A Tale of Two Cities...

er, Retirement Plans

Scott Dauenhauer, CFP, MSFP, AIF Meridian Fiduciary Consulting _____________________________________________________________________ telephone: 949-916-6238 | www.teachersadvocate.blogspot.com | www.meridianwealth.com

A Tale of Two Cities...er, Retirement Plans

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair...
Charles Dickens, A Tale of Two Cities

persecuted by angry vendors, brokers and insurance agents; in many ways it is the worst of times for government dened contribution plans. Time For A Revolution It is my contention that public sector dened contribution plan participants are losing billions of dollars every year to the nancial services industry because of a lack of co-ordinated laws, rules or regulations that create a consistent duciary framework for these programs to adhere to. I believe its time to bring enlightenment to the government dened contribution market, specically the one stuck in the age of foolishness - the 403(b). It is time for a revolution. In October, 2010 I penned a short blog (www.teachersadvocate.blogspot.com) titled Government Employees: Thrown To The Wolves. Little did I know this piece would nd its way into several presentations at conferences on public sector retirement throughout the country. The main point of the blog post was that government dened contribution plans dont enjoy the same protections that private sector plans do, and that dened benet plans are not in and of themselves bad. What I am tackling in this piece are the specic differences between a private sector plan that is covered by ERISA and a government plan that is not covered by ERISA in terms of consumer protections. I realize that many who run government plans are happy to NOT be covered by ERISA and would ght the idea that they should be. My goal is not to promote ERISA coverage for government plans,

So what does this classic Dickens opening have to do with retirement plans? Perhaps today we should rewrite the tale and at the end of each phrase insert dened contribution retirement plans. And so it is today in America that one retirement plan -- the 401(k) is seeing the best of times and another -the 403(b), the worst of times. The new laws and regulations affecting 401(k) plans allow them to offer Qualied Default Investment Alternatives, Automatic Enrollment and Automatic Contribution Increases while the required disclosures surrounding these plans are set to increase substantially, shining a light on the fees in these plans. In addition, the Department of Labor (DOL) has proposed an expanded denition of the Employee Retirement Income Security Act (ERISA) term Fiduciary (awed as it may be, at least we are beginning the conversation). By no means is the 401 (k) now perfect -far from it. But the 401 (k) is experiencing a sort of renaissance, making this the best of times for the widely used retirement vehicle. All the while, the public sector counterparts, the 403(b) and 457(b), are still stuck in the Dark Ages. Enlightenment has come to only a few plans, and they are quickly

A Tale of Two Cities...er, Retirement Plans

but to point out the differences and why some of these differences are harmful to participants. At a minimum, there should be a dialogue concerning a structure that one might term PERISA (a Public ERISA), whether it is simply a standard for plans to benchmark to or an actual set of regulations that specically address the differences in public sector dened contribution plans duciary structures. Private Sector Income Security Government dened contribution plans are universally spoken of as supplementary. It is my contention that they are not supplementary but essential to a dignied retirement for most government employees. While the 403(b) and 457(b) are labeled as supplementary, the 401(k) is often referred to as the the primary retirement plan for the private sector, this is not true. If the 401(k) plan were the primary retirement plan in this country we would be in big trouble as the median value of all retirement accounts of individuals aged 55-64 is only $100,000 1, which includes IRAs and 401(k)s. Read that sentence again: if the median age person getting ready to retire has only $100,000, of which some of that is in IRAs, he has less than $100,000 in 401(k)s - this amount cannot sustain any type of dignied retirement. Using the industry language, the 401(k) looks just as supplementary as the 403(b) and 457 (b). Social Security provides the primary retirement benet for the vast majority of retirees in the United States who dont
1

have another pension, but Social Security also takes the biggest chunk out of a current employees paycheck. My point is that both public and private sector employees have a dened-benet type plan that is funded from current or potential income. This makes the 401(k), 403(b) and 457(b) programs all supplemental in that they are not designed to provide the primary retirement benet. As I stated earlier, while referred to as supplemental, they are, in my opinion, essential to a dignied retirement for both the public and private sector. Given that all dened contribution plans are supplemental and that they are essential to a dignied retirement, why is it that the public sector enjoys few, if any of the protections the private sector enjoys? (Note: while the private sector is entitled to protections, many plans are not receiving the protections they deserve). A Few Differences The following are just a few of the differences between a private sector 401 (k) and a public sector 403(b): Department of Labor oversight for 401(k) New 408(b)2 rules do not apply to the public sector New ERISA 404(a)(5) rules do not apply to the public sector Prohibited Transaction rules, while they may exist on the state level, are rarely

http://www.401kplanning.org/top-401k-planning-questions-and-answers/what-is-a-401k-plan/what-are-averageretirement-savings-for-different-age-groups/

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enforced and there is rarely a mechanism to blow a whistle There may not be ANY duciary standard codied in the state law for a government dened contribution plan Conicts of Interest may or may not be covered by state laws A recent Spectrem Study showed there to be over $183 billion in public sector k-12 school system 403(b) programs. The vast majority of this money is in retail type products. If a prudent environment existed and only saved an average of .50%, this would equal nearly $1 billion a year in savings. In reality, the savings would be much larger. Having said that, I do realize it is not possible to transition the vast majority of existing contracts, but having low-cost, prudently run 403(b) plans as an option going forward will encourage more savings and for employees to move their old contracts to the new institutionally priced ones. The savings would be massive. Many employers would welcome such a framework as it would relieve them of the need to ght the nancial services companies, a task for which they lack the expertise, desire and funding. DOL Expands Fiduciary Denition Doesnt Apply to Government Dened Contribution Plans Recently, the Department of Labor has announced an expanded denition of the ERISA term Fiduciary and is currently in the comment period. Their intent: [T]he[previous denition of duciary]may inappropriately limit the department's ability to protect plans,

participants and beneciaries from conicts of interest that may arise from today's diverse and complex fee practices in the retirement plan services market. The proposed rule is designed to remedy this limitation, and protect plan ofcials and participants who expect unbiased advice, by giving a broader and clearer understanding of when individuals providing such advice are subject to ERISA's duciary standards. Whether this rule becomes nal or not, it only applies to ERISA plans. This rule is actually awed in many ways, but at least there is an ongoing discussion and debate about updating the denition. My point here is that there is a lot being done today to help protect consumers from those that would seek to harm them, just not for consumers that happen to be government employees. Why is it that government employees do not enjoy the same protections as their neighbors in the private sector? The lack of a duciary standard and ERISA-like principles lead to retail distributed plans, confusion, high fees and high spreads (on general account products). The commissions paid to agents is undisclosed and provide incentives to work against the participants best interest. It is not uncommon for insurance agents and registered representatives to earn special trips, large cash bonuses or other perks for the sale of nancial products to school employees. Trips to exotic locales are common rewards for pushing products on school employees that are not in their best interest. In the ERISA world this would be considered a Prohibited Transaction, but not in the land of government dened contribution

A Tale of Two Cities...er, Retirement Plans

plans. You can pretty much get away with anything in this strange land as there is no oversight, no enforcement and seemingly nobody who really cares. Even when state laws are present, the lack of oversight and enforcement (due to budget constraints) essentially continue the status quo. Real Disclosure Nearly Impossible (under current regulatory regime) It was the epoch of belief, it was the epoch of incredulity... In 2007 the IRS embarked upon a program to get 403(b) plans into compliance. For years these plans suffered from lack of any oversight and this led to all sorts of breaches of rules and regulations. The new rules however were NOT designed to make 403(b) plans better for consumers, just easier for the IRS to audit. In fact, the new rules are an incredible burden on employers and in general have not reduced fees or spreads. To be sure, most providers increased their spreads and fees in order to cover the additional costs of compliance. The IRS could have approached the rule changes in a manner that would have been participant and employer friendly while also making the job of the IRS a piece of cake - instead the industry lobby got their way and the status quo essentially remains. In fact, the biggest are getting bigger and low-cost options are beginning to get squeezed. It is time for Congress and the IRS to act to correct the horrible mistakes made in 2007. The ve items that must be done to begin the clean up of the 403(b) market in particular are:

1. 2.

3. 4. 5.

Grandfather all 403(b) plans and contracts prior to January 1st, 2012 Remove the employer from all involvement with prior contracts, except to the extent of minor employee information (such as date of hire, date of termination) Require that 403(b) plans adhere to a Fiduciary Standard Encourage a Single Vendor platform going forward (like the 401(k) world) Remove the requirement that 403(b) plans ONLY invest in annuities or custodial mutual funds

The 403(b) and 457(b) have enough issues to deal with when there is only one vendor, but when the employer must deal with multiple vendors, some of whom no longer even offer products to the plan, it becomes an absolute nightmare. Employers should get a fresh start, require the vendors to be in compliance as best as possible and require them to register with the employer in order to obtain needed information, but free the employer from being so intimately involved with every detail of thousands of contracts issued prior. ERISA Rules Updated, But Not Applicable The Department of Labor has been busy issuing new rules and regulations these past few years. Specically, they updated 408(b)2, 404(a)(5) and a new denition of Fiduciary (which we mentioned earlier). All of these rules seek to increase the awareness of fees and make plans more consumer friendly and transparent. 408(b)2 requires all service providers who receive direct and indirect compensation to provide a

A Tale of Two Cities...er, Retirement Plans

disclosure to the plan duciaries detailing the fees received for the services provided and whether they are acting in a duciary capacity. 404(a)(5) requires that the plan provide a disclosure of fees the participants pay on an annual basis. Each of these items provide the plan duciaries or the plan participants with needed information and allows for full transparency. These provisions will likely lead to lower plan expenses over time and help weed out conicts of interest. If providers fail to provide the data or do not disclose it accurately, they could face severe nancial penalties. It was the season of Light, it was the season of Darkness.... Alas, none of these provisions apply to government dened contribution plans. Not a single 403(b) vendor is required to disclose direct and indirect compensation, employers are not required to send out notices of fees being paid by participants. Government employees are left out in the cold. Of course complying with these rules if they were applicable would be darn near impossible given the ridiculous multi-vendor schemes that are so prevalent in government plans. So it comes down to the states. At least two states have done something about disclosure - California and Texas. California requires all 403(b) vendors to register with the state and disclose fees (similar to 408(b)2)). But in general there is no multi-state initiative to co-ordinate a disclosure regime for government dened contribution plans. Private sector employees who have a 401(k) plan will know what they are paying in fees and the duciaries of their plan will have full disclosure from their

providers; but government employees will see no such protection or disclosure. Prohibited Transactions It was the age of wisdom, it was the age of foolishness.. What would happen if a duciary to a 401(k) plan used his stature or plan assets to benet himself personally? There are many ways this can be done and it happens in the 401(k) world, as often as not the consequences are criminal prosecution and potential jail time. Fiduciaries of 401(k) plans and ERISA covered plans think twice (or should think twice) before taking kickbacks, trips or using the plan for their own benet as the Department of Labor may nd out, investigate and refer them to a criminal prosecutor. There is NO mechanism for this in government dened contribution plans. A plan duciary of a 403(b) or 457(b) could use plan assets for his/her own benet, take trips from vendors and funnel kickbacks to himself and face no criminal prosecution, in fact it may not even elicit a reaction from the public. If you think this doesnt happen, you are mistaken - its a common occurrence in the 403(b) and 457(b) world. In the 403(b) and 457(b) world it is not uncommon that a plan duciary is also acting as a registered representative or insurance agent and actively selling products for a commission or recommending products that will benet that duciary. If the broker is a duciary because he gave investment advice, then the payment of any commission or other compensation to the broker is a prohibited transaction and must be returned to the plan, states Fred Reish, ERISA guru and partner at Drinker

A Tale of Two Cities...er, Retirement Plans

Biddle 2 It is clear that a broker who also is a named duciary (or functional) has a legal issue if receiving commission or other compensation. Robert Toth in his Business of Benets blog writes ..many do not realize that there is a specic anti-kickback rule applying to ERISA plans that is NOT found in ERISA, but instead under criminal law...this section, by the way, only applies to ERISA plans.3 There is a full body of law, rules and regulations for ERISA plans that act to protect consumers from duciaries who act in their own best interest, not that of the participants. But none of theses laws, rules or regulations apply to government dened contribution plans. I attended an industry association meeting several years back where a senior executive of a major player in the 403(b) market -- in my opinion -- was bragging about bribing public ofcials in order to get their business. It was the rst time I heard Hannah Montana and 403(b) in the same sentence! Here I am in a room full of sales agents in a presentation that is being recorded and this corporate executive is bragging about bribery - and NOBODY thinks anything of it. He wasnt even afraid the government might decide to investigate as the IRS was IN THE ROOM. This behavior is pervasive in the 403(b) world and there is no authority to refer too for investigation. Im not saying that we can eliminate corruption, but there should

be an outlet that participants and employers have to refer their concerns who will investigate. Unethical behavior should have consequences. Bullying Why dont more employers, specically school districts work toward implementing duciary reforms and single vendor programs? Much of the time they live in fear of the nancial industry bullying them. In some instances it is pure ignorance, other cases they have other priorities (you know, like educating children). I have personally witnessed school districts both small and large being bullied by the nancial services industry. Yes, I get the irony. In fact, I have experienced the same bullying for my willingness to publicly stand up for the rights of participants. The bullying is both covert and overt. The threat of a lawsuit from a high prole rm will scare even the largest of school districts from implementing needed reforms, and who can blame them? If the choice is to spend money hiring more teachers or hiring more lawyers...its no mystery which one school ofcials will choose. The nancial services industry knows this and uses it accordingly. Any time state legislation comes up that is not favorable to them, but is favorable to the participant, they work to undermine it and bully those who support it. The amount insurance companies spend on lobbyists to keep their agents selling toxic products

2 Who Are The Investment Fiduciaries for a 401(k) Plan - Part IV, Fred Reish http://www.archetype-advisors.com/Images/Archetype/

Fiduciary%20Responsibility/Who%20are%20the%20Fiduciaries%20Part%20IV.pdf
3 http://www.businessofbenets.com/2010/06/articles/complex-prohibited-transaction/erisa-plans-ultimateand-criminalprohibited-

transaction-rule-of-18-usc-1954/

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to school employees runs into the tens of millions of dollars. Of course it is these same companies that then sidle up to the districts once bidding begins for those districts that end up going with a single vendor (or competitive bid multi-vendor). Public employers need a shield from the industry so that they can do what is right for their employees. Where Are The Unions? A refrain I often hear when I explain the 403(b) market is where are the unions on this issue?. The answer is, it depends. Ten years ago I would have told you the unions were clearly in the pocket of the industry, but things have changed. While the NEA still offers in my professional opinion a terrible product, the state and local unions in some areas have started to get involved and are pushing for needed reform as opposed to pushing a product that theyll receive income from. This is a welcome change, but we need more of it. Unions should be working to strengthen the 403(b) and 457(b) for their members. One issue the unions bring up is that they feel that advocating for better dened contribution plans for their constituents is turning their back on the dened benet plan. This line of thinking is understandable given the attacks constantly mounted on the dened benet plan, but there is no good reason why a public sector employee shouldnt have a great dened contribution plan also. We commend the unions and associations who have got onboard with

advocating for better dened contribution plans and invite those who are on the fence to get off it and start helping. If unions would help advocate for great dened contributions plans instead of pushing their own, members could save billions over the next decade and the unions could attract involvement from the current membership and add new members. Nothing wrong with a little ethical consideration on these matters especially pertaining to their members nancial interest. Employers Who Are Unwilling One objection that I continue to hear from the industry is that the employers dont want to be involved in the monitoring and operations of the 403(b) and 457(b) and this is conrmed by the employers I speak to. However, not wanting to be involved and saying that its ne for employees to be taken advantage of are two different things. School employers do not want their employees to have less money or consumer protections just because the employer has other things to focus on. Multiple Employer Plans The solution to this problem is simple and has been around for a long time -- the Multiple Employer Plan. Under this option a state or other entity can sponsor a dened contribution plan and assume all responsibility. By removing the responsibility the employer has no liability. These low-cost multiple employer plans exist now and are popping up everywhere and employers only need to do the diligence and then adopt them. No monitoring of investment options or investment advisors is needed

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as the employer has hired someone else to do it for them. In fact, since the employer has hired a professional independent duciary, the employees are likely to see lower costs and all the consumer protections the ERISA world offers. Conclusion It was the best of times, it was the worst of times...er, it was the best of plans, it was the worst of plans. Are government dened contribution plans about to enter the light, or will they stay in the darkness? Public sector employees need to keep more of their retirement plan money so that they can retire in dignity. Its time public employees enjoyed the same consumer protections as their private sector neighbors.

About The Author

Scott Dauenhauer, CFP, MSFP, AIF is an Independent Fiduciary for families and government entities and has been advocating on behalf of school employees for better retirement plans for over a decade. Scott is a frequent speaker across the country on topics ranging from ination, target-date investments and government dened contribution plans as well as the Co-Author of The 403(b) Wise Guide. He runs two blogs: www.teachersadvocate.blogspot.com and www.meridianwealth.wordpress.com. Scott has been quoted in nearly every major publication including the New York Times, L.A. Times, Wall Street Journal, Smart Money & Kiplingers. He can be reached via e-mail at scott at meridianwealth.com