Dan Otter and Scott Dauenhauer: Why Retirement Savings Options for Educators Are So Bad

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Our guests on the podcast today are Dan Otter and Scott Dauenhauer. Together they run the website 403bwise, which is geared toward providing education and advocacy on retirement planning for educators. Dan started 403bwise in 2000 with John Moore as a means of shedding light on the often opaque landscape of retirement plans for K-12 educators. Scott is a certified financial planner and principal and owner of Meridian Wealth Management. He got interested in the 403(b) space after researching retirement plan options available to his wife, who is a teacher. They've each written books about 403(b)s and retirement planning for K-12 educators. Dan's is called Teach and Retire Rich, while Scott's book is called Wild West: Providing Fiduciary Advice to Public School Employees. They also host a podcast called Teach and Retire Rich, and they recently released a short podcast series called Learned by Being Burned: Teachers in the K-12 403(b).

Background

Teach and Retire Rich, by Dan Otter

Wild West: Providing Fiduciary Advice to Public School Employees, by Scott Dauenhauer

Teach and Retire Rich podcast

Learned by Being Burned podcast

The Ins and Outs of 403(b)s

"401(k) and 403(b) Plans: Knowing the Difference," investopedia.com, March 19, 2021.

"Many Teacher Pension Plans Get Failing Grade," by Kaitlin Mulhere, money.com, Aug. 31, 2021.

"How 403bwise.org Provides Financial Education to K-12 Employees," by Dan Otter, investmentnews.com, April 9, 2021.

"457(b)s: The Solution to Bad K-12 403(b) Plans?" by Dan Otter, investmentnews.com, July 29, 2021.

"Project Aims to Grade 14,000 School Districts' 403(b) Plans," by Emile Hallez, investmentnews.com, Jan. 4, 2022.

"The Two Faces of 403(b) Index Funds," by Scott Dauenhauer, 403b.substack.com, Oct. 7, 2021.

"Bringing Personal Finance to the Classroom for Generation Z," by Ann Carrns, nytimes.com, March 18, 2022.

Transcript

Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance and retirement planning for Morningstar.

Jeff Ptak: And I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.

Benz: Our guests on the podcast today are Dan Otter and Scott Dauenhauer. Together they run the website 403bwise, which is geared toward providing education and advocacy on retirement planning for educators. Dan started 403bwise in 2000 with John Moore as a means of shedding light on the often opaque landscape of retirement plans for K-12 educators. Scott is a certified financial planner and principal and owner of Meridian Wealth Management. He got interested in the 403(b) space after researching retirement plan options available to his wife, who is a teacher. They've each written books about 403(b)s and retirement planning for K-12 educators. Dan's is called Teach and Retire Rich, while Scott's book is called Wild West: Providing Fiduciary Advice to Public School Employees. They also host a podcast called Teach and Retire Rich, and they recently released a short podcast series called Learned by Being Burned: Teachers in the K-12 403(b).

Dan and Scott, welcome to The Long View.

Dan Otter: Thank you so much for having us.

Benz: Well, we're thrilled to have you here. Now, let's just start with a little bit of stage setting. Many of our listeners will be aware that a 403(b) is a retirement plan that's available to educators as well as employees in some other areas. But Dan, to set things up a little bit, perhaps you can talk about what are the key similarities and differences relative to 401(k) plans?

Otter: It might surprise your audience that the 403(b) actually predates the 401(k) by 20 years. The 403(b) was created way back in 1958. They are very similar in terms of operation in contribution amount. The key difference between a 401(k) and the type of 403(b) available to teachers, which is known as a governmental 403(b), is fiduciary oversight. The 401(k), as you know, is subject to ERISA, the Employee Retirement Income Security Act. It's one of the reasons that Apple Corporation has a great 401(k). They have one great low-cost vendor: Fidelity Investments. The school district in the town I live at in Redlands, California, we have 42 vendors in our 403(b) plan. Can you imagine that? Can you imagine Apple offering 42 different financial companies or Morningstar? There's no way. You would be sued.

Ptak: I think we wanted to talk about some of those stark differences that you describe. Before we do that, Scott, I wanted to turn to you. You both have been advocating for improvement in the 403(b) space for some time. But Scott, you're a CFP and a financial advisor. It sounds like you got interested because your wife is an educator. Is that right?

Scott Dauenhauer: Yes, my wife is a middle school science teacher. She teaches eighth grade science, and I think this is her 24th year. And I got into this because some random person walked into her classroom first or second year and basically said that he was sent by the school district and sent by the California State Teachers' Retirement System, the pension system that my wife was belonging to or belongs to. And he said he was there to explain her retirement benefits. Well, I was working at Morgan Stanley at the time, one of those brokerage firms, and I'm like, well, I'd like to learn about your retirement benefits as well. I don't really know anything about them.

And as soon as I came down--we actually met in my wife's classroom--and five minutes into the conversation, I realized that this guy hadn't been sent by the school district. The Teachers' Retirement System had nothing to do with him. He was there to sell us an equity indexed annuity, which is a complex financial product as part of a 403(b) plan. And as soon as I figured out that he was just a salesperson, I just thought that it was the strangest thing. And I asked him to leave, and I called the school district and said, “You've got people roaming around the campuses selling financial products. Do you know this?” Turns out, they didn't just know it; they're like, “Oh, yeah, that's pretty normal.” And I was like, “What?” So, that was my introduction to the 403(b).

I thought it was really strange. And I thought I don't really want to have anything to do with this--until a few months later a colleague of my wife asked me to review a policy that she had been sold in her 403(b), and again, it was an equity indexed annuity, and this thing had surrender charges that were, like, 18%, 19%. You couldn't get out of it for 20 years. She had been told it was going to return like 12% a year. And after analyzing it, I knew it was never going to return more than 2% to 3%. And I just thought what is going on with our teachers and the retirement plans that they're being sold? Is it just here? I was in Orange County at the time, California. Or is it everywhere? And so, I started looking around on the internet, and up pops this little website called 403bwise. At the time, it was a .com; now it's .org. And that's where I started to learn about the 403(b) and this was not just a localized problem, it was a national one.

Benz: Dan, your interest goes back more than 20 years now. You started 403bwise. What was the catalyst for you to get involved to try to make 403(b)s better?

Otter: I was a first-year teacher way back in 1992. The kids had left for the day. I was at my desk frantically trying to get ready for the next day's instruction, as new teachers are apt to do, when a woman poked her head in the door to my classroom. And I'll never forget what she said. She said, "Do you care about your financial future?" Now, this is a jarring comment to get any time but especially when you're in your classroom, and you're so focused on getting ready for the next day's instruction. So, I said—which I think there's only one answer, right? "Yes." And so, she took it as an invitation to come into the room. And she started talking about these investments, which I had no idea about.

I had some vague notion that I had a pension plan. But she was using these terms like TSA, annuities. She helped the third-grade teacher next door, the sixth-grade teacher down the hall. And I just politely listened. And finally, I said, “Look, I'll get in touch if I'm interested.” And I never got back in touch. And that was a good thing to have done, because I later learned that she was selling high-cost investment products, often annuity insurance products. So, I started self-educating myself. And what I found out was this was not unique just to my school or my school district in Southern California. This was a nationwide problem. And so, I start talking to my colleagues about this. And one woman said, “Wow, you should do some workshops for teachers, because you seem to really understand this.”

And by now, it's like the year 2000. It's kind of the internet boom. So, I'm thinking, wow, why don't I start a website. So, got the domain name. And I really think this is part of our secret sauce. I think I lucked into getting a really good name: 403bwise. We want you to come and get smart about your 403(b). So, I launched it in 2000 and connected with a Los Angeles Unified School District teacher named Steve Schullo, who was doing advocacy work. He started spreading the word. Scott Dauenhauer, this amazing guy, who just lived down the street from me, reached out to me. I got interviewed on NPR that summer and then publication started mentioning our website. So, I knew that I had created something that was a niche that was filling a need.

Ptak: We wanted to talk about why 403(b)s are so bad. I don't think there's any sort of delicate way to put it. We wanted to discuss some of the key problem areas in the 403(b) market. But before we do that, let's discuss why people should care. Some people might think teachers usually have pension plans and even teachers might adopt that mindset themselves that their 403(b)s aren't the main financial engine of their retirements anyway. So, why care that much? Do you think that's why 403(b)s are so poor in so many cases?

Otter: No. As I mentioned earlier, I think ERISA is a big driver of the problems. Employers are not required to offer a great plan. So, consequently, they don't. But there are few teacher pension plans that will pay out 100% of a teacher's final salary in retirement each year. Pension benefits have been reduced across the board, especially for new teachers. So, we would argue that the 403(b) is even more important. But here's the irony. I think it also comes down to education, the lack of education. Teacher programs are simply not teaching this to teachers. So, they come onto campuses completely unaware, and what happened to Scott's wife and what happened to me is still happening across schools around the country. And also, school districts are not providing education. And sometimes they're making it worse. Sometimes at new teacher orientations, they're having these high-cost companies "put on education" for the new teachers.

Benz: Scott, Dan just noted that some districts have scaled back their pensions. How commonplace are those efforts to reduce pension benefits? And I guess a related question is, do you think we'll eventually see pension penetration ebb away in the education space, just as we've seen it happened in the private sector over the past several decades?

Dauenhauer: Generally, pensions are dealt with on the state level, although there are a few school districts that do have their own pension systems, Chicago, one of them; New York City, they also have it. Chicago was famously underfunded, which I think leads into that second question of yours. I actually don't think that pensions are going away for educators. I think they're here to stay. I don't think that they're going to go anywhere. I think there might be certain states where they will go away, or they will become a lot less part of the overall benefits package. But I think they're going to be around to stay. They are getting less beneficial, though. They're getting tough to qualify for, they're more back loaded, and I think that's a real issue. And one of the main reasons why teachers do need to be contributing to these defined-contribution plans or making other investments along the way, but I don't think they're going away entirely.

Ptak: You mentioned earlier the fact that 403(b)s are not covered by ERISA, at least in many cases, if I've got that right. Maybe talk about some of the other key factors that cause the 403(b) space to be a Wild West compared with 401(k)s. Why is the oversight so much less in that space?

Otter: Again, I think, the main culprit is, it's not required under ERISA. But let's put some of the blame on the school district themselves. No one says that they can't offer a great plan. So, I would put some of the blame on them. If you contrast this with nonprofit institutions, which have ERISA-based 403(b) plans--nonprofit hospitals, colleges, they offer great plans. Again, I realize more fiduciary oversight is required, but they're both 403(b) plans.

Dauenhauer: Jeff, if you wouldn't mind me jumping in on this one as well. We like to draw the parallel with 403(b)s to another government plan, a 457(b), which is offered to state and local government employees. It's a huge plan. If you know a judge, a police, a firefighter, anybody who works for state and local government in your city, they probably have access to a 457 plan. And those plans almost universally are way better than 403(b)s, and yet they are not governed by ERISA. The difference is, almost every single state has passed a set of fiduciary laws that apply to these programs. And most of those fiduciary laws hearken back to the same language of ERISA. So, I do think that you can have a government-run, a state, local government-run plan that is also good, because we see it every day in these government's 457 plans.

Benz: You note that many investment professionals in the 403(b) space aren't fiduciaries. You talked about some of the high-commission salespeople roaming the halls. Why is that? And is there any chance to enact change there to ensure that anyone selling these 403(b) plans be a fiduciary?

Dauenhauer: Well, it's a good question. That's where it gets a little difficult in this space. Part of the reason we don't have a lot of fiduciaries in this space is because of the way it's structured. Historically, 403(b) plans, at least for K-12 public schools, have been how Dan and I term, multiple vendor, meaning there's more than one vendor and there's really no vetting or very little vetting of those vendors. And because of that there's not any one vendor that can get an economy of scale. And so, it's pretty much every vendor fighting for themselves to get access to employees and to gain assets, to get contributions.

Unfortunately, what happens there is, the only products that are going to gain assets are those products that can afford to put human beings on the ground. And so, most investment professionals like myself, we're not going to go sit in a teachers' lounge. I'm not going to bring doughnuts to the teachers' lounge or sandwiches to the teachers' lounge, I'm not going to do that. Number one, I'm a financial planner. I don't have time for that. I do a lot of work that I can't just be spending handing out doughnuts and signing up people for $50 contributions. And yet, that is the structure of how many of these 403(b) programs work. Whoever gets in front of the teacher gets the sale.

Unfortunately, the only products that can pay those people enough money to keep them doing that kind of business are products that are very low in quality and high in cost. And so, those are antithetical to a fiduciary. That's why we don't see many fiduciaries in this space. It's just not set up for that environment. I ended up getting into the space and working initially on an hourly basis with educators, and that was a really difficult thing to do, because they all assumed they were getting these services for free. And they didn't realize that these people were getting paid, and they were getting paid through commissions, and they weren't seeing this on their statements. So, it's partly the way that the plans are structured in this multiple-vendor environment. You switch that to say a single-vendor environment where all the assets are going to one recordkeeper, you then create an economy of scale that allows you to put human beings to do education, to help people sign up at a much, much lower cost than you do if it's spread across 20, 30, or 40 vendors.

Ptak: Who are the main gatekeepers for 403(b)s in a school district? I would think it's maybe somebody that's akin to a CFO or a head of ops. And who is signing off on the providers that make it onto the menu? And then, a related question: You talk about the profusion of different providers within a district because that overgrowth is just permitted. Why haven't we seen some of the bigger players try and come in knowing that it's a fairly fragmented market, but it's one that's fairly large and potentially lucrative, and compete on price and try and sell districts on consolidating to a single provider that can deliver higher-quality service at a lower cost?

Dauenhauer: Ultimately, it's the school board who signs off on who the vendors are. But you would think that it would usually run through the CFO, and sometimes it does. But generally, the people who are in charge of putting vendors on the list are the third-party compliance administrators that school districts hire to run the plans. There's a lot of rules and regulations. And when you have multiple vendors, like, 5, 10, 15, 20 vendors, there's just so much going on that most school employers just don't have the resources to manage that and keep it in compliance with the IRS. So, they end up hiring these outside compliance administrators. And they will tell you that they don't control the vendor list, but they control the vendor list. And oftentimes, it's just the school district adopting whatever that compliance administrator has. Often the people in the district could ask for a good low-cost vendor to be added to that list and oftentimes they will be added. But you usually have to ask. And sometimes when you ask, they're still not added. So, oftentimes, it's the compliance administrator, not really anybody at the school making these decisions.

As to why there's no competition or why the larger companies aren't coming in to create that competition. We have been advocating for that for years, almost two decades. In fact, one of our very first initiatives here in California was to allow for a school district to manage their vendor list. In California, you have these large vendor lists because of an odd insurance code that we have here, and we wanted that to be changed. And that the school district could just say, “We're going to have one vendor and that's it.” And it's been a long time and there's been a lot of resistance to that mainly from the insurance companies. They have a very powerful lobby. Also, I won't mention the group's name, but another lobbying organization that's very, very big--they spend a lot of money to send people out to shoot down these ideas, and politicians need to get reelected, and they need the insurance company money.

That said, we have started to see a shift from some of the insurance companies, but from some of the bigger vendors as well toward this single-vendor model going into a school district and getting them to consolidate. We've seen it in Montgomery County Public Schools, up in Anchorage, the latest one, which is I think momentous is the Chicago public schools. They just this year consolidated down--you guys might be familiar with this one, given where you're located--they just consolidated down to one vendor. And that vendor actually is AIG, but it's actually a very good program. It's one of the best 403(b) programs we've seen in a long time. We think that this trend is here to stay. But it's a lot of work to do that. And it takes some real commitment on the part of the school district. It's easier to do for a larger school district than a smaller school district. But I think that's going to be the trend. It's just going to take a while. At least, we hope it's the trend.

Benz: One thing that's been on my mind is that is it somehow in the school districts' interest to choose a subpar 403(b) provider versus a better and cheaper one? Are the worst plans somehow cheaper, easier for the school district to offer?

Dauenhauer: Well, not really. This is a question we get a lot because it sounds rather counterintuitive. The people at the district office also contribute to these plans. So, why wouldn't they want the best possible plan that they could get?

Benz: Right.

Dauenhauer: And it's very odd that they would be in favor of just having a bad vendor list. But historically, they haven't had to do anything with these programs. They were the supplemental programs that they just sent money to, they didn't really care about. It wasn't till 2009 that the IRS created a system where you had to have a plan document. You actually had to manage your plan. And it was at that point that they had to really get their act together. But instead of doing it in-house, which is very difficult to do, they hired these compliance administrators, these outside third parties, and they basically just outsourced it to them for the most part. It's not that they don't want to have good plans. They oftentimes just don't have the knowledge to know if it's a good plan or not. And the people that are marketing to them are very persuasive. So, it's just that they're really not educated on this. I think the more they get educated, the more they get upset and actually want to make change.

Ptak: 403(b)s also frequently feature high-cost annuities. I think you've mentioned this at least once earlier in the conversation. Why is that, and why is putting a variable annuity inside of a retirement plan such a bad idea?

Dauenhauer: Well, 403(b)s they're more tilted toward the annuity products, because annuities are the only thing you could put your money into for a long time. It wasn't, I think, until 1974 that you could actually put your money into mutual funds, and they didn't really start gaining traction until the late '80s, early '90s. The companies who essentially created the 403(b) market were TIAA and VALIC, both insurance companies. So, they didn't really have a big incentive to do mutual funds. But that's beginning to change, especially with Vanguard in the market, Fidelity in the market--those are big household names now and people want to invest in those companies.

But to answer your question on annuities inside of retirement plans and why that's such a bad idea, I don't think annuities in retirement plans are a bad idea, which is going to shock probably some listeners. But there's this old analogy that putting an annuity in a retirement plan is like opening an umbrella indoors. And I think that analogy is a bit disingenuous. It makes sense if you're only selling the annuity for the tax deferral because why would you sell it for the tax deferral when the 403(b) is already tax deferred. That would be dumb. But there are other legitimate reasons to have an annuity inside of an IRA or a retirement account like a 403(b).

I have a lot of clients who have fixed annuities inside their 403(b)s or IRAs. And over the past five years, that's been a very good place for them to be when we've had interest rates close to zero. I've had many of my clients who were in accounts that are paying 2% or 3% with no fluctuation if interest rates change. So, there are legitimate reasons to have an annuity inside of a retirement account. It just has to be for something other than tax deferral. I don't see the problem with annuities being that they're in retirement accounts. I see it just as a structure. And any financial structure can be corrupted, can be made problematic.

And the problem with 403(b) annuities is that they are a great structure to hide costs. They're just a very good structure to do that. Variable annuities are a little difficult to hide the costs in. But when you hand somebody a prospectus that's an inch thick, they're not going to figure out what the costs are. Indexed annuities are a bonanza for hiding costs. They are amazing. It's like they were built just to hide costs. And we see these sold left and right. These are the products that pay the highest commissions. They give out the greatest trips as incentives to sell them. And they're bad structures. It doesn't mean they couldn't be done in a good way. Just like there are a lot of bad mutual funds out there, it's not because mutual funds are all bad. It's just that mutual fund is a structure that can be made good or bad. It's the same with annuities. Put generally in 403(b), you do want to avoid the annuity because most of them are bad. Most annuities in 403(b)s are bad. It doesn't mean that all annuities are bad; they happen to be bad in K-12 public 403(b).

Benz: Let's talk about some of the fees that 403(b) participants face. And maybe you can help us understand how they compare to fees in 401(k) plans. Maybe we can talk about mutual fund fees in 403(b) as well as some of these annuity products that we've been discussing.

Dauenhauer: This is a tough one, because there's basically three products that get sold within the 403(b). There's the mutual funds, which are pretty easy to find the fees. Those are pretty simple. We can pull prospectus. I think there's a company called Morningstar that you can go to and find some information about mutual funds. They're easy to find the information out about. Variable annuities, also easier to find out. We have these great regulations that force them to disclose the fees. I can go and find the fees pretty quickly. In California, there's this great database called 403bCompare.com that allows you to find the fees for mutual fund products and variable annuity products. So, those, we can find the fees, but it's still difficult to put it all together. Think about a variable annuity--you got to go and find the mortality and expense fee; then you got to find the subaccount fee; then you got to find the contract fee. Then you got to find what riders are you using; what year were they added; what are the fees on that; are they based on the benefit base or are they based on the value of the actual value of the account? It can be very difficult to put all of those fees together. Oh, and then you have the expenses of the underlying investment options.

So, putting that all together, that's pretty complicated. And the average person is not going to be able to do that. The average advisor probably doesn't know how to do that. And those are the easy products. Then you look at the indexed annuities, which generally don't have "fees." These are spread products for the most part. There's generally some fees if there's living benefits. These index annuities are these spread products where all of the costs are built into the structure of the indexed annuity. So, there's no way to really know what the fees are. Now I forget what your original question was. As you can see, it gets very complicated. And when you are a schoolteacher who is trying to focus on what's going on in your classroom that day, what are you supposed to teach the next day, what books are currently being banned in your classroom--you've got other things on your mind. The things that teachers have to deal with on a day-to-day basis--I see this because my wife comes home, and I hear it for the next couple of hours. They don't have time to go into all this. It's so complicated. And that's why we like the idea of a fiduciary being in charge of these programs to do that work for them. So, that's the issue I have with the products that are in there.

Ptak: Let's talk a little bit more about that. You have a fiduciary pledge on 403bwise that 403(b) professionals can sign on to. What's your thinking on how that pledge might tend to drive better behaviors? I suppose the devil's advocate argument is that people most likely to sign a pledge were likely to behave ethically anyway. What do you think of that?

Dauenhauer: I don't think that there's that many people in this space that are willing to sign that pledge, because they're prohibited from doing so. Most of the people who sell variable annuities are not going to be able to sign a real fiduciary pledge. Oftentimes, they are captive agents. So, if you work for say, Equitable, you're going to be selling Equitable annuities. With one of the last disclosure documents I read, there are some companies that require you to sell enough proprietary products in order to keep your health insurance. So, if your health insurance is going to be held hostage if you don't sell enough of one company's products, you're not a fiduciary, you can't sign that pledge. And you combine that with a lot of the people who are working in this space are not licensed with FINRA, they're not licensed with the SEC, they're not state licensed; they're only licensed to sell insurance products, they're not going to sign the fiduciary pledge either. So, there's just a huge group of people that are never going to sign that pledge, because they can't. They're either prohibited by their employer, or they would have to dramatically change the types of products that they sell. And that's just not going to happen.

It's not that the ones who are going to sign it were going to act ethically anyways. If you find someone who is going to sign that, you actually should be a little suspicious in the 403(b) world. You should be a little suspicious and actually do a little more homework. And here's an ironic thing. I actually got this document back. I actually had somebody reach out and want to hire me. And then, they said, A, before we hire you, we need you to read this document and sign it. I was like, oh, I created that document. So, I think you would want to be a little skeptical of someone who is signing it. But if they are willing to sign it, you've done two things: one, you've got it in writing that they're going to act as a fiduciary at all times. And if they don't, well, the good news is, you now have some recourse there. So, I still think it's a good idea, and it really, really weeds out who you can work with, because there's just a lot of agents in this area who will never sign that document.

Benz: You've noted a few times about how these 403(b) salespeople are roaming the hallways of schools freely, and they might employ techniques to burnish their credibility with teachers who talk about some of these situations in your podcast series called Learned by Being Burned. So, Dan, can you talk about how these salespeople burnish their credibility with other teachers to try to sell their products?

Otter: They do it through doughnuts and Starbucks gift cards, which is a very effective technique. As you know, they camp out in teachers' lounges, or they sponsor teacher appreciation events. They'll often provide food. But the big technique is illusion of district endorsement, or that they work for the state pension agency. They will send out emails that will say something like, "You are eligible to meet with a financial professional," or "I'm here to provide your pension calculation." And again, put yourself in the place of a teacher. If you've never been taught about the 403(b), Scott described how busy a teacher's life is, what his wife goes through, you're going to think, oh, this is someone from the district. This is a benefit I have. And then, I would say, the key thing to keep in mind is that these are not fiduciary advisors. They are not required to put your best interests in place.

Ptak: I wanted to ask about correlation between 403(b) quality and the wealth of a school district. Do you tend to find that 403(b) quality varies depending on how prosperous a particular school district is? Or conversely, do you find in lower-income areas they field worse plans than in higher-income areas?

Otter: This is such a good question. So, to-date, we have rated the quality of 3,000 school districts. And our next step is to map that data. And we will add this metric to that effort. So, I thank you for raising this question.

Benz: I wanted to ask about unions. You note that unions such as the National Education Association endorse products that in some cases run counter to participants' best interests in the 403(b) space. Why is that?

Dauenhauer: Money. It's all about money. Let me take a step back. Dan and I are both pro-union. My wife is part of the NEA, she's part of the CTA, part of the local. And we appreciate everything that they do and have done for us over the years. So, we're very pro-union. But the NEA, for example, has this for-profit subsidiary, and it's called NEA Member Benefits. And it exists to sell a bunch of different products, many of them financial products, with a goal of making money from their members. And the products that are sold in the 403(b) are way more expensive than they need to be. And part of that reason is because it makes money for NEA Member Benefits, and we have called on them for years to stop marketing this product. We think the job of the union should be advocating for better retirement plans not selling retirement plans that benefit themselves. This is unfortunately one of the areas that we differ significantly with them.

I will say that there is one good NEA 403(b) product that is out there that most people don't know about because the reps who sell the products will never tell you about it. It's called the NEA Direct Invest. And it's actually a very low-cost 403(b). And I think it's $35 a year and gives you access to like four or five very low-cost Vanguard funds. So, all in all, a pretty good product. The problem is, nobody knows about it. Most of the money is going into the expensive products that are sold by salespeople affiliated with the entity that the NEA has partnered with. So, if you're if you're listening, NEA, we love you, but you've got some room for improvement here.

Ptak: 403bwise has a lot of great resources for understanding the 403(b) space and even checking up on a particular school district's plan. But before we get into some of those features, can you talk about how 403bwise gets its funding?

Otter: I had always run 403bwise on the side as I taught elementary school and middle school, and when I moved to teaching at the college level. In 2016, The New York Times released a series of articles that Scott and I helped the reporters with, and it was on the problems with the K-12 403(b). And to our great fortune, Tim Ranzetta, the cofounder of Next Gen Personal Finance--this is an excellent nonprofit whose goal is that by 2030 every kid in an American high school will have access to a standalone personal finance class. Well, Tim read these articles and he was horrified to learn that the very teachers he was helping develop curriculum for and work with to use his curriculum were being ripped off. So, he reached out to Scott and I and we had no idea who Tim was. Tim is not a self-promoter. And the ironic thing is I had just accepted a new job. I was teaching at the University of New Mexico, and I had just moved to Southern California to teach at a private university, University of Redlands, and we had a call with Tim and Tim said, "Hey, have you ever thought about turning this into a nonprofit?" And this is nothing Scott and I had thought about, and he said I would love to help you do this. So, we stayed in touch over the next couple of years and continued the conversation. And because of his generous support, I was able to leave my job at the University of Redlands where I was an associate dean to run 403bwise full time. And so, we became an official nonprofit in 2019. So, we are 403bwise.org.

Benz: We want to talk about this plan-rating system that you have on 403bwise. How do the ratings work?

Otter: I'm going to have Scott describe how we apply ratings because he designed the system. But just last night, we updated our numbers. I want to tell you how bad it is out there. We've always known anecdotally it was bad, but now we've got raw data. So, there are 14,500 school districts in the country. We now have data on the plans of 3,041 school districts. So, this is more than 20% of the school districts in the country. We've only assigned 27 A's, that is less than 1%; only 12 B's, that's an even smaller number. There are 1,754 C's, so 58%; 745 D's, which is 25%; and over 500 F's. So, together, D's and F's make up more than 40% of the plans that we've rated so far. And we doubt that when we get to 30%, 40%, 50%, these percentages are going to change.

Ptak: That's depressing. Maybe you can talk a little bit about what goes into those grades that you assign. I'm sure that cost is going to be one of the dimensions that you're evaluating. What else? And maybe how does that relate to so many of these plans that got poor grades under your system?

Dauenhauer: It is depressing. But there is some hope. And so, I'll get to the hope here in just a moment. But we have a two-tiered system in terms of the grade. So, first of all, what we do is we grade the vendors themselves. So, the products that are being offered, we grade those according to a traffic light system. And very simple--green means go, yellow means be cautious with the vendor, and red means you need to stop and reevaluate. We put all the vendors into one of those three categories. And it is mainly driven by fees. So, the lower the cost, the better the structure of the product, the more likely it is to be green.

We do have some qualitative measures as well. So, if the company has had some issues with how they're distributing products. So, for example, we have one of our vendors that would probably have been green a few years ago, we've placed into the yellow category, because of some issues they've had, some settlements they've had. So, that does feed into it. But then, we use that information to drive the actual grading system, the A, B, C, D, F grading system. And we reserve A's and B's for school districts that have done the job of taking their plan out to bid and coming up with either a single vendor or a bidded multiple-vendor plan that has reasonable fees, and they've really taken control of their plan. That's really the only way you can get an A or a B.

If a school district does not offer a green vendor, then they're going to get either a D or an F. So, if they don't have one of our great vendors, they're going to get a D or an F. And as you can see, a significant percentage, over 40%, they offer multiple vendors, but they don't offer multiple quality vendors. They don't even offer one. You only need to offer one good vendor to go from an F or a D to a C. That's it. You just have to offer one good green vendor. And it's amazing to me that there's so many school districts that don't even offer one good, high-quality vendor. The good news is, it's easy. It's not that difficult to add a high-quality vendor, especially if you're using a compliance administrator to do the work for you.

So, a lot of these schools that have D's and F's, I realize they're not going to all be able to take their plans out to bid overnight and become A's or B's. But they can do something very similar in less than three months. They could move from an F or a D to a C just by adding one high-quality vendor. And so, in that respect, I think there is a lot of hope there that, yeah, it's bad, they have D's or F's, but they could do something immediately and have an effect. And then, hopefully, they let their employees know that that good vendor is available. That's the other issue. School districts do not like to give any notoriety to any vendors. They don't want to look like they are promoting one vendor over the other. But that's how it works. That's our system, in a nutshell, it's how it works. You can visit 403bwise.org and go to the advocacy section and we have a whole page on how the rating system is done.

Benz: I would guess that many of our listeners have friends and family members who are educators. I know I do. So, let's talk about some steps that educators can take if they've done their homework and decided or determined that they have a lousy plan. Would you say it's usually better for someone to just forget the 403(b) and focus on maxing out their IRA first before even looking at the 403(b)?

Otter: I can take that question. Scott and I are really big fans of the Roth IRA, particularly for young teachers who might not need tax deduction that a 403(b) can offer. So, we want to see all teachers have a really good Roth IRA plus a good 403(b). And as you know, the contribution amounts are very different. You can only do up to $6,000 in a Roth IRA. But with a 403(b), you can do up to $20,500. So, people listening saying, first of all, "Can I see how good my plan is?" And then, the next question is, "How can we improve it?" Come to 403bwise.org, go to our advocacy section, check our vendor database. We may very well have rated your district. And let's say, we don't have your vendor information, you can easily upload it, which is what dozens and dozens of people are doing. We upload that data and then we grade it. And I would also encourage people to join the 403bwise Facebook group. Scott and I are not fans of Facebook, but we really do like the group structure. And we have more than 6,500 teachers in our Facebook group. And on a daily basis they are posting things like, "I just found out about how bad my 403(b) is. What can I do to make it better?" And we've developed quite a community there. And, of course, we just have so many resources on 403bwise.org.

Ptak: Since you mentioned it, what recourse do the teachers have if they determine that they'd been investing in a high-cost plan that wasn't in their best interest? It sounds like many 403(b) participants can't sue the providers like people investing in ERISA plans can. So, what's the alternative, apart from availing themselves of the resources it sounds like you offer on 403bwise?

Otter: As you mentioned, there's no legal recourse. I would say join our advocacy movement, work to make the system better. In fact, our mantra is: the K-12 403(b) is broken; together, we can fix it. Scott and I cannot do this ourselves. So, we need more people as part of this fight. Get in there, make improvements. Scott and I have this advocacy network of teachers that we meet with every two months. And, in fact, they are the ones that said that we should affix an A through F grade to these plans. We were going to just stay with the green, yellow, red rating. And they said, no, do not do that. Use grades. So, join us. We need more people in this fight.

Benz: You've mentioned that some of these annuities that are offered in 403(b)s have steep surrender charges. What's your counsel to educators who perhaps opted in to one of those programs, and their only choice is to either pay one of those steep surrender charges, or stick it out? How should they decide what to do in that instance?

Otter: It's complicated. If they're in a high-cost mutual fund or a high-cost variable annuity that uses a mutual fund, it probably makes sense to transfer it to a new, better vendor. But if they're in a fixed account, paying a decent interest rate, it gets a little bit more complex, and that's where we would say, that's when you want to go ahead and hire a fiduciary advisor like Scott. But our general advice is, stop contributing. See if you have a better lower-cost option. Direct whatever money you were sending to the high-cost vendor to the new vendor. Getting out of these annuities is so complex. In fact, it's the most read story on 403bwise is how to get out of a bad 403(b). And then, the second-most read story is how to get out of Equitable AXA. It's also the most popular topic on our Facebook group.

So, let's say you don't have a good vendor, that's where the lobbying, the advocacy work begins. But to your point about the Roth IRA, if you don't have a Roth IRA, and you only have a bad 403(b), go ahead and start a Roth IRA. And Scott touched on this. Teachers are eligible to contribute to something called the 457(b), and in in many cases, it is better than the 403(b) for the very statewide fiduciary reasons that Scott described. In fact, all things being equal, we actually think teachers should start with the 457(b). And another advantage of the 457(b) is, almost every state has a state-run 457(b) plan, which has enormous economies of scale, because it's not just teachers who are eligible. It's firefighters, police officers, government employees. We always use the New York 457 plan, which is called the New York Deferred Compensation Plan, as an example. They have $23 billion of assets under management, and New York teachers are eligible to participate. Scott, you can help me here on this, but I believe they have an S&P 500 fund that charges 0.008. Is that right, Scott?

Dauenhauer: That's right.

Otter: So, there are a lot of ways to come at this.

Ptak: Do you have any 403(b) success stories to share where concerned individuals have affected positive change within their own 403(b)s?

Dauenhauer: Actually, before I answer that question, Dan had mentioned that it might be a good time to hire a fiduciary advisor like myself. Just want to make clear that related to the nonprofit work, I don't take on clients related to the nonprofit. The nonprofit is focused solely on education, advocacy, and building community. It is not here to build my business. I refuse to take clients through the work that we're doing. So, I just want to put that out there.

But thank you for the question. Because we have a new upcoming podcast series. We have a regular podcast, Teach and Retire Rich podcast, but we have this new one coming up that we've worked on for almost two years called Learned by Being Burned. And it is almost entirely made up of educator success stories, educators who have been burned by a high-cost, low-quality vendor, who have then taken it upon themselves to get out of that product, get into a good product, but then do something more. They end up advocating on behalf of those in their district. They will hold meetings and do education. They will try to get new, better vendors added. Dan and I receive emails all the time from people who have been able to get Vanguard or Fidelity or Aspire or one of these really good low-cost, high-quality vendors added to their 403(b) list. We see that all the time. We have teachers who are helping teachers move money from bad providers into good providers. So, we see these success stories weekly. We get emails from people weekly from something that they have done, whether it's just moving from a bad vendor to a good vendor, or whether it's getting their school district or their union to hold a meeting and talk about this and provide education. A lot of those stories are going to be featured in Learned by Being Burned, which we'll be releasing very soon.

Benz: How about individuals who aren't educators but are just concerned citizens who would like to improve the quality of the 403(b) in their district? I'll give you an example. I looked up my elementary and high school districts locally and they got C's for the quality of their plans on 403bwise. And then I started looking at who do I know on the school boards at these two districts? But how should people proceed if they are listening to this, and they want to try to make sure that their educators in their community have access to good-quality investment options?

Otter: I would say lobby the school board. They might be happy to talk about something other than masks.

Benz: True.

Dauenhauer: I keep promoting our upcoming podcasts, which is probably bad to do on someone else's podcast. But it's kind of a roadmap for how to enact change. And so, I think just forwarding that to a school board member that you might know and just making them aware of what it is. And it's not that we need every school board to immediately go out and go single vendor. I think that would actually be problematic. But we do need every school board to have a plan to eventually do that and figure out a way to do that. I think it's really just raising awareness of the issue. And whether it's a local reporter following us on Twitter and retweeting our stuff--that kind of information, it gets out there. And school districts, they don't want to have a bad rating. Some of them don't really care, honestly. But most of them, they don't want to have a bad rating in this area. And every superintendent that I talked to, they don't want their employees to have high-cost 403(b) plans. Think about it from a school district perspective.

They want their employees to retire successfully. And they don't want their employees to work longer than they have to. Nobody wants a teacher who's burned out and can't do this anymore, and they're just working in order to get that extra year of pension because they hadn't saved enough during their working years. Nobody really wants that. And also, when a teacher retires, oftentimes, a school district can hire one to three teachers or one-and-a-half teachers for the money that they were paying the retired teacher. So, a successful 403(b), 457 plan is not just good for the educators in the school district, it's good for the school district's finances long term. And I think once they start to see it from that perspective, maybe they will take a closer look at what they're doing.

Benz: Well, Dan and Scott, this has been such an interesting conversation. Thank you so much for taking time out of your schedules to discuss your work and share with us what you've been doing on 403bwise.

Otter: Thank you.

Dauenhauer: Thanks for having us on.

Ptak: It was our pleasure. Thanks so much.

Benz: Thank you for joining us on The Long View. If you could, please take a moment to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

You can follow us on Twitter @Christine_Benz.

Ptak: And @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis, or opinions, or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)