Looking at the history of 403(b) plans, many utilized the services of multiple providers—or vendors, as they may still be called in the 403(b) world.
The plans were often called tax-sheltered annuity plans, and plan sponsors would let annuity product providers come into their cafeterias or employee lounges and speak one-on-one with employees about putting away savings for retirement. When 403(b) regulations were issued by the IRS in 2007, more plan sponsor oversight was needed. Among other issues, individuals were overstepping statutory contribution and loan limits while working on their own with providers.
Plan sponsors in many segments of the 403(b) market have since moved to a single-provider model, often citing lower costs for participants and easier administration for plan sponsors as the reason. However, K-12 public school 403(b) plans have typically stayed with the traditional model, whether to maintain the status quo, due to objections by employee unions or fear of backlash from participants for taking away their choice.
Legislation in some states has also kept K-12 403(b) plans from moving to a single provider. For example, just recently, an act inserted into Pennsylvania’s Public School Employees’ Retirement Code requires school districts, beginning July 1, to have a minimum of four separate “financial institutions or pension management organizations” for each 403(b) plan sponsored. This is four in addition to any of the Pennsylvania School Employees Retirement System’s approved providers for the School Employees’ Defined Contribution Plan that the school district may be using for its 403(b) plan.
California and Texas have laws that require K-12 403(b) plan sponsors to use any providers participants choose, according to Israel Tannenbaum, CPA, director at Mazars USA, a global accounting, advisory, audit, tax and consulting firm, in New York City. Ellie Lowder, consultant to 403(b) plan product providers, based in Tuscon, Arizona, says these laws have a condition that the providers must be able to comply with the information sharing requirements of the IRS regulations. There are similar laws in the State of Washington and Massachusetts, she adds.
A law passed in Texas this May took away restrictions once in place for K-12 403(b) providers, including limits on fees and that they register with the Teachers Retirement System.
What is the impetus for such laws? Is the multiple provider model good for 403(b) plan participants or does it cause confusion and higher costs?
Multiple providers: Good or bad?
While some argue that it is the insurance industry and its lobbyists causing state lawmakers to put into place such legislation, others contend the multiple provider model has advantages for participants. The debate over whether having multiple providers is good or bad has been going on for years.
Looking at costs, Debby Karton, benefits coordinator at the Illinois Public Pension Fund Association (IPPFA) in Glenview, Illinois, offers some data.
Founded in 1985, IPPFA is a not-for-profit organization with the primary function of educating and training all Illinois Public Pension Fund Trustees. By leveraging the buying power of hundreds of public-sector employers, IPPFA built a co-operative that public-sector employers are able to join at no cost—the Wise Choice for Educators Combined 457(b)/403(b) Plan. Wise Choice utilizes a single-provider model.
After one school district joined Wise Choice, the weighted actual expense ratio for the participants in the 403(b) plan is 1.08%, versus the 403(b) industry average annuity plan fees and fund expenses of 2.95% (source: Morningstar). Another school district, which joined the plan in 2008, boasts a weighted average expense ratio for participants of 1.09%.
However, Lowder points out that fees should not be the only consideration when selecting a plan’s provider or investment options. “Plan sponsors need to look at results,” she states. In addition, she contends that the lowest-fee providers generally don’t offer the full-service approach that participants need. For example, some may not include one-on-one consultations with employees, which Lowder says is needed to increase the likelihood of participating in the plan and of increasing contributions to the plan over the years.
According to Tannenbaum, K-12 403(b) plan sponsors don’t typically go out to bid for providers. He says the state laws could get the state or a school district to go out to bid for the best provider for participants. At least they may get more people looking at the providers being offered. However, Tannenbaum adds that in general, if plans are splitting services between providers, they cannot use economies of scale to get a better deal.
Tannenbaum says those on both sides of the argument make good points. He notes that 403(b)s have limits on the types of investments made available, which can result in higher fees. “Having multiple vendors might be a way to try to reduce this,” he says.
Giving participants choice is the most often-cited reason for sticking with the traditional multiple provider 403(b) model.
According to Tannenbaum, states are looking at what they can best do to protect participants’ savings, and some have concluded that more providers means more potential for diversification. But, Karton says, moving to a single provider doesn’t necessarily take away choice. Just like 401(k)s, 403(b)s “can have multiple investment companies in the plan and still have one recordkeeper,” she says.
Choice vs. Efficiency
Karton cites Pennsylvania State Senator and Majority Leader Jake Corman as saying the state doesn’t just pick one company for one thing; it gets bids for different options. Karton says getting bids for different options is being responsible, but retirement plan sponsors usually ultimately pick one. “There are not multiple vendor 401(k)s, and even in Pennsylvania, its state 457 plan has one vendor. If having multiple vendors is so good, why is Pennsylvania not doing it for state employees?” she queries.
For plan participants, though, taking away choice may mean taking away a relationship. Lowder says many K-12 403(b) plan participants have formed a relationship with their current financial advisers—the person who speaks with them from each provider. “When they are told they can’t use that adviser anymore, it takes away the motivation to participate in the plan,” she says. Lowder adds that the vast majority of participants need motivation to participate and save, and they need help calculating the gap between what they have in other retirement plans and what they will need for retirement.
But Karton says she hears all the time that a participant signed up with one person and never saw them again. “In a single-vendor environment that wouldn’t happen, because the adviser’s relationship is with the provider,” she contends.
Karton also says providers in the K-12 403(b) market segment may not have all the tools participants need. “Each vendor only pushes its product. If the vendor doesn’t have a Roth option, the rep wouldn’t tell a 23-year-old teacher he should be in a Roth. The participant won’t get the right information because the person doesn’t sell the product,” she says.
There’s also a debate about whether multiple providers encourages or deters participation in 403(b)s. According to data provided by Karton, after one school district joined Wise Choice, participation increased in the program from 287 participants to 443 currently active participants deferring into any of the pre-tax 403(b), 403(b) Roth, pre-tax 457(b), and/or 457(b) Roth money sources. In another school district, participation increased from 440 to 544 over two years. Karton adds, “How is a participant supposed to have the skills to evaluate a vendor. There’s no data-driven decision. They make a choice either because it is allowed or their co-worker friend chose it.”
However, 2018 research published by the National Tax-Deferred Savings Association (NTSA) based on data from nearly 4,500 school districts across the United States found 25% greater participation in plans with 15 or more investment providers compared to plans with only one provider. It found single-provider arrangements have the lowest participation rate; 8% below the national average.
Lowder says participation needs to be encouraged. “These employees need a supplement because they won’t get enough from pensions—many public pensions are reducing future benefits or eliminating COLAs. Also, around 15 state’s public-school employees do not participate in Social Security. Financial advisers in our industry understand the impact on participants.”Tannenbaum expects that as time goes on, more states will consider similar laws. “We are talking about a lot of money. States want to be properly advised and managed,” he says. “I don’t know if these are the right solutions—there are some downsides. For example, any time requirements are put on plan sponsors, they balk. Some nonprofits also have a 401(k) plan, so enacting rules on one type of plan could drive more to adopt 401(k)s.”
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