Tasked with picking investment options inside their employer-sponsored retirement plan, teachers are often sold on investing in products many experts claim they don’t need—annuities.
When Lauren Woodcock, a Boston Public Schools math teacher, was asked by a representative if she wanted to retire comfortably, she answered as most would—a resounding yes.
After she sat through what she recalled as his pithy speech, the AXA (now called Equitable) Life Insurance rep “sold” her on contributing to an annuity in her 403(b) plan, specifically the Equi-Vest variable annuity plan.
But she was unaware of the high fees and surrender charges associated with the annuity — which ultimately, she alleges, cost her thousands of dollars of her life savings and, if not that, certainly countless hours of anxiety.
“It took me five weeks to move my money this summer,” she said. “My blood still boils.”
This may ring as a cautionary tale of one teacher down on her luck, but Woodcock’s story isn’t an anomaly. Teachers (and others who work at institutions where the 403(b) is the employer-sponsored retirement plan) across the United States are sold on contributing money earmarked for retirement into annuities that may quite literally cost them their futures, and most aren’t aware of the impact of their decisions until it’s too late.
“The people sold these annuities don’t need them,” said Michael Webb, a senior financial advisor at CAPTRUST, one of the largest registered investment advisors in the United States.
Teachers in 403(b) plans are usually offered the opportunity to invest in fixed annuities, variable annuities, or mutual funds. But there’s a substantial difference in fees between annuities and mutual funds. For instance, an independent review of the Equi-Vest (Series 201) variable annuity found the following: administration charge: 2% or $30; separate account charges: 1.20 % (mortality and expense charge 0.95% plus other expenses 0.25%); underlying portfolio operating expenses: 1.03% (average fund expense); personal income benefit charge: 1%; withdrawal or surrender charges: 5%.
Webb and other experts argue that investing in high-fee annuities is unnecessary, as some teachers have a defined benefit plan, which provides a benefit similar to annuities—lifetime income.
“They already have an annuity, sometimes even two: Social Security and a pension,” Webb says. “Annuities are a form of insurance; they ensure that you don’t run out of money.”
In an ideal world, Webb argues there would be a small market for this product. “Almost no corporate plans have them,” he says.
“We also haven’t had this epidemic of retirees running out of money," says Webb. "They [the annuity providers] play on the fear that you’re going to run out of money.”
This fear isn’t entirely unwarranted though. For instance, Teacherpensions.org, a project of Bellwether Education Partners, reports that just half of public school teachers have a defined benefit plan.
But whether a teacher needs to contribute to an annuity in a 403(b) requires that the plan provider’s representatives make recommendations in the context of a teacher’s entire financial picture. And because of the curious nature of this nation's retirement rules and regulations, some representatives are required to act in the plan participant's best interest while others are not.
Bonnie Treichel, the chief solutions officer at Endeavor Retirement, also says an individualized approach is necessary to determine whether annuities are appropriate, which is often thrown to the wayside when educators are “sold” on contributing to an annuity by commission-based representatives. Factors such as risk tolerance, time horizon, and whether a pension is included in retirement all dictate which investment vehicle is necessary for an individual, she says.
Annuities can, of course, play a role in a teacher’s retirement plan. Such products, by definition, can provide a fixed income stream for a person’s lifetime or a specified period of time. And that payout is guaranteed, which is not the case when a teacher invests in mutual funds where the return might be greater, but so too is the risk.
For some teachers, having a guaranteed payout is worth giving up a higher return.
“These were teachers who were willing to give up some of the potential return in order... to know this was the outcome they were going to get,” says Treichel. “They wanted that predictability."
But even if it makes sense on paper for a teacher to contribute to an annuity, Treichel says annuities for public school teachers can be inappropriate, especially when “someone has not had the opportunity to understand all of the risks and associated rewards” or when “the annuity is essentially selected for them.”
And Webb doesn’t think investing in an annuity in a 403(b) is the right decision at all. “Most people end up spending a lot of money in their annuity, and end up rolling into an IRA when they retire anyway,” he says. “To be quite frank, teachers would be better off opening an IRA rather than participating in these products.”
How Insurance Products Dominated the 403(b) Market
Many American workers are enrolled in an employer-sponsored retirement plan such as a 401(k) plan, a pension, a Roth 401(k), or a 403(b).
Teachers typically participate in 403(b) plans, which are similar in some ways to a 401(k). Both have the same contribution limits, catch-up contribution age, and when one can withdraw funds penalty-free.
However, most 401(k) plans don’t offer plan participants annuities as an investment option while most 403(b) plans do. The difference, in part, lies in its history.
According to the National Tax-Deferred Savings Association, 403(b) plans were first made available to public education employers in 1961, with investments limited to annuities. Mutual funds held in custodial accounts were added in 1974.
By then, firms selling annuities had their foot in the door to classrooms and to this day are still recommending high-fee options. And the sad reality, according to many teacher advocates, is that educators either remain unaware that there are better options or are unable to even choose from a list of trusted vendors in the first place.
Many districts supply a list of scores of vendors, with brands that are hardly recognizable. Overwhelmed and unsure about which option is best, teachers tend to take the bait and select the options that have had representatives patrolling teachers’ lounges or flooding their email inboxes with solicitations.
Meanwhile, low-cost mutual funds remain buried in a sea of offerings.
In her case, Woodcock recalls the representative reassuring her that the fees associated with the annuity were just “pennies on the dollar.”
As a math teacher, she assumed this made sense, but neglected to realize that the 2%-4% annual fees in her annuity were astronomically higher than most retirement plans. For reference, most low-cost index funds charge 0.2%.
Despite bringing her concerns to her representative, he reassured her that things were fine.
But they weren’t. While investors in a traditional mutual fund menu were being charged the typical annual operating expenses and shareholder fees, Woodcock was wrapped up in paying a litany of other expenses.
Fortunately for Woodcock, she was able to transfer her funds to a different provider, but not without months of arduous work.
Others have experienced trouble getting out of their annuities. Jeff York, a former custodian at a Redding, California school district, still remembers the chilling response from his VALIC plan’s sales rep when trying to cancel his plan and roll his funds into a new account. York figured out through hours of research that the plan his district approved was misleading him and his colleagues.
He confronted the annuity company’s rep, asking him to explain the fine print in the contract that he signed years ago. To York, the high fees and low returns just didn’t make any sense. The sales rep replied, “You now understand Jeff, you don’t need us anymore.”
School districts are partly to blame for the problems staff like Woodcock and York are facing. Many plan participants, for instance, feel as if their district doesn’t keep the best interests of their staff in mind. Ironically, the lack of education on how their retirement plans work is prominent, so most end up picking a recognizable name among the list of vendors.
“I was pretty emotional. I was very upset, I felt betrayed,” said Tom Butterfield, a middle school teacher of over 27 years at the Chicago Public Schools district. “I felt I was scammed. I was just extremely upset that nobody was there to advocate for teachers. Why wasn’t there anyone to support us?”
Traditionally the role of selecting retirement benefit plans falls into the hands of the district superintendent; schools lack the resources to appoint staff to vet plans. In some cases, the act of vetting plans is actually prohibited. “Open access” states allow “any willing provider” access to plan participants, regardless of how high fees may be.
According to a study by the TIAA Institute, it was found that “plan sponsors [in open access states] offer 403(b) plans with limited screening and oversight of the vendors seeking certification. Plan sponsors typically do not negotiate fees prior to certification nor do they monitor the vendors after certification. Participants in open access states face significantly higher asset-based fees relative to participants in controlled access states.”
How High Fees Sabotage Savings
The power of compounding interest highlights how severe the consequences of being looped into a high-cost plan can be. For instance, let’s take a look at the math from 403bwise’s website:
The total value of an investment after 35 years, assuming $250 contributed monthly with a 6% average annual return:
As shown above, the total of an investment after 35 years, with a $250 monthly contribution and a 6% average annual return yields only $185,391 with a variable annuity with 3% in fees. Three percent may seem nominal, but compare that total with the average cost of a managed mutual fund, which is 1.74% in fees. Suddenly the retirement total is $241,537.
An even higher total results from just investing in an average index fund with a 0.07% expense ratio. The total has exponentially increased to $343,474.
When teachers do have the choice to invest in mutual funds, options are limited and fees are astronomical compared to other custodians. Expense ratios can vary from .02 to 5%. In contrast, a low-cost basic S&P 500 mutual fund from Vanguard only charges .03% annually.
The math doesn’t take into account the plethora of other fees which bombard faculty:
- record-keeping fees,
- advisory service fees,
- transaction costs,
- perhaps most frustrating— should one decide to surrender their annuity or access their funds prematurely, surrender fees can span up to 10 years.
A Helpline for 403(b) Plan Participants
Dan Otter, a former California educator-turned-activist, grew weary of seeing others fall for the same high-cost plans as he did. In 2000, he founded the nonprofit 403bwise, which aims to not only educate teachers on commonly-missed fine print in 403(b) plans, but also advocates for districts to step in and better support their staff.
The nonprofit prides itself on its large Facebook group, which serves as a forum for teachers to share their own frustrations and ask for advice about how to find the best plan. Many send images of their limited vendor lists, desperate to secure a plan that doesn’t eat away at their retirement savings.
Allegedly the toughest plan to leave has been the AXA/Equitable plan that Lauren Woodcock found herself in, which entails a multistep process one must follow precisely if they wish to close their account.
“They’re designed to be impossible to leave,” Otter says. “That’s the whole point.”
Hopefully, change may take place for some 403(b) plan participants in the future, thanks to Otter and others. For instance, staff at universities are today filing lawsuits alleging that 403(b) plan fiduciaries haven’t been complying with their obligations to best serve their participants.
An example is the Hughes v. Northwestern case, scheduled to be brought before the Supreme Court this month. Plaintiffs in the suit allege that Northwestern’s fiduciaries breached their duties, citing excessive recordkeeping fees, too many investment options, and an offering of retail class shares of mutual funds when cheaper institutional class shares of identical funds were available.
Of note, 401(k) plan participants are protected under the Employee Retirement Income Security Act of 1974 (ERISA). ERISA requires plan vendors to provide participants with plan information, including details about funding and plan features.
Most importantly, fiduciary responsibilities are outlined for those who manage plan assets. Participants have the right to sue if any of these guidelines are violated.
And while private schools and universities have ERISA-protected 403(b)s (and can sue if such protections are violated), public K-12 schools do not, according to the U.S. Department of Labor. Lack of this crucial legislation influences the length of vendor lists, high fee structures, and individual contracts.
Teachers Demand Better Plans
Luckily, some strides have been made in an effort to reduce the influence high-fee plans have on educators. The Boston Teachers Union (BTU) developed a contract that prevented individual vendors from accosting teachers in classrooms and lounges, warning that some companies have the reputation of having “overly aggressive salespeople.”
Former BTU president Richard Stutman says the contract will help lessen the hold traditional insurance companies tend to have on teachers’ savings.
“These companies are selling them a product where they’re essentially a sitting duck,” he says.
He became a strong proponent of the Massachusetts SMART Plan (although it is a 457 plan, not a 403(b), it is still available to teachers), which is a retirement savings plan offered by the state for its employees.
“The state treasurer and a board of financial advisors are screening everything going on so you won’t get screwed,” he says. The plan specializes in low-fee investment options rather than high-cost annuities, and is non-commission based.
While other states offer their own sponsored plans, many teachers are so barraged by the list of other vendor options that these get lost in the mix.
Despite efforts to make the 403(b) selection process less burdensome for teachers, the issue lies in the fact that 403(b)s as a whole are so complicated. With more education on how to identify the best 403(b) plan, ERISA protection for public school educators, and increased advocacy for better retirement plans, the plight of 403(b) selection will hopefully be an issue of the past.
As for now, Stutman offers his sympathies to teachers trying to figure this out on their own.
“It’s hard to expect people to master this.”
What To Do if You Find Yourself in a Bad 403(b)
If better 403(b) options don't exist in your school district, another alternative could be opening a Roth IRA instead (or in addition to your existing 403(b)). Pros and cons of opening a Roth IRA while enrolled in a 403(b) are here.