403(b) Plans in TX – The Terrible Problem of Choice

RetirementSchool district employees in Texas attempting to fund their own retirement – through 403(b) defined contribution plans – face a garbage fire of bad choices.

A neutral and expert observer – anyone not directly benefitting from insurance industry money – can look at the retirement options mandated by school districts and see a rigged game.

Problem of Choice

How is the game rigged? Let’s start with the 403(b) plan problem of “choice.”

School district employees typically have access to a 403(b) plan – a tax-advantaged retirement savings plan through automatic payroll deduction. 403(b) plans as designed and regulated in Texas appear uniquely suited to make a lot of money, not for school district employees, but rather for the insurance industry.

Here’s the first problem with the 403(b) options, because of regulatory and legislative restrictions. In Texas, as in other states like California and Ohio, school districts may not be proactive or selective about what retirement companies and products teachers may access. This is known as an “any willing vendor” rule, according to school district retirement consultant Cecile Russell.

I imagine this “any willing vendor” idea was once sold to legislators as reasonable because it encouraged “choice,” which sounds appealing at first glance. What it actually does is stuffs the menu of investment options to a ridiculous point with insurance companies and insurance products.

Better Design

A better program design, better than this “any willing vendor” model, would involve limiting choices in 403(b) plans to low-cost and appropriate retirement products. A better plan would be designed by experts with fiduciary responsibility looking out for the best interest of school employees. Just as private sector 401(k) designers have to do. School districts in Texas are not allowed to do this with their 403(b) plans.

trsIn Texas the Teachers Retirement System has approved 65 separate vendor companies. There are actually 74 approved vendors listed by TRS but some of those are affiliated companies.  These vendors in turn offer 10,520 eligible investment products to school district employees.

That’s the first problem. Having 10,520 choices is not good. It’s a behavioral finance nightmare which produces what an economist would call “The Paradox of Choice” but which we could also understand more simply as “The Deer in the Headlights” response. For some, their 403(b) plan contributions stay stuck in a money market account earning no return. For others, they use the random dartboard approach to investing. The third option, by design, is that school district employees invest according to the plan of that nice insurance salesman offering free pizza in the teacher’s lounge. All of these are bad results in their own way.

At least two-thirds of approved 403(b) vendors in Texas are insurance companies or have insurance affiliates. Do you want to guess the result of having insurance companies as the dominant providers for 403(b) plans?

A study by independent consultancy Aon Hewitt estimated in 2016 only 24 percent of 403(b) investments are in mutual funds (the preferable products), compared to 43 percent in fixed annuities (the inappropriate product) and 33 percent in variable annuities (the abominably high-cost product.) Those last two products are specifically insurance-company products, whereas mutual funds are typical brokerage company products.

aon_hewittThe result of these asset allocation choices, AON Hewitt estimated, is $10 billion in extra costs paid by 403(b) participant investors, as compared to a comparable 401(k) style investment platform available to private sector workers and products. This is a multi-billion dollar fiduciary failure involving many responsible parties.

One way to understand the asset allocation problem is to understand the effect of compounding different returns over a long career. A school employee who managed to put away $50,000 in her 403(b) by age 30 faces a vastly different retirement depending on what she chooses as her primary investment vehicle. A 4% return on that investment would become worth $240,000, as compared to an 8% return becoming worth $1.08 million by age 70. Differences in returns, when compounded over 40 years, lead to massive divergences in results. Costs and investment products matter tremendously.

Before 1974, only insurance companies could provide investment products to 403(b) plans, giving them a head start with these types of plans. But 45 years later, the relative absence of mutual fund providers stands out as a shocking result. After so many years that result must be considered a feature, not a bug, of 403(b) plan design. It suits the insurance industry to keep this territory for itself, at the great expense of public school employees.

Can reasonable people disagree reasonably?

Now, I haven’t yet explained yet why insurance products are particularly pernicious in Texas 403(b) plan platforms. Many nice people, including especially insurance company employees, believe these to be fine products.

They are not.

I am not anti-Insurance. I buy insurance. It has an important role to play in all of our financial lives. Fixed and variable annuities are not good products, however, for a retirement plan. They are specifically inappropriate within a Texas public school employee’s retirement account. But they account for 75% of the products!

I don’t work for any finance or brokerage company. This is precisely why, even if you don’t understand my point straight away, you should at least believe that I don’t have an ax to grind, except to state the truth as I understand it.

I would go so far as to say that any independent fiduciary for a teacher’s retirement plan – and by independent again I mean someone not paid by any finance company – would agree that these are not the best products for public school district 403(b) plan participants.

And yet, they are the dominant products. Why is that?

In subsequent posts I will lay out the plausible explanation for this result, which is a perfectly legal  – but ought to be illegal – crime hidden in plain site.

A version of this post ran in the San Antonio Express News and Houston Chronicle.

See Related posts:

403(b) Plans – Failed Reform Only An Insurance Company Could Love

Teachers and Their Retirement Problems

Public Policy Debate on Teacher’s Retirement in TX

Nobody Advocating to Fix Teachers’ 403(b) Plans in TX

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I founded Bankers Anonymous because, as a recovering banker, I believe that the gap between the financial world as I know it and the public discourse about finance is more than just a problem for a family trying to balance their checkbook, or politicians trying to score points over next year’s budget – it is a weakness of our civil society. For reals. It’s also really fun for me.

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