Teachers are using a costly retirement plan with conflicting advice, poor service and high fees.
Our public school teachers are terribly under-valued. They devote their lives to shaping young minds and our collective future for modest pay and too little appreciation.
That’s why it’s infuriating to learn that these vital public servants are routinely fleeced of their retirement savings by purveyors of expensive, inefficient tax-deferred savings plans that are, sadly, absolutely legal.
The 403(b) VS the 401(k)
Under federal law, public school employees are not permitted to have 401(k) accounts, arguably the most effective retirement savings tool in the world. Instead, their employers are allowed to offer a bastard cousin of the 401(k), known as the 403(b). Employees of religious organizations, non-profits and some charities are also limited to 403(b) participation.
Here’s the problem with that. Many of these 403(b) plans are exempt from the financial regulations and consumer protection provisions that govern 401(k)s. In fact, 403(b)s aren’t even covered by the recent SEC “fiduciary” regulation that requires stock brokers to always act in their clients’ best interests. The result of this limited oversight is conflicted advice, poor service and high fees.
While 401(k) participants are usually offered a manageable range of easy-to-understand investment options, 403(b) plans tend to barrage teachers with a huge number of often-complex choices. California educators have 220 options offered by 59 companies. When 403(b) participants seek guidance they are frequently steered into variable annuities, which are complicated and expensive. The kicker: if an educator realizes their mistake and wants to drop the annuity for a better-performing asset, she must often pay an outrageous surrender fee.
The real cost of a 403(b)
The New York Times recently shared the story of an Illinois teacher who decided to exit an annuity in his 403(b) because he was being charged a 2.34% in annual fees — nearly five times the average 0.5% fee charged by many large 401(k) plans. He had to pay 5% of his annuity’s balance to get out.
Even more outrageous is the paper’s story of a New Jersey teacher who paid $37,500 in 401(b) commissions and fees on high-expense assets in just eight years. An independent retirement expert who reviewed her account said the teacher, a widowed mother of three, would have an additional $113,000 in her account if she had been placed in simpler, lower-cost funds.
When a group of New Jersey teachers turned to their union, the National Education Association, for a better retirement savings option, they were referred to a firm that offered a similar line-up of expensive annuities – and just one low-cost stock index fund. Interestingly, many employees of the union participate in a 401(k) not a 403(b).
This teacher and her colleagues were charged a minimum 2% per year to manage their money, and an additional 6% sales commission every time they made a contribution to their account. On top of that, they were charged management fees averaging 1% by the various mutual funds in their portfolios. That’s 9% of their savings siphoned off in fees!
What can be done
While 401(k) participants can sue to force a plan to act in their best interests, most public school employees must go to arbitration to settle performance disputes. Why? Because the contracts signed by their employers with 403(b) providers require arbitration.
Sadly, these lousy programs are likely to continue to play an important role in funding educators’ retirements. Yes, many school districts have traditionally paid generous pensions. But many teachers don’t serve the decades required to fully vest their pensions. And many jurisdictions have dramatically reduced the pension benefits offered to new teachers.
This situation is a national embarrassment. As one expert told The New York Times, it represents a huge transfer of wealth from Main Street to Wall Street. Our teachers and public employees are being denied the regulatory protection afforded private sector workers. Outrageous.
President-elect Trump campaigned as a champion of working Americans and a critic of Wall Street excesses. I’d love to see his Administration push for an overhaul of the 403(b) mess. It would send an important message to the financial community and show support for our everyday heroes in classrooms across the country.