Fleecing 403(b) Plan Participants (Part 5)

W. Scott Simon


In last month’s column, I offered 13 suggestions to help create a model 403(b) plan
suitable for any school district in the country. School officials making the effort to
implement this model will find it easy in some districts but probably difficult in many
others. That difficulty will result from the withering onslaught coming from the big
insurance companies against any attempts to replace the absurdly overpriced, junky
investment options they offer all too often to schoolteachers in 403(b) plans. These
companies dominate the K-12 market for 403(b) plans, and they will not give way
easily to the model 403(b) plan I have suggested. That model doesn’t allow for
annuities and, therefore, the entities that sell them, insurance companies. See my
suggestion No. 2: Get rid of annuities and offer only mutual funds.

Elected school superintendents and school board members are subject to political
pressure by insurance companies (among other groups). The most effective form of
this pressure, of course, is to withhold campaign contributions from any elected school
district officials brave enough to make a move to replace insurance company products
in 403(b) plans with the kind of low priced, broadly diversified mutual fund investment
options discussed in last month’s column.

There’s no doubt that the money weapon can be very effective when insurance
companies use it against elected school district officials. Jesse “Big Daddy” Unruh,
former Speaker of the Assembly who dominated California politics for over two
decades, wasn’t far off when he purportedly said: “Money is the mother’s milk of

On the other hand, no one is asking elected school district officials to lay down their
lives in the fight against terrorists in 140-degree heat either. All such officials have to
do–within their own context of making America better and stronger–is know what the
right thing is, brace themselves for a (rhetorical) fight (against insurance salesmen
mostly), and then simply do what they already know is the right thing: implement that

Think (Slightly) Outside the Box

School district officials who are interested in adopting the model 403(b) plan must
think slightly outside the box. They should begin by mentally throwing out what most
existing 403(b) plans feature: annuities that usually are much too costly and are lousy
investments to boot. This mental exercise may be difficult for many school district
decision-makers because the insurance companies have hoodwinked them into
believing that such companies and the nonsense they peddle are the only game in
town. This belief has (bad) consequences: School district officials who continue to
allow schoolteachers in 403(b) plans under their control to usually pay retail (nay,
retail-plus) costs for mediocre (nay, less than mediocre) investment options.

My partners and I in our registered investment advisory firm have been able to obtain
from a major retirement plan services provider an additional percentage point in
interest on its money market account for a client of ours with less than $5 million in
assets. Now, if little old us can leverage a large provider like that with such little
money at stake, imagine the huge amounts of money that school district officials could
save for participants in 403(b) plans, some of which have millions of dollars in them,
or tens of millions or hundreds of millions or even billions of dollars.

School district officials should insist that any retirement plan services provider wishing
to do business with them conform to their requirements. In far too many cases,
insurance companies and other providers have somehow convinced the decisionmakers
at these school districts that they must kowtow to them. Like Cher in the
movie “Moonstruck,” I want to (rhetorically) slap such officials across the face and
say: “Snap out of it!” These decision-makers are the ones in control because
ultimately they’re the ones who are sittin’ on a pile of assets. School district officials
have enormous purchasing power that can be used to the full advantage of their
participants; they shouldn’t think for a minute that the providers can push them
around and make them conform to their silly requirements.

Define the Goal First and Then Work Back

After clearing their minds of the prattle often voiced by insurance companies and other
offending providers, school district officials should then be in a position to start with a
clean slate and define clearly the kind of model 403(b) plan they want (I described
that model in last month’s column) and then work back from that goal, filling in the
process along the way.

The overall goal of any 403(b) plan must be to (1) operate solely in the interest of
plan participants and their beneficiaries for the exclusive purpose of providing them
with retirement plan benefits, (2) have transparent costs, each of which is reasonable
vis-à-vis the service provided in return and (3) feature broadly diversified investment
options designed, within a portfolio context, to reduce risk and increase return. This
goal simply tracks the language of ERISA section 404(a) which outlines the essential
duties of ERISA fiduciaries. (Section 404(a) language is incorporated into the laws of
many states governing the conduct of fiduciaries responsible for 403(b) plans).

Retain a Consultant for Guidance

School district officials that wish to implement a model 403(b) plan should retain a
consultant for help in guiding them through that process. The consultant will be–by
far–the most influential person in this process. This will require officials to be on guard
for any biases harbored by the consultant. For example, a consultant that is a big
player and is close to certain retirement plan service providers will more likely have
built-in biases and a way of thinking how things should be done–not how they could
be done (e.g., a model 403(b) plan).

It is vitally important that school district officials not allow the consultant to
manipulate the process in such a way to favor its biases or to perpetuate how things
should be done. For example, school officials should avoid retaining any consultant
that builds in a continuing role for itself once the process to select the retirement plan
service provider is finished. A consultant that tries to pull this monkey business merely
confirms that it’s thinking “old school” and not the kind of “new school” thinking
needed by decision-makers interested in implementing a model 403(b) plan. School
district officials must insist, of course, that the consultant they retain disclose every
affiliation, revenue stream, consideration, remuneration, everything, to them.

Retain Truly Independent Legal Counsel

School district officials making the decision to implement the model 403(b) plan should
also retain legal counsel expert in fiduciary law. That counsel should be truly
independent in the sense of having no ties to any retirement plan services providers or
consultants. This will help avoid a bias or spin that could compromise information and
advice (including that concerning the new IRS regulations governing 403(b) plans that
will take effect on Jan. 1, 2009). This independence will be sorely needed by the
decision-makers as they wade through the process of implementing their model 403
(b) plan.

School District Officials and Their Consultant Must Select the Initial
Investment Options

School district officials and the consultant they retain must select the menu of
investment options (i.e., low cost and broadly diversified mutual funds that have no
commissions, 12b-1 fees or any form of revenue-sharing) for the model 403(b) plan
before starting the process to select the winning retirement plan services provider.
(This obviously means that such winner will have no say in selecting the menu.) If
school district officials were to throw the field wide open to bidding retirement plan
services providers (each with their own menu), the officials would quickly find it nearly
impossible to compare all the apples-and-oranges bids in a rational way.

Doing it this way forces the providers to price their bids on the basis of the investment
menu already selected by school district officials based on input from the consultant.
This has two very big advantages for them. First, it allows the officials (and their
consultant) to avoid wasting a lot of time trying to fit square pegs into round holes
(i.e., comparing some bidders’ apples to other bidders’ oranges). Second, school
district officials will quickly find out which bidding providers can offer true open
architecture. “Open architecture” means that any investment option required for the
menu of any given 403(b) plan (or 401(k) or 457(b) plan) can actually be made
available by a bidding retirement plan services provider without such provider
additionally trying to weasel in its own more expensive (to plan participants) and
profitable (for the provider) proprietary products.

School district officials must remember that they are in the drivers’ seat here, not plan
providers–so such providers should be forced to submit their bids on the school
districts’ terms and offer true open architecture.

Ensure the Consultant Doesn’t Design the 403(b) Plan as a Supplemental Plan

403(b) plans (as well as 401(k) plans and 457(b) plans, for that matter) were
designed to be supplemental retirement plans. Supplemental, that is, to defined
benefit plans. With the continuing reduction in the number and importance of defined
benefit plans, though, 403(b), 401(k) and 457(b) plans have now evolved to become
the primary retirement plans for most American workers. The 2006 Pension Protection
Act, which reinforced this trend, made clear that these plans are no longer sideshows
but now are part of the main show.

School district officials, accordingly, should ensure that their consultant designs the
model 403(b) plan not as a supplemental retirement plan but as a stand-alone plan–
whether a school district has a strong defined benefit plan or not. Even with a strong
defined benefit plan, it’s possible that, given the increasing pressures on local and
state governmental budgets, many defined benefit plans in the public sector will be
phased out over time.

Require Low Cost and Broadly Diversified Model Portfolio Investment Options

There’s no reason why officials at school districts can’t offer their participants in 403
(b) plans investment options for 40 basis points (in mutual fund annual expenses) or
less. The best way to do that is to require the winning retirement plan services
provider to offer, as noted, a menu of pre-built model portfolio investment options
ranging from less aggressive to more aggressive, with each portfolio comprised of a
wide array of low cost and broadly diversified mutual funds that have no commissions,
12b-1 fees or any form of revenue-sharing. District officials should not allow retail
target date maturity funds due to cost and other reasons noted in last month’s

My suggested model 403(b) plan, as noted in last month’s column, prohibits loans.
Prohibiting loans, however, doesn’t prohibit “hardship withdrawals”; it just prohibits
plan participants from treating their retirement account like an ATM machine, subject
to arbitrary withdrawals based on how good Las Vegas is looking this weekend.

Separate the Costs of Administering the 403(b) Plan

School district officials must require the bidding retirement plan services providers to
separate out the costs of administering the 403(b) plan. They need to make providers
un-bundle each of the administrative services provided to the plan and match up the
costs that correspond to them. Services and corresponding costs must be clearly
delineated. School officials must require this even in cases where they intend to have
participants bear the costs of administering a 403(b) plan. The reason why is that such
officials have a duty to understand whether the total and component costs of a plan
are reasonable.

Require Cost-Free Conversion from the Old to the New 403(b) Plan

If the winning retirement plan services provider conducts business in the existing 403
(b) plan, school district officials must require the winner to promise in writing
(preferably in its own blood) that it will convert all its business in the existing 403(b)
plan over to the new 403(b) plan – without participants incurring any penalties,
including surrender charges. Otherwise, as sure as the sun rises in the eastern
morning skies, the winning bidder will encourage plan participants to stay in the
existing plan with its (usually) higher fees and junky (not to mention nutty)
investment options.

Require the Winning Provider to Assume ERISA Section 3(38) Responsibilities

School district officials should require that the winning provider become (through
written contract) an ERISA section 3(38) “investment manager,” thereby making it an
ERISA section 405(d)(1) “independent fiduciary” to the sponsor of the 403(b) plan
and, by implication, to the plan participants and their beneficiaries. This means that
such provider accepts full responsibility for the selection and monitoring of the
investment options offered in the 403(b) plan.

This also means that by law the provider is required to work for the exclusive benefit
of plan participants for the sole interest of providing them with reasonably priced and
broadly diversified investment options in their retirement plans. The “exclusive benefit”
and “sole purpose” rules of ERISA section 404(a) comprise, as noted, the backbone of
ERISA fiduciary requirements. (School districts sponsoring 403(b) plans are not
subject to ERISA as made clear in last month’s column. Yet many states, as noted,
have simply taken the text of ERISA section 404(a) and adopted it as their own,
thereby making sponsors of 403(b) plans in those states into fiduciaries subject to a
panoply of duties. My column next month will cover this in more detail.)

403(b) Plans Are Easier to Record-Keep than Other Defined Contribution Plans

School district officials should be aware of one last point. Many retirement plan
services providers have bamboozled school officials into thinking that the recordkeeping
services required for 403(b) plans are much more specialized and difficult
than those required for other defined contribution plans such as 401(k) plans. This is,
quite simply, poppycock; it’s designed to trap these officials into staying with the
fibbing (and overly expensive) services providers.

In fact, the contrary is true: It is far simpler to administer a public sector 403(b) plan
than a large 401(k) plan in the private sector. Defined contribution retirement plans in
the private sector, after all, require record-keeping company stock, other assets,
cross-testing and other testing requirements, etc. that are not required by public
sector plans.

It’s only because of the balkanized nature of the 403(b) plans at school districts that
large numbers of otherwise highly competent record-keepers have chosen not to enter
this market. Doing away with this unnecessary balkanization will open up the market
to much greater competition–resulting in lower costs for 403(b) plan participants–
while creating much greater investment flexibility (i.e., open architecture). That’s
exactly what the model 403(b) plan discussed in my last two columns is designed to
help achieve.

W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. The author’s views expressed in this article do not necessarily reflect the views of Morningstar.

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