insurance along with their investments. Full comprehensive planning includes looking at income taxes, estate planning, and benefit planning.
These questions will help you get a good idea on who you are dealing with. Generally if representatives are not aware of the options or costs of their products, or hand you information that they can’t answer themselves, you might want to look at other options.
What are some of the common plans in my area?
Here is a breakdown of the options available in the Tri-City and Thumb area. On the chart, annuity option means the 403(b) can also be a variable annuity with higher expenses. I want to be clear on this: Just because there is an annuity option for your 403(b), DOES NOT MEAN YOU ARE IN AN ANNUITY. Check with your advisor on the plan to see. For example, MEA financial services offers 2 different plans. The MEA 7000 plan has zero M&E expenses or surrender charges while the 6978 plan does. Thrivent Financial often has multiple platforms that can be utilized for mutual funds and annuities. Also, if one of your providers are not annuity based, check to see if you are in A Shares or C Shares. Look to see if you have an option for no load share classes. If you do have that option, ask your advisor which one makes more sense and why.
What are some low cost options available?
Here are the options that primarily offer low cost investment options. Again, this does not mean that your current provider does not offer low cost options. Some of the vendors are planners and have different options available. On the list, Ameriprise is the best example of a vendor capable of this. They have multiple different investment solutions ranging from annuities, front end load mutual funds, low cost no load funds, and ETFs. The best source is to ask your advisor what your options are. The list of vendors that primarily offer no load funds are as follows:
-MEA Financial Services 7000 plan. The 6978 plan is annuity based with a 1.00% M&E Charge. The 7000 plan has more options without a surrender charge, M&E expense, or fund sales loads.
-T. Rowe Price
What do I need to do if I am caught in a high fee retirement plan?
What happens if you find yourself in a high fee retirement plan that doesn’t make sense in your situation? The first thing you need to do is see what your other options are. If your plan does not offer any options that you like, ask your administration what the process is to add another vendor.
What if you already have another option in your vendor list that you like? Participants are allowed to transfer vendors within the plan; however, if your current plan is an annuity or a C-Share, there may be penalties to leave the plan. If there is a penalty, compare the costs of paying the penalty vs. the cost of staying in the plan. If it is cost prohibitive to leave the plan, stop making contributions to your current plan and start a new one. After a certain time, the penalties will go away, and you can make the transfer at that time. You do not want to keep contributing to the wrong plan.
Lastly, you need to evaluate if it even makes sense to be contributing to your 403(b). Sometimes contributing to your 403(b) can be the easiest option, but isn’t actually the best option long term. There are other options available outside of the school system. You aren’t able to transfer out your current 403(b) savings, but you can stop future contributions to it at any time. You should speak with your financial advisor to see if this makes sense.
If after reading this you still have questions about what makes the most sense, please contact me at email@example.com. I will be happy to look at your plan free of charge to help you evaluate what you currently have and what your options are.
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