403(b) Reform: California Dreaming of Better 403(b) Plans
Arcane state legislation may be to blame for lack of low fee investment choices in California K-12 and community college 403(b) plans.
Choice is usually a good thing — especially as it applies to investing. When it comes to the 403(b) retirement plan, however, Californians are literally drowning in choice, bad choice. The typical 403(b) plan here is littered with scores of high fee vendors. So what looks like choice is really no choice at all.
Way Back in 1970
It wasn't meant to be this way. Way back in 1970 the California legislature created a 403(b) tax-sheltered annuity program for employees of the Department of Education serviced through a single broker of record, chosen by the board. Concerned over the "monopoly" created by this single provider and the lack of control and choice given to employees, the legislature subsequently amended the Insurance Code (Section 770.3) in order to allow employees to purchase annuities through a provider or company of their choice. Amended over the years, Section 770.3 now reads:
"...in any case in which a tax-sheltered annuity under an annuity plan which meets the requirements of Section 403(b) of the Internal Revenue Code of 1954 is to be placed or purchased for an employee, the employee shall have the right to designate the licensed agent, broker, or company through whom the employee's employer shall arrange for the placement or purchase of the tax-sheltered annuity. In any case in which the employee has designated such an agent, broker, or company, the employer shall comply with such designation."
What began as a law intended to protect employees' freedom of choice has resulted in an unwieldy system that has resulted in excessive providers, administrative burdens and ongoing liability concerns. This affects not only K-12 employers but also California community colleges.
From the employers perspective they must let all interested financial providers sell product, regardless of vendor quality or fee structure. In an attempt to control legal responsibility, districts have turned to the use of hold harmless agreements. These onerous "agreements" purport to transfer liability that might result from improper 403(b) administration to participants and investment providers. Liability concerns have become even more significant since the IRS began auditing 403(b) programs in the early to mid-90s.
Participants Point of View
From the participants' view, there is virtually no screening of providers or products and little or no access to independent product information or financial education. Districts rarely provide educational programs to faculty and staff regarding the various tax-deferred investments. As it now stands, some districts believe such a program would increase both potential cost and potential liability for the district. So even well meaning districts — yes, there are a few out there — are loath to get involved. Instead, districts refer employees to the providers' representatives to communicate information on enrollment, asset allocation, distribution options and other features of the program. This lack of district involvement clearly favors a commissioned sales force (i.e. more expensive) over non-commissioned, direct distribution, low cost providers — the very vendors 403(b) participants crave.
What is the solution? 403(b)wise advocates amending Insurance Code 770.3 to allow school districts and public agencies to implement a competitive bid process. Known as a request for proposal (RFP), this is exactly how 403(b) business is done in most other states, and this is exactly how business is done in private sector plans such as the 401(k). For the first time, school districts and public agencies would be free to prescreen vendors. They could actually assemble a manageable list of quality vendors including no load choices. Imagine that. California dreaming indeed.
Among findings: worry about not having enough money to last them through retirement.