by Dan Halle, Regional Director of Retirement Plan Sales
Understanding important characteristics of retirement plans help employers maintain more control over their plan offerings. Recent changes to the structure of 403(b) plans make it a more viable option for some employers but there are crucial elements plan sponsors need to be aware of that can help reduce investment costs and employee confusion. First, let’s look at how regulatory changes have impacted 403(b) plans and how they fare compared to 401(k) plans.
New IRS regulations governing 403(b) plans came out in 2009, 43 years after comprehensive IRS guidance was first released for 403(b) plans. These rules, which are written for both ERSIA and non-ERISA 403(b) plans, cover plans sponsored by public sector educational institutions, churches, government, and non-profit organizations. Their intent is twofold: 1) to rein in the insurance company dominated marketplace and 2) to begin the process of making 403(b) plans operate more like their greater efficient 401(k) counterpart by bringing increased scrutiny to the operation, fee structure and practices prevalent in the 403(b) retirement plans.
401(k) vs. 403(b) Plans
Distinct differences between 401(k) and 403(b) plans have allowed large insurance companies that dominate the 403(b) market place to react slowly to these IRS regulations as they continue operating with a “divide and conquer” approach. For example, the 403(b) market has long been highly individualized and focused on retail pricing while the for-profit based 401(k) market has been more focused on pooling individuals into group plans and institutional pricing. Additionally, each plan has its own provider model. Most employer sponsored 403(b) plans offer a multiple-provider model where their employees can select annuity products from several different insurance companies. This might sound like a benefit but these products often have the same investments within them, creating confusion, fund overlap and higher pricing due to multiple products with differing fee schedules. On the other hand, most 401(k) plans use the single-provider model that offers a multi-fund family platform, letting participants select investments from several different fund companies housed on a single platform, which allows for asset pooling and lower pricing.
In the multiple provider model offered for most 403(b) plans, fixed and variable annuities known as Tax-Sheltered Annuities (TSAs) have long been the product of choice by some of the largest insurance companies. Nearly 80% of participants’ 403(b) retirement money resides in individually-priced fixed or variable annuities. These individually-priced annuities typically have high investment, mortality and risk expenses that drastically reduce the investment performance. They normally have long and costly surrender penalties if money is withdrawn. By using these products that do not recognize group pricing and pooling of assets, the insurers offering these products have been able to effectively “divide and conquer” the retirement plan, allowing them to keep their expenses and margins higher than those offered in the corporate 401(k) plan. This eliminates the plan sponsor’s ability to effectively negotiate lower fees for their plan and participants. What’s more, many well-intended employers trying to offer more choices for their employees have allowed several annuity products from differing companies in their plan, which further hinders employers’ control. Fiduciary liability is another big issue affecting 403(b) plan sponsors and in some cases their board of directors. As a fiduciary, the employer representative or trustee is tasked with ensuring that the plan is run in the best interest of the employee. Plan trustees and board members can be held personally liable if there is a breach of this fiduciary responsibility. Because of this, the trustee needs to not only understand the pricing structure, fund offering and operation of the plan but also feel comfortable it is being run in the best interest of the employee. If there is a multiple-provider structure to the TSA and a long list of annuities being sold, it can be difficult for the trustee to fully understand what is being offered to the employee. This can present fiduciary and legal issues in the future.
As an employer sponsoring a 403(b) plan, what can you do to take more control and move towards a single-provider platform that helps reduce employee confusion and investment costs? Here are some things to consider:
- Hire a consultant or advisor that understands both ERISA laws and the pricing and fee structures associated with TSA accounts. You may want to work with an advisor who will partner with you as a fiduciary.
- Move away from more costly, individual TSA products. Use a single-provider option that is priced on a group basis. These platforms mirror the products available to group 401(k) plans. Moving to a single provider gives the employees the ability to select mutual funds from some of the best known mutual fund providers and pools the participants’ assets for pricing purposes. The single-provider structure also allows plan trustees to better manage what is being offered to the participants, providing more negotiating power when working with the various product platforms available.
- Create a plan to stop new contributions into these higher-cost products. In some contracts, each new contribution activates a new deferred sales charge. This can further extend the time it takes to move from these TSA contracts. Some 403(b) providers can provide a buyout to help absorb these deferred sales charges. The key to remember is that the process will take some time. Put together a multi-year strategy that moves the plan assets to a new provider and stick to it.
- Avoid products with long, back-end deferred sales charges. Today’s retirement products typically do not have any back-end deferred sales charges. It is rarely advisable to enter into these contracts.
The regulatory updates were meant to help plan sponsors and trustees of 403(b) plans better manage their retirement plans and fiduciary obligations. Unfortunately, the industry supplying products for these plans has been slow to embrace the transition. However, the advent of many new 403(b) products is allowing employers to better control costs while increasing fund choices. As a trustee, fiduciary or board member for a 403(b) plan, you should consider working with an independent advisor who is willing to share fiduciary liability and who can provide you with the advice and planning needed to move your organization away from these standard TSA products.