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Fiduciary Focus: Fleecing 403(b) Plan Participants (Part 5)

We've gone over how to create a suitable 403(b) plan. Here's how to help school officials to put it into place.

W. Scott Simon, 08/02/2007

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 politics."

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 model.

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 decision-makers 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 column.

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. PAGEBREAK

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 record-keeping 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.

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