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| Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 4) |
| by
W. Scott Simon
| 07-05-07 |
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Section 403(b) was first added to the Internal Revenue Code (IRC) in 1958. In 1964, regulations were first issued that detailed some of the basic statutory provisions of section 403(b). The Internal Revenue Service is now in the process of finalizing new regulations to govern 403(b) plans. The best guess at present is that these regulations, the first in over 40 years, are to become effective Jan. 1, or shortly thereafter.
A Suggested Model 403(b) Plan
The new 403(b) regulations make clear that officials at school districts offering 403(b) plans will take on some fiduciary duties to plan participants and their beneficiaries. Smart (or even purely self-interested) officials should understand that by placing the interests of 403(b) plan participants first, they will gain the greatest fiduciary protection against lawsuits filed by the government and the plaintiffs' bar. (I know, I know, such officials are protected by governmental immunity laws, contractual indemnity clauses and insurance policies. Yet I don't know of anyone, including school officials, who likes to prepare for, and be subjected to, depositions and the other niceties of modern litigation.)
The truly wonderful thing about placing the interests of 403(b) plan participants first is that it also actually produces the best outcome for them. A "win-win" if there ever was one. To help ensure that outcome, though, school district officials must jettison the absurdities currently plaguing so many 403(b) plans. What follows, then, are some suggestions for creating a model 403(b) plan.
1. Get rid of the multi-provider model and adopt the single-provider model. The multi-provider 403(b) model, which is the most prevalent by far at school districts, allows teachers to choose their investment options from among more than one retirement plan services provider such as an insurance company or mutual fund company.
The multi-provider model can be confusing to teachers (or anyone else with a pulse) and often generates the "deer in the headlights" phenomenon: teachers have so many investment options they make no selections at all, or make them by throwing darts. This model has reached its logical absurdity in my state of California where, as a result of adoption of insurance code section 770.3, California teachers get to choose from (at last count) 123 providers - each of which has a glut of investment options.
The multi-provider model also balkanizes the 403(b) assets held by teachers into separate insurance contract accounts held at separate insurance companies. Schools districts with no fiduciary duties don't need to keep track of all that money so they have no incentive to try to get a low cost deal for teachers.
The single-provider model, on the other hand, allows school districts greater purchasing power, thereby resulting in lower and more transparent investment costs for teachers; this enhanced employee benefit gives districts a competitive edge in recruiting teachers. This model also offers a centralized way to provide plan documents, monitoring and reporting of participation rates, monitoring and reporting of participant contributions and withdrawals, a full range of investment options and customized and consistent communication materials, all of which help reduce the administrative burden at school districts.
2. Get rid of annuities and offer only mutual funds. Annuities and other insurance products have their place--just not in 403(b) plans (or 401(k) plans or 457(b) plans for that matter). I have, for the record, purchased lots of insurance products and believe fully in the idea of insurance. I just don't think such products should be on the menu of investment options in retirement plans. They are just too costly. I detailed in last month's column the fact that investment products offered by insurance companies in 403(b) plans cost between 200 and 500 basis points. In his testimony before a congressional committee in March, noted independent fiduciary Matt Hutcheson was less charitable in his estimate of 300-500 basis points. Given this, it just seems crazy for school districts to offer teachers investment options that have an added layer of fees. It's not that such options have no value at all; rather, it's that they do not have value enough to justify their (oftentimes) grossly higher costs.
Compounding this problem is the fact that these costs are usually hidden--because they're high. A cost, under any body of fiduciary law, must be reasonable in relation to the service or product received in return. If a cost is hidden, how is it possible to determine whether that cost is reasonable in relation to the service or product received so that the recipient knows it's getting full value?
Insurance companies favor this kind of obfuscation because it allows them to get away with charging higher costs than would otherwise be the case in a cost-transparent environment. A recent example of this absurdity involved one of the large insurance companies active in marketing retirement plans to school districts. The Los Angeles Unified School District (LAUSD), led by a very well-informed advisory committee, insisted that the insurance company disclose to plan participants a revenue-sharing fee in the district's 457(b) plan. An insurance company vice president refused, stating that "I'm afraid the revenue-sharing would just confuse people."
Apart from the contempt that statement reveals for those who are educating our next generation, perhaps this person could (a) actually try to make revenue-sharing understandable to teachers or (b) better yet, advise his company to do away with its revenue-sharing fees altogether. No school district official should have to spend time debating the intricacies of such nonsense with insurance companies or any other retirement plan services provider. (LAUSD eventually prevailed in this debate.)
Investment products offered by non-insurance retirement plan services providers (i.e., brokerage firms and mutual fund companies) in 403(b), 401(k) and 457(b) retirement plans are generally less expensive but there are still too many of them that are too costly, especially considering their general resistance towards the idea of accepting any fiduciary responsibility. Some of these providers will accept fiduciary responsibility if a 403(b) plan is large enough, but historically they haven't been too keen to do so. The exemption that brokerage firms have hidden behind, the so-called "Merrill Lynch Rule," was struck down by the United States Circuit Court of Appeals for the District of Columbia a few months ago, and this may have a positive impact on the 403(b) investing culture.
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| W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing. Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals. For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. |
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