The Case for the Traditional K-12 403(b) Model

Recently, articles in the New York Times focused on what it called problems with 403(b) plans for K-12 public school districts.

K-12 403(b) plans often have annuity contracts, thousands of investment options and hundreds of providers in which individual participants have directed their deferrals and savings into providers they picked, often after the sales rep visited the workplace. As the most recent Times’ article pointed out, these sales calls often led employees to purchase retail-type products with large sales charges, and/or annuity products with long and potentially confusing contracts and what was later found to be requirements to keep their money there for good.

The articles argued that fees were one of the problems associated with K-12 403(b) plans.

Ellie Lowder, tax-exempt and governmental plan consultant at TSA Consulting and Training Services, in Tucson, Arizona, shared her thoughts with PLANSPONSOR.

PS: When selecting investment options for their retirement plans, are employers, who seek the lowest available fees, meeting their fiduciary obligations?

Lowder: Not if fees are the only focus, according to the Department of Labor. “Higher investment management fees do not necessarily mean better performance,” says A Look at 401(k) Plan Fees, published by the DOL and Employee Benefits Security Administration in 2013. The publication goes on to advise, “Nor is cheaper necessarily better. Compare the net returns relative to the risks among available investment options. And, finally, don’t consider fees in a vacuum. They are only one part of the bigger picture including investment risks and returns and the extent and quality of services provided. Keep in mind the importance of diversifying your investments.”

NEXT: Tradeoff of focusing only on lowest cost

PS: What can be the tradeoff of focusing only on the lowest cost investment provider?

Lowder: “The extent and quality of services provided.” That’s the key. Planning for retirement alone, without any kind of personal, face-to-face professional advice, can be a full-time job—something very difficult for someone who already has a full-time job. Retirement plans are so complicated, with so many moving parts and opportunities to derail, that a professional adviser is worth the cost—provided the cost is reasonable and commensurate with the service.

Even Vanguard, one of the foremost proponents of low-cost investing, understands the value of professional advice. According to Vanguard research, published in 2014, financial advisers can add up to about 3% in net returns for their clients.

Even so, many continue to try to make the case that low fees are the nirvana of any retirement plan. In general, when selecting the investment options with the lowest possible fees, it’s usually the advantage of individualized service that falls by the wayside. The lowest fee provider, instead, will provide a web site where any interested employee can get information and enrollment materials. But accessing and using a website requires a level of motivation that many employees, particularly the younger ones, don’t have.

NEXT: Advantage to traditional model for K-12 403(b)s

PS: For the K-12 market in particular, what is the advantage of the traditional strategy of having an adviser meet with employees at the worksite to discuss retirement?

Lowder: Having advisers meet with employees is especially helpful in the 403(b) market segment which in many of those markets consists of voluntary salary reduction contributions only, and NO employer matches. 

Frequently, plan sponsors who select providers based only on those with the lowest fees find that the services needed by employees were not met by those low-cost options because of the limited services they provide. In addition, the limited service does not motivate employees to enroll in a retirement plan when those employees need personal consultation with a financial professional.

I remember a superintendent of schools who had read an article about variable annuities versus mutual funds. The article focused only on fees as so many do. He called to ask why the financial adviser had placed him in a variable annuity. When the adviser reviewed the guarantees in that VA, the superintendent said “That makes sense to me. And, I just realized that I am only participating in the plan because you sat down with me and talked about retirement in general, including a review of my state pension plan and Social Security. I doubt that I would be saving this money at all had it not been for your help in understanding why voluntary savings is important.”

NEXT: Room for improvement

PS: Is there room for improvement, or a place for lower-cost investment options, in 403(b) plans?

Lowder: Whether an employer is sponsoring an Employee Retirement Income Security Act (ERISA) plan or a non-ERISA plan, it wants to have successful retirement plans for their employees. A successful retirement plan is one in which employees are participating in order to successfully prepare for retirement. Sometimes that can be the lowest cost option (provided that long-term performance is good) for those who are self-starters, and sometimes that will need to include the “one-on-one” touch that is necessary to the larger number of employees who need that kind of help.

The takeaway for 403(b) plan sponsors is to offer both types of options in their plan so that every employee can meet his or her goals. This will satisfy the self-starters (estimated by the National Education Association through focus groups at 15%), and the larger group who have expressed a need for personal consultation with a financial professional (85%). Plan sponsors and consultants working with plan sponsors should never fall into the trap of focusing only on the lowest fees.

If paying reasonable fees for individualized service under a full service model causes employees to participate in their voluntary plans, it would make no sense not to offer such an option when selecting providers. Plan sponsors should consider offering options for both populations of employees—the self-starters, and the non-self-starters.