Because public K-12 403(b) plans are exempted from ERISA, vendors are in many cases unregulated in key cost, investment and fiduciary areas of plan management, according to “Emulating ERISA: Providing a safety net for public K-12 educators,” a white paper from TIAA-CREF. “This leaves them in many unfortunate circumstances free to market questionable products on educators, in some cases with hidden and hefty fees,” the paper says.
“The most important single element is to get the advice piece right,” Bruce Corcoran, managing director and head of the K-12 segment at TIAA-CREF in Charlotte, North Carolina, tells PLANSPONSOR. “So if providing access to investment products and services, get the conflicts of high commissions out and make sure investment advice is objective.”
The paper notes that being exempted from ERISA, means public K-12 plan sponsors’ employees are operating without the safety nets the law provides, which may ultimately leave them less prepared for retirement. But, Corcoran says TIAA-CREF is seeing these plan sponsors start to apply ERISA principles such as the “prudent expert rule,” which holds that a fiduciary must act “with the care, skill, prudence and diligence” in administering plans under the law that a reasonable person “familiar with such matters” would use, as well as the “exclusive benefit rule,” which states that a plan’s fiduciary must act solely in a participant’s or beneficiary’s best interest (see “Meeting Expectations of the DOL”).
Applying those principles and the ERISA requirement to diversify investments has a significant potential economic impact to educators, and the biggest benefit to K-12 plan sponsors, according to Corcoran, is it helps them attract a globally competitive work force and have less financially stressed employees who can do their jobs better.
The K-12 retirement plan market has traditionally been dominated by insurance providers offering fixed annuity products. While fixed annuities do belong in a retirement portfolio and help K-12 educators save and prepare for retirement, the TIAA-CREF paper contends, when they stand alone as an investment strategy, employees lack diversification and long-term risk management benefits. Corcoran says he is a big advocate of the products, “but if K-12 employees also have a pension and are able to get Social Security benefits, locking into a high-cost annuity for 30 years has a staggering economic price.”
The paper offers a hypothetical case of two California teachers, both age 35, who save 5% of their income each year and at age 65 begin taking monthly withdrawals of $2,500. The first has 100% of her assets in a fixed annuity product. The other is in a portfolio that has an evenly split allocation between fixed annuities and equities (the 50/50 portfolio), with periodic rebalancing to maintain that allocation. A set of calculations—based on actual results of the equity and fixed income markets—shows the 50/50 portfolio generates $427,000 by the time that teacher retires at 65. The 100% fixed annuity solution generates only $296,000. That $130,000 difference represents approximately 40% more in retirement assets and widens even further to more than $600,000 by the time the teachers reach age 77, at which time the 100% fixed annuity investor is projected to run out of money.
So, what steps can K-12 plan sponsors take to emulate ERISA principles? Corcoran says TIAA-CREF is seeing some establishing plan committees just as their 401(k) counterparts have. In addition, many are starting to competitively bid their programs, moving towards an institutional design, as well as pare down to a single-vendor administration model. Some are also outsourcing administration and investment decisions as internal staff do not have the expertise.
TIAA-CREF also sees consultants and advisers becoming more active with K-12 plan sponsors, offering sponsors their experience and voice in the market, according to Corcoran. And, some states are addressing high costs and sales models of 403(b) vendors.
Corcoran says higher cost-structure providers and distributors are using fear to oppose these better structures, telling plan sponsors “If you take control of changes, products and processes to improve outcomes, you will create liability for employee choices.” But, these plans will never be subject to ERISA. Some states do have fiduciary statutes that overlay K-12; “Just use a little caution as plan sponsor,” Corcoran suggests.
For the best guidelines for K-12 employers, “look at the best practices of ERISA,” Corcoran concludes. “If you have a process, you’re better off than with no process at all, and improving [employees’ retirement savings] outcomes will help everyone.”
The TIAA-CREF paper is at https://www.tiaa-cref.org/public/pdf/emulating_ERISA.pdf.
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