It wasn’t a ‘done deal.’
The new regulations posted by the Texas Teachers Retirement System on January 4th would have reduced the maximum fees allowed on 403(b) plans. Teachers would have saved over 1 percentage point a year in fees. The new rules were slated to go into effect in June.
Rules allow the 403(b) marketplace to remain virtually unchanged.
The changes restore the front or back end loads. They had been slated for elimination.
They also restore administrative fees up to $50 a year. They, too, had been slated for elimination.
Finally, the changes allow annual fees of up to 2.75 percent a year. To put the fee cap in some perspective, 96 percent of the variable annuity sub-accounts in the Morningstar database have total fees under 2.75 percent. In a nutshell, the revised rules support the high cost, commission-driven distribution system favored by the insurance industry.
| Comparing January and Current Teachers Retirement System Proposals | |
| Proposed Rule Published January 4 | Staff Recommended Alternative Fee Caps |
| No Front end or back-end sales loads | Allows a front-end load and/or back-end load for annuity and non-annuity products, for a maximum combined charge of 6 percent. |
| No surrender charges on variable annuity accounts. Surrender charges allowed on fixed annuities but capped at 6% and required to terminate within 6 years. | Surrender charges allowed for fixed and variable annuities: capped at 10 % declining annually for up to 10 years; 1% allowed each year after 10 years if applicable, for a maximum of 12 years. |
| No annual, recurring, one-time fixed dollar fees, record keeping or administrative fee. | Allows an annual administrative fee capped at $50. |
| Maximum expense charge by asset class: Money market/stable Value 0.90%; Diversified Bond 1.10%; Balanced 1.25%; Large Cap Equity 1.25%; Small-Mid Cap Equity 1.50%; International/Global Equity 1.50% | 2.75% maximum fee on all other total aggregate charges in addition to those listed above, not distinguished by asset class; applies to the total assets of both variable annuity and non-annuity accounts. |
| Source: TRS website. | |
The Texas State Teachers Association objected to the original rules. Association liaison to the TRS Jack Kelley said the Association was concerned that the new rules were “too restrictive.” Teachers would have “fewer choices from fewer vendors.” The Association feared that reducing the number of vendors might also reduce the quality of offerings to teachers.
Unfortunately, leaving the field open to the highest expense vendors may also work to virtually shut out the lower cost vendors.
Worse, higher fees can reduce the amount a teacher can accumulate in a 403(b) plan by hundreds of thousands of dollars.
How do I figure that? Simple.
Imagine a 25-year-old teacher with a starting salary of $2,424 a month—that’s the starting salary of a Texas teacher for the 2000-2001 school year. We’ll also assume the teacher gets annual raises that average 5.64 percent (2.64 percent a year for twenty years of annual experience steps plus 3 percent for inflation) and that he saves 6 percent of income each year. (For the sake of simplicity, we’re assuming step raises continue another 20 years.)
In a costless world where the teacher earned a gross return of 10 percent a year, the teacher would have $1,525,000 after a 40-year career. Subject the same savings to a 2.75 percent annual fee and the teacher will accumulate only $838,000. That’s a whopping $687,000 less, a reduction of 45 percent.
To be sure, this is a statement of extremes.
A more realistic measure would be the difference between the accumulation in the average variable annuity (about 2.25 percent) and in established low-cost providers such as TIAA-CREF (less than 0.40 percent). TIAA-CREF has been serving college teachers for nearly a century.
In that case, the teacher would accumulate $1,392,000 at TIAA-CREF and $930,000 at the average variable annuity. The difference is $462,000.
That $462,000 is the cost of supporting the high cost distribution system used by the insurance industry. There are 500,000 teachers in Texas and California— the other state most commonly burdened with expensive variable annuities for 403(b) plans. They are literally paying a fortune for handholding, otherwise known as commission driven marketing.
Related columns:
Scott Burns, “Laredo Class Action Improves Teacher Retirement,” 03/03/2002
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(c) A. M. Universal, 2002