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Teachers investment plans flunk
403(b) plans could hardly be worse: fees are outrageous, theres no match and there's no oversight.
By Timothy Middleton
A 401(k) is a personal portable pension plan, which you can take from one job to the next. Theres a company match; the boss is on the hook if something goes wrong; hordes of federal regulators are looking over his shoulder.
A 403(b) is what you have if youre a school teacher. You cant always take it with you, at least without incurring steep fees; there is no company match; the boss has no responsibility to know anything about the plan, and he doesnt. There is no cop patrolling this beat.
When self-directed pension plans for teachers, nurses and other not-for-profit workers are not very, very bad, they are horrid. Costs are two to three times those in the private sector, and can nag you for years after youre gone. What you dont lose to greed and mismanagement, you might lose to fraud.
In recent months, Ive written a number of columns describing the nations self-directed pension system, focusing on the strengths and weaknesses of 401(k) plans. But almost any of them is better than almost any 403(b). The insurance companies that dominate this marketplace have done a terrible job of helping workers, but a masterful one of concealing their abuses by simply refusing to reveal them to anyone -- especially the participants whose money they are frittering away.
Its virtually impossible for a (403(b) plan) participant to really understand what the fee structures are, says Tim Burns, founder of Hunter Capital Advisors, a pension consulting firm in West Hartford, Conn. The principal reason: The lack of employer involvement and responsibility, he says.
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Irregular regulation
Self-directed plans for teachers actually predate the 401(k) system by 16 years, and most of their woes are attributable to their unfortunate history. Initially, only insurance companies were allowed to administer 403(b) plans. They continue to oversee more than 80% of the systems $578 billion in assets, owned by 6.7 million participants, according to Spectrem Group in Chicago.
Corporate plans, which cover 41.1 million participants with assets of $1.978 trillion, are institutional accounts, one per company, that are economical to operate. In contrast, 403(b) plans are individual retail accounts that are more expensive to administer.
When the Employment Retirement Income Security Act of 1974 created 401(k)s and the web of regulation to which they are subject, it exempted state and local governments. Today, the Internal Revenue Service takes a glancing interest in the plans, because contributions are tax-deferred. True regulatory oversight is left to state insurance commissioners, for whom pension rights aren't a priority or an area of expertise.
While the Securities and Exchange Commission, which oversees investments offered by 401(k) plans, requires extensive disclosure of fees and other contract terms, vendors of 403(b) plans are only required to make disclosure to the plan sponsor, such as a school district, in its contract. The school, hospital or other not-for-profit employer isnt required to pass this information along to participants, and it doesnt.
California has done the nation, if not its own teachers, a great service by putting the financial disclosure it requires onto a Web site, 403bcompare.com. In reality, it is cumbersome to use and certainly doesnt encourage teachers to join up. Robert Deegan, an official of the Los Angeles Unified School District, says 74,000 of its employees qualify for its plan, but estimates only about one-third participate. That's just a guess, he says, because statistics arent kept.
Expensive, worthless insurance
How expensive is a 403(b)? MassMutual Artistry is an annuity plan that imposes insurance charges on investments equal to 1.03% of assets and administrative charges of 0.15%, for a total of 1.18%. The insurance is in the event a participant dies before taking the money out of the plan in retirement. It ensures that a participants heirs get at least as much as the participant contributed, even if markets are lower. Over the very long term, markets are rarely, if ever, down. So the charge is pure profit for the insurance company.
These charges are in addition to the fees charged by the mutual funds that actually invest the money. MassMutual offers Scudder VIT EAFE Equity Index Fund, which has fees of 1.09%. The total, therefore, is 2.27%, or $227 a year on a $10,000 balance.
Compare this with Vanguard Developed Markets Index Fund (VDMIX), which is identical to the Scudder vehicle except for expenses. Vanguard charges 0.34%, or $34 a year on a $10,000 balance. What the 403bcompare Web site calls fee impact for Vanguard after 20 years is $1,110. For MassMutual, it is $7,618.
The difference, $6,508, comes directly out of the participants pocket, and nothing of value is received for this expense. Vanguard is an approved vendor in California but not, alas, in Los Angeles.
In addition to extravagant annual expenses, MassMutual imposes surrender charges that begin at 8% and take 10 years to disappear. The charge in the fifth year is 5%. So if you switch jobs then and want to move this money into your new plan, or an IRA rollover, you could pay more than your investments earned in a year.
Mutual-fund companies can likewise impose surrender charges, and many do, on what are called the B class of share. No-load fund companies do not assess these charges, however, so you dont have to pay them if you dont want to. The best corporate plans dont offer B shares because of this liability, and indeed the best load-fund companies, such as American Funds, are phasing them out.
Adding insult to pension injury
Even when a corporate 401(k) plan is expensive, the employer typically matches some portion of the employee contributions, which more than offsets the plan's high fees. In the 403(b) world, these matches are almost nonexistent. Employers defend this practice because they typically also provide traditional pensions to employees. To qualify, however, you have to stay with the same employer your whole career. Who does that these days?
In the 401(k) world, unscrupulous employers at small, underfunded companies sometimes abscond with pension assets, only to be tracked down by the Department of Labor. In the 403(b) world, employers arent liable for fraud. If you are a victim, you are on your own.
In one recent case, a plan administrator, now defunct, is alleged to have looted $1.2 million from a total of 76 school districts from New York to Ohio. In San Diego, a teacher-turned-salesman paid $7,000 to settle charges he switched teachers money from mutual funds to annuities, which pay two to three times as much in commissions.
In one Long Island, N.Y., school district, 117 teachers claim a plan administrator failed to invest their contributions over a four-year period. The district took no action, allegedly telling each of them it was an isolated incident.
So far, federal authorities have been very reluctant to rein in this state-controlled chaos. The SECs contribution is to operate a Web site it calls Just for Teachers, which explains the basics of investing.
The IRS, as part of an effort to make all self-directed pension plans similar, plans to eliminate the single feature of 403(b) plans that is superior to 401(k)s. This is the so-called 90-24 transfer, which allows participants to switch from an employers plan to one of their own choosing, provided the employer and the plan administrator permit such transfers. The new rule takes effect in 2007.
Everybody knows that public-sector employees make less than those in private industry, as if knowing it somehow makes it okay. A scandalous pension system is an insult added to this injury.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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