Who benefits from expanding options on teacher retirement plans?

Randy Richardson, retired associate executive director of the Iowa State Education Association, shares the backstory on regulations Iowa Republicans weakened during this year’s legislative session. -promoted by desmoinesdem

On December 8, Bleeding Heartland shared a post entitled “Iowa Republicans Found Yet Another Way to Hurt Teachers This Year.” The post outlines the passage of House File 569, a bill that allowed 30 additional vendors to offer 403(b) products to teachers starting this year. GOP State Senator Tim Kraayenbrink, who is also a financial adviser, dismissed Democrats’ claims that the array of investments would be too confusing and allow companies to charge exorbitant fees on teachers’ savings. But is that accurate?

As someone who was very involved in the transition to the Retired Investors Club that is administered by the Department of Administrative Services, I thought it might be a good time to revisit why this all took place.

In July 2006, the Internal Revenue Service (IRS) published new rules that impacted 403(b) plans (also known as tax sheltered annuities or TSAs) for public employees. Those rules went into effect on January 1, 2009.

Prior to this time we lived in a virtual Wild West of 403(b) plans. Vendors faced little regulation and any vendor could receive a payroll slot for a teacher to contribute to a retirement plan. This resulted in literally hundreds of plans being offered across the state. Employees of the Des Moines school district alone participated in over 150 different plans. No oversight or fiduciary responsibility was required by the school districts. Employees could invest as they pleased and borrow from their accounts as needed.

The new IRS rules greatly increased the responsibility of school districts for 403(b) plans. The additional paperwork requirements also meant a significant increase in work for district personnel. As school districts began to grapple with how to work with the large number of 403(b) vendors, they also began to discuss the possibility of finding a way to limit the number of providers.

Staff from several education organizations began to talk behind the scenes to see if there were any common solutions that might be used to address this issue. As the discussions continued it also became obvious that several other shared concerns needed to be addressed. Among those were:

1. Relatively few teachers actually contributed to 403(b) plans and a way needed to be found to get more people saving for retirement.

2. There were way too many 403(b) plans in existence around the state and many of those were of low quality and high cost.

3. The number of complaints from teachers concerning the business practices of 403(b) vendors was increasing.

In the spring of 2008, staff from several education groups began meeting to discuss how to handle the new IRS rules and to address some of the other issues around retirement planning. One of the early problems they encountered was that many of the 403(b) plans being offered to teachers were variable annuities. Variable annuities often come with very high fees and surrender charges. The group quickly discovered that very few teachers knew what the fees associated with their plans were or if they were paying surrender charges.

It is important to point out that fees on variable annuities can run as high as 2.25 percent, while fees on mutual funds often are less than 1 percent. A fee of just over two percent doesn’t sound like much to a lot of people, but when applied over the lifetime of an investment it is significant.

For example, let’s take two teachers earning the same salary and investing $10,000 annually over a 40 year teaching career. Their investments earn the same annual return, but one has a variable annuity with a fee of 1.5 percent, while the other invests in a mutual fund with a fee of 0.5 percent. Over that 40 year period the person with the low-fee, mutual fund would earn $300,000 more than the teacher with a variable annuity due only to the difference in fees.

Not only were teachers paying ridiculously high fees, but they were also falling victim to unscrupulous brokers who promised high earnings on low-quality investment products. A year later the same broker would return with a brand new product that would provide even higher earnings. The unsuspecting teacher would then pay a surrender charge to get out of the original product. Teachers filed numerous complaints during this time.

During a meeting in 2008, the education groups became aware of a plan offered by the Iowa Department of Administrative Services (DAS). The plan, known as the Retirement Investors Club (RIC), provided state employees an opportunity to invest in a 457(b) retirement plan. The group decided to invite representatives from DAS to attend the meetings and to explore the possibility of using that agency to act as a plan administrator for a statewide 403(b) program.

DAS was quick to accept the invitation and was eager to assist. The education groups realized that the plan required a change in the law in order to go into effect. The group began to work with legislators to draft language for a bill that would dramatically change how 403(b) plans were made available to public employees in the state. One of the group’s highest priorities was to provide school districts and associations with the option of maintaining local control over any 403(b) plan. The Iowa House and Senate approved that legislation, and Governor Chet Culver signed it into law.

It went into effect on July 1, 2008. As most everyone knows by this time, the plan included two options:

1. A local plan where up to eight 403(b) vendors could be selected. Up to five vendors would be selected by the school district and the other three by the local association.

2. Participation in the state plan where six vendors were eventually selected.

The legislation established 2009 as a transition year. During the transition year, the selection of vendors would take place as described above. However, both local school districts and DAS would be required to go through an request for proposals process to select new vendors for 2010. Although education groups anticipated that quite a few school districts would choose to remain with the locally controlled plan, the vast majority (330 of 362 districts) opted to go with the state plan.

The new plan immediately ran into obstacles. Independent insurance agents lost considerable business under the new law and began lobbying to have it overturned. In addition, the American Society of Pension Professionals and Actuaries began sending members of the education group letters promising a class action law suit. Eventually the parties backed down, and all was well with the plan. Teachers were able to invest in high-quality, low-fee mutual funds that often included no surrender charge. The number of complains about shady annuity brokers dropped to almost zero.

Unfortunately, Republican legislators began to propose bills that threatened to chip away at the new law. By 2015, an additional tier of optional vendors was added to offer 403(b) plans that did not meet the standards of the original DAS plan. This year, House File 569 further opened up the field to more brokers.

This is a very lucrative market for insurance brokers, but having more options doesn’t necessarily mean having better options. Fortunately school districts are largely satisfied with the plan offered by DAS and have been somewhat successful in limiting other vendors from gaining access to teachers. There is still a general lack of knowledge by school district personnel about the impact of fees and about the difference in the quality of investment options.

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