Overhaul overdue for nonprofit plans

The Baltimore Sun

Retirement savings plans at schools, hospitals and other nonprofits are about to undergo their biggest overhaul since Lyndon Johnson was president.

It's about time.

For far too long, many 403(b)s have operated with little or no employer oversight. Workers can be confronted with hundreds of investment options, a daunting prospect for even sophisticated investors. And it isn't unusual for many of their choices to be high-fee mutual funds and annuities.

The overhaul is coming from the Internal Revenue Service, which first proposed changes more than two years ago.

The IRS says it will soon release final regulations, which could take effect as early as January.

Many of those affected will be teachers and staffers at public schools, and already some school districts are changing their 403(b) programs in anticipation.

The goal is to make voluntary, tax-deferred 403(b)s more like 401(k)s in the for-profit world, where employers have a fiduciary duty to offer a diverse selection of investments with reasonable fees.

As proposed, the IRS regulations don't go that far.

But employers will be expected to be more hands-on in managing 403(b) programs and to know more about the companies offering investments and their products, says Michael Beczkowski, a senior consultant with Bolton Partners in Baltimore, which advises school districts.

Employers for the first time will have to provide in writing their 403(b) plan's rules, such as who is eligible, whether hardship withdrawals or loans are allowed, and the names of companies offering investments, Beczkowski says.

Those eligible for the plan also will be notified, something that doesn't always happen now.

"Schools have done a horrible job of letting eligible people know," particularly support staff, says Dan Otter, founder of 403bwise, an online provider of plan information.

Workers will lose some flexibility. Right now, they can steer their 403(b) money to any investment company, whether it's on the employer's list of vendors or not. This has been an escape hatch for workers seeking low-cost alternatives among a sea of high-fee offerings, Otter says. This no longer would be allowed, he says.

The regulations will add more administrative burdens on employers. Benefits experts predict employers will simplify things by reducing the number of insurance and investment companies serving their 403(b) programs.

That could be a good thing for workers' retirements. Often 403(b)s are filled with annuities with high fees and stiff penalties called "surrender charges" if workers pull out their money within six, nine or more years. "The more egregious products will be weeded out," Beczkowski predicts.

When 403(b)s were created in the late 1950s, the only investment option was annuities. Mutual funds became available in the 1970s.

Annuities remain the primary investment today. Assets in 403(b) plans last year reached $652 billion and nearly 80 percent of that was in annuities, according to Spectrem Group in Chicago.

Without guidance from employers, workers have been left on their own to wade through a dozen or more vendors with each offering dozens of investments. Many teachers have come to rely on advice from salespeople visiting schools.

"We have some try to get into staff meetings ... and set up desks in teacher break rooms," says Tom Kappra, chief financial officer for Cecil County Public Schools. "Some vendors are more aggressive than others."

Teachers can't always count on their unions for unbiased advice, either.

The Los Angeles Times reported last year that some of the country's largest teacher unions - including the National Education Association - received millions of dollars for endorsing companies' high-fee products to their members.

Some school districts aren't waiting for final regulations from the IRS to be more hands-on.

Montgomery County Public Schools changed its plan in January.

"We have $1 billion under management and we should be getting better prices and better services," says John Kevin, the school district's investment officer.

To bid on the district's business, companies couldn't offer mutual funds with sales charges or annuities with "rolling" surrender charges, Kevin says. A "rolling" surrender charge means that each time you put money in the annuity the surrender charge clock starts on that contribution.

After the bids, the district went from 14 companies to nine. It estimates the changes will save employees about $2 million a year in fees.

Cecil County Public Schools will introduce changes in October. Currently, the district has seven investment vendors, each offering 20 to 30 investments. "There is a point where you get overload," Kappra says.

He figures the huge number of choices put off workers and accounts for the low participation rate of 30 percent.

The school district teamed up with the county when seeking bids, figuring together they could get a better deal from vendors, Kappra says. Last month, they chose to go with a single company, MetLife. Investment choices will be about a dozen diverse mutual funds, but no annuities, he says.

Kappra likes the proposed IRS regulations. "I definitely think it will be to the employees' benefit," he says.

Others aren't quite as sure.

Daniel Kaufman, a spokesman for the Maryland State Teachers Association, says it will be good for members if regulations bring greater oversight and better investment information. But the union is concerned that school districts might move too quickly to revise plans and limit choices without input from members.

Michael Kerley, a senior vice president with the National Association of Insurance and Financial Advisors, which represents agents selling annuities, says his group worries the new rules might be so cumbersome that smaller school districts and nonprofits will drop their 403(b) plans.

Overall, the new regulations should be good for workers. Maybe they won't have hundreds of investment options, but too many choices can be confusing and workers could end up not participating at all.

If employers use this as an opportunity to look for low-cost, high-quality investments, workers will come out ahead in the long run. And workers, too, should take this time to lobby employers for these types of investments.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com

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