Advisor Works to Bring Low Fees to 403(b)s

Editor's note: Charles Keenan is a freelance financial journalist.

Tony Isola is on a mission to upend the fee-heavy market for teacher retirement plans. Throughout his career, the Certified Financial Planner has extricated teachers from expensive financial products in their 403(b) plans, which are tax-deferred retirement vehicles used by public schools and other tax-exempt organizations. Typically, these plans are rife with lousy deals for investors, with annuities contracts and mutual funds with high loads. These products significantly erode the long-term returns of teachers and nonprofit workers. Isola, also head of the educator/403(b) division at New York-based Ritholtz Wealth Management, sees a much better way to help these investors by providing them with a simple mix of low-cost, indexed mutual funds. As part of that effort, he collaborates with Vanguard Group to make its funds more accessible to teachers. One goal of the alliance is to find the best way to get teachers' attention to make the switch. "We are attempting to grow this into a grassroots movement," he says. "Vanguard helps us bring huge credibility and resources to what we are trying to do. Like Amazon, we want volume, and we know this could work." It's a big market. 403(b) plans held about $1.1 trillion in assets at the end of the fourth quarter, according to the Investment Company Institute. There were about 3.3 million K-12 teachers nationwide as of 2018, the most recent numbers published by the U.S. Bureau of Labor Statistics. With Vanguard's brand name and scale, Isola sees a big opportunity. Yet it's also a tough market to infiltrate, resembling a financial backwater of sorts. While 403(b)s are similar to private-sector 401(k) plans, they do not fall under regulation of the Employee Retirement Income Security Act, which says that 401(k) providers have a fiduciary duty to put participants' interests first. Not so for public schoolteachers. The 403(b) world is dominated by commission-based salespeople, who Isola says descend on school administrators and prey on the financial naivete of teachers, especially young teachers just starting their careers. Often the annuities contracts within the plans come with annual expenses of 2% or more of assets and surrender clauses of 5% or more. Over a long period, these high annual fees can cost teachers hundreds of thousands of dollars in retirement savings. "Public schoolteachers deserve an F in fee comprehension," says Isola, 55. "They are helped by annuity salespeople, who win them over with charm yet don't have their best interests at heart." The party has to stop, Isola says. "It's a social issue. We have an opportunity to change an industry." Out of Finance, Then Back In Isola had never planned to be a financial advisor. After graduating from college with a bachelor's degree in economics, he worked on Wall Street trading currencies in the late 1980s and early 1990s. His days were chaotic, with lots of yelling and screaming from the start. When trades went bad, it ate at him, and he quit the profession in 1992. Motivated to make more of a difference in people's lives, he enrolled in a master's degree program in education, moved back into his childhood bedroom, and took a job at a sporting goods store. He first taught in Queens in New York City; then in 1998, he took a teaching position in Stony Brook, N.Y., a suburb on Long Island. Word got around to the staff about Isola's Wall Street background, and teachers started approaching him with questions about their 403(b) statements, which were full of high-cost investments with unnecessary tax-deferred structures. "What is this?" Isola would say to his colleagues. "Why did you do this?" What he found was that K-12 schools everywhere had been infiltrated by so-called 403(b) experts, who were giving out horrendous financial advice. He advised people to just invest in index funds. After a while, teachers were coming to him with all sorts of financial questions, on life insurance, 529 college-savings plans, and budgeting techniques. Dina Isola, Tony's wife, encouraged him to pursue financial advising as a business. He resisted at first, not wanting to officially return to the financial world. But after she showed him some literature on how much money salespeople were making off of fee-rich products in 403(b)s, he changed his mind. Isola became a Registered Investment Advisor in 2003. Dina Isola left her job in communications for mutual fund company J&W Seligman to handle the marketing and operations of their new business. Over time, the Isolas amassed assets from teachers and others, working out of a loft above their garage. They used Morningstar for its portfolio management and research tools, until they moved the practice in 2015 under the umbrella of Ritholtz, freeing up the pair to focus on customers and marketing. They handed off operations and trading to others in-house. They still work from home. While teachers still represent the lion's share of clients, they account for only 30% of overall assets under management, which ran about $90 million in March, including some high-net-worth households. Clients get a basic approach of buy-and-hold market exposure. Isola doesn't try to time the markets, but rather has clients make regular contributions that increase over time, with annual rebalancing. "Focus on the cost and diversification," Isola says. "The returns will take care of themselves." Going Direct Isola is a big fan of Vanguard's Admiral shares—a suite of mutual funds in domestic and international equities and bonds, and sectors. To get teachers access through their 403(b)s, he uses two approaches. One is by using Aspire, a provider that offers Vanguard funds and has a large footprint in K-12 schools. The other is by working directly with Vanguard, which has a 403(b) platform it markets to schools but doesn't yet have a critical mass in the market. Both methods allow Isola to keep fees low while providing financial advisement to his clients. The maximum Vanguard fund fee is 0.07% of assets annually, plus a yearly $65 administration fee per account. He charges his clients a yearly fee of 0.4% of assets, giving his teacher clients an all-in cost of 0.47% with this setup compared with 0.62% if he uses Aspire. Either way, the overall fees significantly undercut annuities that charge 2% or more annually. The challenge is getting into the schools to spread the word about Vanguard's low-cost option. It would seem like an easy sell, but many schools are resistant to change, Isola says. While Vanguard is available to 403(b) participants in a lot of institutions, teachers often instead just sign up for the expensive annuity contracts. "Who's in the schools?' Isola says. "It's all of the annuity salespeople." Isola doesn't expect a wholesale conversion overnight. He has weekly meetings with Vanguard to strategize on how to educate teachers, including through centers of influence such as union leaders. The tandem had arranged some in-person presentations with union leaders in the spring, but the coronavirus shutdown put everything on hold. They were working on organizing an online version of their talk, which will give them a much wider audience. There's a lot of work to be done to crack an entrenched market, but with Vanguard at his back, Isola sees a disruptive force taking shape. "There is no one attempting this on this scale," Isola says. "We have a chance to make some headway. The more that people could be aware of this, the more momentum we'll have." And the more teachers and others will be able to rid themselves of costly financial products in their 403(b)s and save more for retirement.

This article originally appeared in the second-quarter 2020 issue of Morningstar magazine. Learn how financial professionals can subscribe for free.