403beware !

Rodney Dangerfield received “no respect” from his son in the 1986 film “Back to School”. Thankfully, the actor who played his son inhabits parts unknown, but the lack of respect for teachers’ finances is very much prevalent. Most teachers are modern-day versions of Rodney Dangerfield based on the way they have been treated by the army of conflicted salespeople who manage the majority of their retirement savings in the form of 403b plans.

While a 403b can be an excellent way to save for retirement, its misuse is rampant. Taking a step back, 403b plans were created in the 1950s as a way for teachers and others who work for not-for-profit organizations to save for retirement. The name comes from the section of the tax code the plan was created under. Initially the only product available to place within these plans were annuities sold by insurance companies. These plans were given little oversight by employers who offered virtually no investor education support. This provided a huge opportunity for the unscrupulous vendors (i.e., the individual investment products’ sales reps). For the most part, this situation still exists today, though some moderate reforms have been implemented recently. However, the legacy of annuity-only plans carries on today. Over 70% of teachers have these products in their current plans.

The way this has come about is through the use of a dirty trick. Many of these agents still refer to this plan as a TDA or tax-deferred annuity. This gives the misleading impression that only high-cost variable annuities are available for purchase. No mention is made of low-cost, efficient index funds that might be available through other vendors. Often the insurance salespeople stake out an area where teachers congregate, like the teachers’ lounge, not unlike lions hanging around the oasis waiting for their unsuspecting prey. They are usually very friendly and are trained to make connections through real or contrived common interests. After landing a prospect, the web spreads deeper. The teacher is encouraged to introduce their friends so the salesperson can “help” them also. The next thing you know, the majority of employees are locked into contracts that cannot be broken without excessive surrender fees. Even those who figure out what has happened are put through a Soviet-style bureaucracy (which does everything it can to obfuscate the process). Frustrated, the teacher gives up and the pool continues to expand.

Why are these products so toxic for teachers? To begin, they are both investment and insurance products. Usually, this combination only benefits commission-based salesperson. What’s not to like about receiving a 5-10% commission (if you are the salesperson, that is). This does not include the annual costs of up to 4%, and onerous surrender charges. To put this into proper prospective, hypothetically speaking, if a teacher purchased a low-cost index fund and saved $250 a month for 35 years, the account would grow to $548,750 assuming average annual market return of about 8%. A Variable Annuity earning the same investment return would provide a client with an accumulated value of just $336,320 over the same time period. How is this difference possible? There is an enormous difference in fees paid by both investors. The teacher in the variable annuity paid over $200,000 for the insurance that guaranteed that the original investment would be safe and when she retired and, she would be able to annuitize an income stream. Teachers already have this in the form of their pension, in addition to their social security benefits. Most teachers would be better off with a more equity-like component (i.e., a global portfolio of low-cost index funds) to diversify their portfolios from the more bond-like features of their pension and social security checks. While the annuity is marketed as a safety feature, the data is much more dubious. The broad U.S. stock market has NEVER lost money over any 20-year period in the market’s history (which, though it’s no guarantee of future results, certainly gives a jittery investor some perspective). Of course, this fact is conveniently left out during the sales pitch to the nervous and uninformed teacher. If you think this is a good deal, beware of meteor insurance salesmen, who will spot you coming from a mile away.

Having taught for 22 years and owning a fee-only Registered Investment Advisory (RIA) Firm has given me a unique perspective on this sad situation. Many are complicit in pulling the wool over the eyes of the inexperienced and trusting teachers. There are teachers’ unions that have received financial rewards from the large insurers in order to gain access to their members. This happened a few years ago in New York involving ING and NYSUT. Though some reforms have been passed many third-party administrators take payments in order for certain vendors to be eligible in school plans. If you don’t pay to be preferred member, you don’t get to play. Low-cost providers (whose fee structures are in the best interests of the investors) are left out while deep-pocketed insurers benefit. While new rules have helped in keeping predators out of the faculty rooms, there are loopholes and many innocent teachers are still being mislead about their options. My former principal and I once chased a salesperson out of our school when we found him roaming the hallways before homeroom!

The bottom line is: If you own a variable annuity in your 403b plan, it is like wearing a belt and suspenders. You are paying for the privilege of having your money grow tax-deferred by purchasing a variable annuity. The inconvenient truth is the tax deferral is available for any product placed in this type of account. In other words, the 403b account grows without the effect of taxes, regardless of what investments you put in the account. Why pay high fees for tax deferral from an annuity, when the account automatically offers this feature? With low-cost index funds saving the investor 300% to 400% compared with the high-cost annuity, why would anyone informed choose the annuity? If you own one of these products, immediately call your sales representative and ask how much you are paying in fees. Many teachers believe the product is free because they receive no bill. This could not be farther from the truth, The majority of your profit is being skimmed right off the top and under your nose. If an inadequate explanation is given on the points mentioned above, go to your business office and get a list of alternate vendors. Go online and do some research by visiting a site like 403bwise or hire a fee-only RIA to help you. A fee-only RIA is a fiduciary bound by law to work in your best interests and will not accept any compensation from the investment products they recommend.

As I have seen more and more hard working teachers cheated out of having reasonably-priced investments in their 403b plans, there are many who I have lost respect for along the way. Clearly, the best weapon for teachers is to get educated. Most teachers need to go back to school to relearn everything they have been taught about their so-called TDAs, and then they can demand the respect they deserve.