Average mutual fund expense ratios by class

[Guest marie567]

Where could I find information on average mutual fund expense ratios by asset class, for example, large cap growth average expense ratio, small cap value average expense ratio, etc.

I want to compare our 401(k) funds' expense ratios to an average by class.

[Harwood]

The monthly Principia diskette from Morningstar has this information. I'm not sure how much my company pays for it.

Phone: 800-735-0700

MorningstarAdvisor.com

Large Cap Growth 1.56

Small Value 1.55

[MWeddell]

Note that the average expense ratio doesn't include sales loads, so it understates the expenses that the average retail investor pays. On the other hand, if you're talking about the average cost of mutual funds in a 401(k) plan, then that's specific to the size of plan you're talking about and using the Morningstar averages will overstate the typical expense ratios for medium or larger plans.

Use those averages carefully.

[Kirk Maldonado]

MWeddell:

Could you explain why the ratios vary according to the size of the plan?

It doesn't seem intutive to me that the expense ratios would be overstated for medium and large plans.

[joel]

Kirk: Are not the morningstar averages retail? Surely a qualified plan is not going to pay retail. And a large plan is not going to pay what a small or medium size plan pays.

[Guest jmarini]

Other interesting tidbits about what is including in a fund's expense ratio, and what is included in its return (from Morningstar):

Accounted for in Fund’s return

*Management fee

*Group fee Back

*Performance fee

*Administrative fee

*12(b)-1 feeBrokerage costs

Bid-Ask spreads

Interest costs

*Only the asterisked items are included in a fund’s expense ratio

Not Included in Fund’s return or in its expense ratio

Front-end sales load

End sales load

Transaction fees

Redemption fees

Account Maintenance fees

[MWeddell]

Medium and large 401(k) plans are more likely to select lower-priced funds and to qualify for lower-priced class of shares than the average retail investor.

Of course jumbo 401(k) plans often have 1 or more asset classes than no longer use mutual funds but instead will use lower-priced institutional alternatives.

[Kirk Maldonado]

I want to thank the people that have posted information on this thread. There has been some very enlightening (at least for me) messages.

[KJohnson]

For example, check out this American Funds prospectus for the Growth Fund of America.

http://prospectus-express.newriver.com/pne...undid=399874874

They have started selling R shares for retirement plans (that throw in some extras with regard to recordkeeping and a daily valuation platform) that range from an expense ratio of 1.53% for R1 shares to 0.43% for R5 shares.

[Jon Chambers]

A couple of other quick points on the Morningstar averages:

1) The averages are weighted by fund, not by dollars invested, so very small funds (which tend to have higher expense ratios than larger funds) are given the same weight as larger funds with lower expense ratios. This inflates the averages.

2) Multi-class funds (i.e., funds with A shares, B shares, C shares, etc.) are counted as independent funds for purposes of calculating the averages. Since loaded funds are more likely than no-load funds to have multiple share classes, and since the 12b-1 fees in loaded funds tend to increase the expense ratio, the share class factor tends to inflate Morningstar's calculated averages.

The Principia database listed above can be easily used to calculate averages for more realistic peer groups. For example, you could use Principia to calculate the average for no-load large value funds with assets greater than $500 million, for institutional small growth funds, or for indexed large blend funds. This type of service is regularly provided by the plan's investment consultant (we definitely do this for our plan clients).

[joel]

The NYC Deferred Compensation Board (457(b) and 401(k)) has reduced its expense ratio by 40 percent. This was accomplished by switching to separate manage accounts. Its weighted average expense ratio is now 0.34 percent with 41 percent or 0.14 representing an Administrative Fee of $50.00 per year.

[GBurns]

Does all this mean that no one really knows for sure what fund expenses really are?

[Guest Reliant1]

It is a simple task to identify exactly what expenses are for any mutual fund, whether that fund share is owned by an individual or a qualified retirement plan. Morningstar Principia is an excellant centralized source of information for mutual funds.

An entirely separate issue, the question of comparability of a qualified plan's investment expense structure is not as simple as would seem at first blush. In short, it is not simply a matter of comparing the plan's fund expenses with the average (based on the morningstar data or other source).

The reason for this is that a qualified retirement plan, by definition, represents a group of shareholders as well as a service recipient (the plan sponsor & group of participants) that are not at all the same as a regular individual (person) shareholder. The plan may receive plan document, recordkeeping & administration, investment advisory, regulatory compliance, participant enrollment, employee education & communications, & other services as part of its arrangement with a financial services organization. There may also be intermediaries involved, resulting in expenses with no apparent services.

Many qualified retirement plan sponsors have elected to contract with financial services organizations (including mutual fund complexes, broker/dealers, insurance companies, etc) on the basis of mutual fund expenses & revenue sharing in numerous forms to pay for investment & other services (described above).

In general, economies of scale mean that plans with large average account balances should have low expense ratios while plans with small average account balances will have higher expenses.

Aggregate size also matters, meaning that a 10 life plan will see very different (worse) pricing than a 10,000 life plan, even if the average account balance of the 10 life plan is 40% greater than that for the large plan.

Our practice is that expenses and revenue sharing be completely detailed along with performance assessment of funds as part of a regular performance monitoring & due dilligence. This should also include some sort of assessment of whether fees are competitive for an organization's plan.

Your company's Fiduciary Committee should provide a formal reply to the question of competitiveness of mutual fund expenses offered by the plan. In light of what is going on in the financial services industry today, participants should be asking for & receiving this information.

I have been writing & speaking about the practice of Revenue Sharing in Qualified Plans for many years & attach a 1998 Whitepaper on the subject.

Daniel Clark

revsharewhite.pdf

[Kirk Maldonado]

Daniel Clark:

Thank you for your thoughtful posting and for attaching your article.

You mentioned what you think that the participants should do.

What are your commendations that the fiduciaries of the plan should do, in light of the recent mutual fund debacles?

I would also like to pose that same question to Jon Chambers, and to any other knowledgeable investment professional who is willing to share their views.

[GBurns]

Daniel Clark;

You state that "It is a simple task to identify exactly what expenses are for any mutual fund, whether that fund share is owned by an individual or a qualified retirement plan. Morningstar Principia is an excellant centralized source of information for mutual funds." But as pointed out by jmarini in an earlier post, there are some very important and costly items that are not in Morningstar's listing or calculation of a fund's expense ratio. In fact it seems that in general these are not made known to the share holder, So the share holder does not know of the expense.

How then is it "a simple task"???? if a share holder does not know what the expense items are, when they are incurred, how much they cost or even when and how they are extracted from his/her account??

[Jon Chambers]

GBurns makes an excellent point about mutual fund's unreported expenses. One blatant example of an unreported mutual fund expense is the practice of directing brokerage functions to wirehouse firms that sell large volumes of the fund. These arrangements are known as "payments for shelf space". By paying higher than average commissions, the fund can compensate the wirehouse, without triggering any reportable expense at all. Furthermore, payments for shelf space are not subject to the maximum limits on 12b-1 fees imposed by SEC rules. According to several studies, costs attributable to payments for shelf space are, in some cases, equal to the mutual fund's reported expense ratio.

It's noteworthy that several fund companies have recently announced that they will discontinue these arrangements--e.g., MFS and Putnam. Perhaps this is due to the SEC's recent investigations of Morgan Stanley, and other wirehouse firms. Morgan Stanley had payment for shelf space arrangements with 16 mutal fund companies; these 16 companies controlled virtually all of Morgan Stanley's mutual fund business.

[Jon Chambers]

Kirk Maldonado asked me to suggest how plan sponsors might respond to recent mutual fund developments. The following points are from a recent presentation that I gave jointly with noted ERISA attorney Brad Huss, the points are Brad's, but I agree with them completely:

Fiduciary Actions:

* Stay informed about the mutual fund industry developments and understand the issues

* Request information from all fund companies with which your plan is invested (See, for example, http://www.nagdca.org/resource/mutual_fund(11-03).doc)

* Place the fund companies with known involvement on a watch list

* Engage a qualified investment consultant

* Consider whether to divest from the involved fund companies

* Consider interim steps while the mutual fund situation continues to develop, such as stopping new inflows to the affected funds

* Assess the cost and disruption that may be caused by replacement of funds as plan investment options

* Consider whether a new fund company may later be implicated itself with improper activities

* Plan out a transition procedure for converting into any new or replacement funds

* Consider what steps may be prudent to recover any lost value from your plan’s investments due to improper activities

* Document your process, including information gathering and analysis, as well as the reasons for the decisions you reach

* Communicate as appropriate with plan participants as to the developments and the steps you are taking

[Guest rmeigs]

Jon:

An excellent post. Brad Huss' points are right on target. Now if we can just get plan sponsors to act.

[mbozek]

While the above checklist is extremely helpful, there is a practical problem in that most plan admin/ fids for small or medium size plans don't have the the time , attention span or financial resources to do a though review. It is difficult enough to get DC plan fids to draft an investment policy statement let alone to gather information on fund cos. Why cant small plans invest in index funds with a low cost provider such as Vanguard without trying to analyze contradictory and opaque information on 8000 mutual funds when 75% of the active manageed funds fail to beat index funds in any year.

[Jon Chambers]

While I'm generally a proponent of index funds, your 75% number (for funds underperforming index) is probably too high. It depends on the category being indexed, and the time period being reviewed. I normally tell sponsors that 35-40% of funds will beat the index over time (i.e., 60-65% will underperform), and that they are probably best served offering participants choices of both active and indexed funds.

Indexed funds are subject to the same late trading/market timing risks as actively managed funds. Using indexed funds is no panacea.

At the risk of sounding self-serving, Brad's fourthe bullet point (Engage a qualified investment consultant) is relevant. Investment consultants don't have to be expensive, and we can help small and mid sized plans to address issues for which they don't have the expertise internally.

[mbozek]

Jon: Even using your numbers an actively managed fund only has about a 1 in 3 chance of beating an index fund over the long term and has significantly higher mgt expenses. One could question whether an actively managed fund could ever be a prudent investment. So why can't a small plan limit investments to 5 - 8 index funds of a low cost provider and meet the 404©/ prudent man rule to provide a broad diversification with the lowest cost without the need to retain an investment advisor.

While all investment funds are susceptiable to violations, no index funds have been cited by the regulators. To limit risk the plan could use only funds that use fair value pricing.

[Kirk Maldonado]

I agree with Jon Chambers that it is important to retain competent investment advisors.

One of the best ways in which I fiduciary can demonstrate that he or she executed his or her duties under ERISA with respect to the plan is by engaging competent advisors.

[Guest Reliant1]

To GBurns: The OER is simple. The transaction costs that a fund manager incurrs in the operation of its investment management activity is impicit in the daily NAV calculation of the fund. This information is also reported in a fund's SAI - Statement of Additional Information. It is important to recognize that as transaction costs are already automatically built into the NAV, it would not be accurate to apply a transaction cost factor to the NAV of a fund.

Should you care what a fund's transaction costs are? Perhaps, but from my perspective (that of an investment professional - and not a broker or broker affiliated advisor) what I really care about is the fund's performance in relation to a benchmark. I advise client's to hold an investment manager accountable for net performance (after all fees) that is equal to or greater than that of an appropriate benchmark. If the fund has high transaction costs but generates excess returns, perhaps high transaction fees are a good thing?? As Jon has posted, I am probably more concerned about where brokerage commissions are directed and what is obtained in exchange for those dollars.

Sponsors need to do a couple things:

1. Fiduciary Oversight Process.

2. Committee, Policy, Meetings, Documentation.

3. Avoid getting blind-sided. Is your advisor independent or part of the revenue sharing ssystem. Track all Fees and Services.

Sponsors can do in-house or hire expert. They will be held to Prudent Expert Standard.

I favor simplicity, indexing & keeping costs low. If you look carefully at the scandals the common link is overly aggressive asset gathering fed by fast/loose investors and enabled by too-hungry financial services firms.

By their nature, qualified plans should be boring, conservative, long-term, low-cost ventures.

DC

[joel]

It takes millions of dollars to operate a union the size of the New York State United Teachers NYSUT that has 500,000 members. Unions are always looking for sources of revenue to augment their reliable dues flow. Recognizing that pre-tax retirement savings plans funded through convenient payroll reduction is by far the most popular fringe benefit offered to teachers by the 620 school districts in the state of New York, the NYSUT saw an opportunity in 1989 to use section 403(b) of the Internal Revenue Code as a means of raising revenue. All it had to do was find an investment provider willing to buy advertising space in the union newspaper, the "New York Teacher." Once it found a willing investment vendor it would be more than willing to "sponsor/endorse" its products. Later that year NYSUT endorsed two arrangements issued by ING Life Insurance and Annuity Company — the Opportunity Plus variable annuity and the Opportunity Independence 403(b)(7) custodial account. Union Blessing Should Equal Quality PlanAt first glance one might assume that the Opportunity Plus and Opportunity Independence plans must be outstanding programs lest it would never get the union's "endorsement." In fact the NYSUT website describes Opportunity Plus as "an innovative 403(b) tax-deferred variable annuity (TDA) designed specifically for NYSUT members and agency fee payers." Sounds good. Since school districts usually do a miserable job explaining the 403(b) to teachers it would only make sense that the union would pick up the slack and offer quality 403(b) education and/or quality 403(b) investment products. Lets go inside the numbers to see if this is the case. Opportunity Plus: Fees in Excess of 2% Nearly all of the choices in the 50-60 investment funds (sub-accounts) in the Opportunity Plus program sport expense ratios of 1-2 percent and include the notorious 12b-1 fees. All of the funds charge a sales commission on withdrawals made within 5 years of purchase (contingent deferred sales charge). In addition to the expenses charged by the individual investment funds the teacher is also charged 1 percent for insurance expense by the Separate Account maintained by ING. This means that investors are paying on average more than 2% in fees with Opportunity Plus. Why Didn't the Union Negotiate a Better Plan? It Did — for Itself!Why didn't the union "negotiate" with a superior low-cost investment provider along the likes of Fidelity, T. Rowe Price, TIAA-CREF, or Vanguard? These vendors offer a host of investments with fees well below 1%. It is my opinion that NYSUT did not seek out a low-cost provider because such firms do not have the advertising budgets that a high cost provider like ING has. So rather than endorsing a low-cost provider and communicating the endorsement through union paid mediums the union decided to endorse the high-cost provider and collect advertising revenue from ING instead. Opportunity Plus and Opportunity Independence are prime examples of 403(b) arrangements that are described as “sharks” by the American Federation of Teachers (AFT). The AFT is the national parent of NYSUT. See Special Report by Don Kuehn of the AFT following this article. I think this is a critical breach of trust on the part of NYSUT. Ironically, NYSUT did negotiate a terrific plan — for itself! Since September 1, 1984 the NYSUT has collectively bargained for three 401(k) plans with three unions that represents its own employees: The NYSUT Managerial & Legal Association, the NYSUT Professional Staff Association and the NYSUT CWA local 1141 Union. All three plans are administered by Fidelity Investments and sport fees of about 0.5%. Lets see... 2% in fees for the teachers/dues paying members of NYSUT and 0.5% in fees for the employees of NYSUT. This is a moral outrage. NYSUT Teachers Lose Tens of Thousands of DollarsIt is important to remember that all of the expenses to maintain an investment in Opportunity Plus are paid for by the teacher/investor, not the school district, and not the union. Expenses translate into smaller account balances and less retirement income. Lets do some arithmetic to knock the point home: The ING/NYSUT "endorsed" Opportunity Plus 403(b) program costs the public school teacher about 2 percent while the 401(k) Plans sponsored by the NYSUT costs the NYSUT employee about 0.50 percent. If we start with an initial investment of $30,000 (with no additional contributions), and earn an average 8 percent a year for 30 years the teacher investing in the ING/NYSUT endorsed 403(b) program sees his $30,000 grow to $172,305 while the NYSUT 401(k) Plan participant sees his $30,000 investment grow to $262,649. Apparently the NYSUT believes high costs are both good and bad. It's good if NYSUT, the union, "endorses" the high cost ING 403(b) program for teachers, and then collects some of those high fees teachers pay to ING by selling ING advertising space in the union newspaper where ING boasts that its 403(b) arrangements are blessed by the union. But its bad if NYSUT, the employer, sponsors a similar high cost 401(k) plan for its employees. NYSUT cannot have it both ways. Opportunity Independence More Than Twice as Expensive as NYSUT 401(k) PlanWhile cheaper than Opportunity Plus, investment choices in Opportunity Independence, the other NYSUT endorsed ING offering, average more than 1% in fees — twice as much as the NYSUT 401(k) plan. Many choices in this plan average 1.5% in fees. It is my opinion that an expense ratio in excess of 1.5% makes pre-tax investing inferior to after tax investing in a low-cost plan. But the real issue is why should the dues paying members of NYSUT pay more than twice as much in retirement plan fees than NYSUT employees? Why Plan Expenses VaryWhy pay 2% for a mutual fund when the same type of investment is available at 0.50 percent? There is a reason why some plans charge more than others. The 403(b), for example, is really not a plan at all but a legal arrangement between the employee and the investment provider. The employer is simply responsible for deducting a pre-determined amount from the employee's paycheck and sending it off to the investment provider for investment pursuant to the employee's instructions. The 403(b) arrangement contrasts sharply with the other two popular salary reduction plans, the 401(k) and 457(b). These savings vehicles are formal retirement plans and as such the law requires the plan sponsor (employer) to perform its due diligence and establish a Board of Trustees, prepare a written Trust instrument, write a Plan Document, appoint a Plan Administrator, and write a Summary Plan Description. The 403(b) arrangement does not require such due diligence, which is why the arrangement is generally more costly to the employee. This lack of oversight paves the way for the investment provider to sell commissioned based funds through a network of agents. It is not uncommon for these agents to be found in the workplace prospecting for customers. On the other hand, the due diligence required of employers offering 401(k)/457(b) plans results in fees being kept to a minimum (no commission, no 12b-1 fees, no surrender charges and no variable annuity). School Districts Need to Do MoreWhile not specifically required by current law to establish a Board of Trustees, prepare a written Trust instrument, write a Plan Document, appoint a Plan Administrator, and write a Summary Plan Description as required in 401(k) and 457(b) plans, school districts, especially the 620 in New York, need to begin putting their employees first when it comes to the 403(b). Their laissez faire attitude results in high cost 403(b) investment products being sold to their employees. School year after school year New York school districts continue to shirk their responsibility by allowing the high cost ING/NYSUT endorsed 403(b) programs to be sold to the tens of thousands of teachers in this State. Employees Need to Take ActionConcerned employees should arrange a meeting with their school district's benefits director. Tell him/her how outraged you are that you do not have a low-cost program. Make the same statement at a Board of Education meeting. Write a letter to the editor of your local newspaper. The employer is a fiduciary and as such has a duty to its employees to offer a low cost 403(b) program. Send a letter detailing your outrage to: Mr. Walter Dunn, Chairman of the Board of Trustees of the NYSUT Benefits Trust, Inc.800 Troy-Schenectady RoadLatham, NY 12110-24551-800-626-8101 May I also suggest that the leaders of the various local affiliates of the NYSUT call upon the NYSUT Professional Staff Association (PSA), the labor specialists employed by the NYSUT to help local affiliates negotiate collective bargaining agreements with their school districts, for help in negotiating 403(b) arrangements along the low cost lines (no commission, no 12b-1 fee, no surrender fee and no variable annuity) of the 401(k) Plan that the NYSUT PSA has negotiated for its members with NYSUT management. Mr. Jeffrey Cassidy is the President of the NYSUT PSA. He can be reached at 1-800-287-3903.

The following comes from the Opportunity Plus Prospectus:"Agreement with the CompanyNYSUT Benefit Trust is a non-profit trust organized and existing under the laws of the State of New York. This Trust operates for the benefit of its members and agency fee payers of the New York State United Teachers. The Company (our, we) and NYSUT Benefit Trust agree to the following:· Sponsorship of the Opportunity Plus program by the NYSUT Benefit Trust; · Our provision, to all members and agency fee payers of educational programs focused on financial planning for retirement; and · Our employment of trained personnel to conduct these programs exclusively for members.Additionally:· We reimburse NYSUT Benefit Trust for direct out of pocket expenses up to a maximum of $40,000 per year incurred in the promotion of the Opportunity Plus program. · We will pay NYSUT Benefit Trust $338,000 per quarter during 2002. This payment will increase in subsequent years, and may include in the future, an asset-based component. NYSUT utilizes these amounts to enhance benefits to the participants in programs it sponsors. · We contribute to the cost incurred by NYSUT Benefit Trust for retaining up to six employees who assist in management of the Opportunity Plus program. · We compensate United University Professions $6,000 per month for the use of on-site campus facilities and the sponsorship of the Opportunity Plus program."

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May/June 2000 by Don KuehnShark attack!

Investors in 403(b) plans, beware:You are especially vulnerable to predatorsTeachers, college professors and other education workers are being threatened by sharks--but not the kind that swim in the sea! These equally dangerous predators are "land sharks" who prey on unsuspecting or uneducated investors and devour their hard-earned retirement money. It's time we put a stop to them.Under Internal Revenue Service Code section 403(b), employees of educational and charitable organizations are eligible to participate in pre-tax investment arrangements usually called tax-sheltered (or tax-deferred) annuities (TSAs or TDAs). These popular but little understood investments are used by an estimated three-fifths of public school employees and many college and university staffs to augment state or local defined-benefit retirement plans.In many ways, TSAs resemble 401(k) plans that have become widespread during the past 10 to 15 years. The TSAs allow the participant to put money aside in a variety of investment vehicles before Uncle Sam gets his hands on any of it. The invested money grows tax free--until it is withdrawn through regular (annuitized) payments after retirement--although the amounts are subject to Social Security withholdings. Sounds good. So, what's the problem?The returns that participants realize on their investments are all too often way below returns on comparable investments in the marketplace. The reason is that many companies and salespeople in the business of selling financial instruments can think of countless ways to part investors from their money. These include high front-end costs, massive surrender charges, redemption fees, inappropriate investment choices, sub-account fees, two-tier plans, big commissions and hidden charges for unneeded life insurance.Unlike a standard employer-managed pension plan, in 403(b) plans the employer keeps an arm's-length relationship with the vendor. Because the employer typically does not contribute to the plan, schools and colleges neither recommend nor make judgments about which companies have access to the pre-tax payroll deductions that make TSAs work. There is no "plan document" to govern the employer's service arrangement with vendors. That means no federal paperwork, no fiduciary relationship and low administrative costs.It also means no investor education.For workers, it means that just about any insurance agent who can round up a minimum number of subscribers can hawk annuities or mutual funds. So, in Los Angeles, for example, more than 100 vendors create a bewildering array of investments and options to sift through. Financial products are pitched with dizzying variety in school lounges, cafeterias and in home visits by the sharks. Because there are so many different products to choose from, it is nearly impossible to become an educated consumer.More than $422 billion is invested through 403(b) arrangements and, sadly, most of it sits in low-performing fixed annuity contracts, reports Spectrem Group/Access Research, a San Francisco-based consulting and research firm. Some 2 million public school teachers have more than $116 billion invested in 403(b) programs.Only 15 percent of total TSA assets are invested in mutual funds. The big fund companies that fight tooth and nail for 401(k) investors generally cede the 403(b) market to insurance companies and their annuity products.In spite of a roaring stock market that has run nearly unabated for more than five years, these TSA contracts may be netting less than the return on certificates of deposit. Over the work life of a typical participant, underperforming assets could cost hundreds of thousands of dollars in unrealized growth.Agents whose companies have a computer slot for payroll deduction for TSAs in a school district or college are expert at promoting, explaining and selling their products. And certainly there is an allure to the idea that--in addition to a state retirement system and Social Security--for those who participate and qualify, a relatively painless investment each payday (unseen and before taxes) can grow to eye-popping numbers.Once the hook is set, few participants monitor their statements or check the relative performance of their TSA against a benchmark such as the S&P 500 stock index or a corporate bond index.What the law allowsUnder the law, education employees can shelter up to $10,500 this year in a 403(b) plan with some limitations (you cannot exceed 25 percent of salary). Three broad categories of investments are allowed: annuity contracts, mutual fund custodial accounts, and life insurance contracts.An annuity contract is an insurance company's written promise that, after retirement, it will pay a monthly amount to the participant no matter how long the person lives. These can be either "fixed" or "variable."The problem with buying an annuity inside a tax-preferred investment vehicle like a 403(b) is that earnings on the annuity are already tax-sheltered. It's like buying an umbrella exclusively for indoor use.In a "fixed" annuity, the contract has a guaranteed interest rate of usually no more than 3 percent or 4 percent. A $100 investment in a fixed annuity might be guaranteed to earn $3 or $4 over the year, but could earn $5 or $6 if market interest rates go up and the issuer elects to pass those rates on to the customer.A "variable" annuity contract's cash value rises or falls depending on the performance of separate accounts that are invested in mutual funds. There is no guarantee that these "subaccounts" will meet their investment objective.Mutual fund custodial accounts allow a participant to buy into a fund held by a bank or by (some) registered securities broker/dealers. Mutual funds are pools of assets (company stocks or corporate bonds, for example) managed with specific objectives in mind. Most readers are familiar with names such as Vanguard, Fidelity and T. Rowe Price, purveyors of a broad array of funds in the commercial marketplace.A life insurance contract obligates the vendor to pay a specific sum of money when the insured person dies. There is no mystery here; life insurance is a common ingredient in nearly everyone's financial planning. Premiums are determined by the age and health of the insured. In a 403(b) plan, however, the life insurance component is called "incidental" and must meet complex rules and limits set by the IRS Code and by state insurance laws.In many cases, the vendor can offer "multiple-choice" annuities. You can have a percentage of your deduction invested in a fixed contract and the rest in a variable product. This gives the participant a chance to practice what is known as "asset allocation," a way of tempering risk by investing both in conservative (fixed) and more aggressive (variable) components. The costsA teacher who invested in variable annuities during this decade--even if it was through high-priced mutual funds or annuity contracts--might not have noticed the exorbitant fees they were charged. The roaring bull market masked the high costs. But if we have another period like 1973 to 1983, fees could easily overwhelm any growth in the value of a TSA.How costly can fees become? Here is an example borrowed from Steve Butler and cited in an article in the New York Times. A couple contributes $10,000 a year to a retirement program through equal deductions twice a month. If they earn 10 percent a year, after fees, they will have $641,000 after two decades. After three decades (through the magic of compounded interest) their portfolio will have grown to $1.9 million.But if their annual fees are just 1 percent higher, so they earn 9 percent on their investments, they will have $75,000 less after 20 years and $355,000 less after 30.Annuities, the most common vehicle for 403(b) plans, come wrapped with a layer of insurance and extra fees.Surrender fees, assessed if the annuity is sold within seven to 10 years after purchase, can be as high as 8 percent. Life insurance, covering only the amount invested (not growth on the investment) runs about 1.25 percent. Some insurers will guarantee a minimum amount of investment growth, but little more than can be realized in the most conservative investments.The average 403(b) annuity charges administrative costs of 2.11 percent of assets a year, according to Morningstar Inc., a financial research firm. By comparison, the average mutual fund has expenses of 1.36 percent. Many large mutual funds, such as those offered by the Vanguard Group, have expenses as low as 0.18 percent of assets each year. Compounded over the span of one's career, this difference in fees means serious money.Get out the shark repellentThe marketing of 403(b) products to school employees typically depends more on the one-on-one relationship between the sales agent and the prospective customer than it does on the investment's cost, expected returns or its features.Many educators will acknowledge that they are novices at investing (never having had much money to invest) and that they need any help they can get. Vanguard and Fidelity won't send someone to sit across the kitchen table and hold their hands like insurance companies do.That makes public school and college employees easy prey for the sharks who feed on these plans. Historically, it has been difficult for participants to get out of these low-performing annuities and into better mutual funds. Surrender fees are one part of the story, roadblocks put up by vendors are another. Some school systems are revamping their 403(b) offerings. In Chicago, for instance, a new program is expected to save employees more than $6 million a year in fees. Before the change, according to a school official, teachers paid 2 percent to 3 percent in fees and more than two-thirds of their money was tied up in fixed investments. Now Chicago school workers can buy no-load funds and reduced-fee annuities through three companies.The New York State United Teachers, Education Minnesota and the United Federation of Teachers (New York City) have also used their significant clout to force positive changes in the 403(b) options offered to their members and to reduce administrative expenses.Stop the bleedingSo, you do your homework and find that you have a two-tier, fixed annuity that charges a surrender fee. Although it declines over the first seven years, it's renewed each time you make an investment (kind of a Catch 22 since you make investments every month). The rate of return is guaranteed at only 4 percent, and the cost of the life insurance component is eating up more than 40 percent of the guaranteed gain.There are steps you can take to remedy a bad situation (see sidebar, "What you should know"). Employees need to act if their 403(b) options are turning them into shark bait.Because most public employers do not screen vendors, a relatively small group of workers can petition for new and better choices in their TSA accounts. These may include some of the bigger mutual fund companies mentioned in this article, or others interested in doing business with your system.The union can make this an issue in future negotiations. Contact your local, volunteer to be on a committee, investigate your options, make a presentation to the school board, write a column for the union's newsletter...raise hell. This is your money. That's not to say it will be easy. Stephen Schullo, a Los Angeles teacher, is becoming something of a celebrity on this issue. He was horrified to discover the confusing, underachieving choices he and his colleagues faced in their 403(b) program. His tale has been reported in the Los Angeles Times, the New York Times and other publications.Some insurance vendors and other providers are lowering fees or broadening investment options in the face of competition and employee complaints.If you hold an annuity contract executed more than five years ago, it is likely you are paying too much. Seek out the agent who sold you the contract to see about converting it to another, better-performing, lower-priced option offered by the same company. If conversion isn't possible, find out about surrender charges. It may be better to pay a penalty than to continue suffering with an underperforming annuity. Consider getting out before you leave any more blood in the water. Don Kuehn, a senior national representative and a trustee in the AFT employees' retirement plan, is the author of "Your Money," a regular column in this newspaper. John Abraham, AFT senior associate director of research, contributed to this article. This article is intended to increase knowledge and awareness of issues of interest to members and retirees. For specific advice relative to your personal situation, you should consult competent legal, tax or financial counsel.Related SidebarWhat you should know

American Federation of Teachers, AFL•CIO - 555 New Jersey Avenue, NW - Washington, DC 20001Copyright by the American Federation of Teachers, AFL•CIO. All rights reserved. Photographsand illustrations, as well as text, cannot be used without permission from the AFT.

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PLEASE NOTE THAT THE AFT HAS RECENTLY ENDORSED/SPONSORED THE ING VARIABLE ANNUITY FOR 403(b) INVESTING. HOW'S THAT FOR A KICK IN THE HEAD.

Joel L. Frank

[MWeddell]

Joel,

That was a bit of a conversation stopper. I liked your Frank v Arronson posts better.

[Guest EWagner]

Man, that was a mouthful, Joel!

Attaching an article we wrote back in 2001 ("Whose Money is It?") directed at plan sponsors, advisors and media. It was intended to clarify fund expenses as they relate to ERISA DC plans, fee transparency issues, and recovering fees for the benefit of plans. A handy, readable resource for plan fiduciaries.

(NOTE: the attached does NOT apply to retail shares/annuities held by non-ERISA 403(b) or 403(b)(7) plans, as there is typically no trading sub-accounting being done by third parties, as discussed in the article.)

[Guest EWagner]

Dang. Here's the article.

McHenry_Revenue_Sharing_Report_Rev_2_11_03.pdf

[MWeddell]

Looks like there's a rebuttal to Joel's article on 403bwise.com. The rebuttal is here - http://www.403bwise.com/features/nysutrebuttal_lm.html - and at the top of that page is a link to Joel's article, in a much easier to read form than a message board post.

[Jon Chambers]

Coming back to mbozek's post, I'm not sure that offering 5-8 index funds obviates the need for an investment advisor, or for any fiduciary review. Even when you offer index funds, there are many questions to be asked (beyond expense ratios) such as:

1) Which indexes should be used? Which categories should be offered?

2) Should the funds be full replication or sample based?

3) Should the funds employ any filters not used by the underlying index?

4) When should the funds trade when the index changes its underlying components?

Some indexes (e.g., the S&P 500) are relatively easy to track. Others are much harder. Evaluating index funds is in many respects more important than evaluating active managers, b/c it's obvious what the fund was trying to do, so a plaintiff would find it easy to identify unsuccessful index funds.

We did a paper (that originally appeared in the September 1999 issue of The Journal of Investing) on the fiduciary duty to review passive funds. You may find it interesting. It's available at http://www.advisorsquare.com/advisors/schu...ns/82713112.pdf

Finally, while I've seen the argument (advanced by Scott Simon and others) that active funds could never be prudent selections, I don't agree with it. I continue to believe that the prudent course of action is to offer both active and indexed funds, and to monitor both types of funds using standards appropriate for the funds' objectives.

[joel]

Two facts have been added to my article about the NY state teachers' union sponsoring a 403(b) program. For those of you who have already read the article you will find the two additional points of fact at the end. The article can be found at: http://www.403bwise.com/features/nysut_jlf.html.

Peace and Hope,

Joel L. Frank

[mbozek]

I am not sure what all of the above posts mean other than that that each of the platforms for deferrals by public school teachers have different cost structures based upon the type of funding vehicle and service provided. 403(b) plans are the primary vehicle because 401(k) plans are not available. Also I disagree that school districts that offer a 403(b) program are fiducaries because the district permits employees to make contributions by salary reductions. The districts do not sponsor or maintain the plans and should not have any responsibility for administration or investment choice because these costs as well as litigation risk for poor investments should not become liabilities of the taxpayers whose taxes support the school district. Also no employee is forced to contribute to a 403(b) plan and could elect to contribute to an IRA or Roth IRA.

Because the 403(b) platform has to be sold on an individual basis it will have costs associated with the distribution system, e.g, use of agents and salesman. However even low fee 457 plans and qualfied plans and have hidden costs such as obtaining an IRS determination letter, frequent amendments, administration, record keeping and trustees fees. If one wants to follow Jon Chambers advice the plan also needs to hire and investment advisor. The costs of maintaining qualified plans can be passed along to the participants. In short there is no free lunch for any salary deferral platform available to employees and the costs of each are ultimately borne by the participants.

[GBurns]

School districts do not become fiduciaries because "because the district permits employees to make contributions by salary reductions." They usually become fiduciaries because of being involved in other things such as the selection of providers; endorsing in various ways, whether directly or indirectly, the providers; the setting of marketing parameters; the collection of "administrative service charges"; and involvement in availability etc etc.

A school district that limits their involvement to that of only providing a payroll deduction slot, making the salary reduction and remitting the reduction would not become, or have much chance of being made, a fiduciary.

[mbozek]

GB: I am interested in any cites regarding your statement of activities that create fiduciary status to school districts that make 403(b) plans available. Some of the practices you cite, e.g., selection of providers and collection of reasonable charges for providing services to the plan do not make a 403(b) salary reduction plan of a TXO subject to the fiduciary provisions of ERISA. See DOL reg. 2509-3-2(f).

[GBurns]

29CFR 2510-3-2 et al adequately explains the limited exceptions, which if not applicable creates the ERISA involvement. Even without ERISA, as pointed out to you many times in many threads, there are sometimes state laws that would apply when ERISA does not.

The subject has been discussed many times in many ways, rather than rehashing obvious things, maybe some of the old threads will help you along with a re-read of the postings and 2510 etc:

http://benefitslink.com/boards/index.php?showtopic=18566

http://benefitslink.com/boards/index.php?showtopic=14267

[joel]

Re: The NYSUT/ING case.

Who is legally culpable for not offering the teachers of NY a no-load 403b alternative to the ING 403b offerings...the union, the school district or both?

[mbozek]

Where is there a legal requirement that participants in TSAs must be offerred a no load fund under a TSA? Even ERISA does not require that participants in self directed accounts be offerred no load funds. I am interested in state laws or cases that govern the selection of TSA options.

[GBurns]

Did someone claim that there were any "state laws or cases that govern the selection of TSA options." ?

Did someone claim that "collection of reasonable charges for providing services to the plan do not make a 403(b) salary reduction plan of a TXO subject to the fiduciary provisions of ERISA." ?

You always seem to bring up or invent issues just to either extend an argument or just to divert the discussion.

[joel]

Re: NYSUT/ING

Isn't the financial agreement between the Union and ING better described as a "pay for play" agreement?

[joel]

Hi mbozek,

Please note that the 403(b) is the primary salary reduction arrangement for public schools not because 401(k)s are not permitted (unless they were grandfathered)but because they had a near two decade headstart on the 457(b). It is only recently that teachers have clamored for the 457 because the offset rule has been repealed. Many statewide 457 plans are offered to local employers including school districts. You would be hard pressed to find a high cost 457(b) Plan administered by a state government. Are not these victims of high cost 403b products entitled to the alternative 457(b)? Of course they are! The question is how to make it a reality when the school board is out to lunch and the union is negotiating a "pay for play" deal with ING.

Peace,

Joel L. Frank

[mbozek]

I dont think that you have provided proof that 457 plans are low cost when compared to 403(b) plans. All retirement plans permitting salary deferral have cost structures which are passed on to participants. Govt 457 plans have additonal costs including trustee or custodial fees, record keeping requirements and 12b-1 fees. Also 403(b) plans allow employees with 15 years of service to defer an additional 3k a year for up to 5 years above the maximum permitted under a 457 plan. School boards should focus their limited resources on more important matters such as the quality of the education provided and the cost to taxpayers instead of providing more perks to teachers since where I live 75-80% of the district budget goes for wages and benefits. Adding another benefit program only increases the administrative burden on school staffs and accounting personnel without providing any benefit to the students or taxpayers who foot the bill for the school districts. Finally employees who do not like their choices in a 403(b) plan can make IRA/Roth contributions of 3k (increasing to 5k) to a low cost provider.

[joel]

mbozek: You are totally unresponsive to my points. Again, do you consider the financial agreement between the union and NYSUT to be that of a "pay to play" arrangement? I will respond to your comments in CAPS.

Joel L. Frank

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I dont think that you have provided proof that 457 plans are low cost when compared to 403(b) plans.

I DID NOT KNOW I WAS IN A COURT OF LAW OR NEEDED TO PROVE THAT THE EARTH IS ROUND. THE 457 PLAN OF THE CITY OF NY CHARGES 0.34 PERCENT WHILE THE NYSUT SPONSORED 403b PLAN CHARGES ABOUT 2 PERCENT. THESE EXPENSE RATIOS COME FROM THEIR RESPECTIVE WEBSITES AND PROSPECTUSES. THE FEDERAL THRIFT SAVINGS PLAN CHARGES 0.03 PERCENT AND THE INVESTMENT PLAN OF THE STATE OF FLORIDA CHARGES ABOUT 0.20 PERCENT.

All retirement plans permitting salary deferral have cost structures which are passed on to participants.

THANKS FOR STATING THE OBVIOUS...THE ISSUE IS WHICH EXPENSES SHOULD BE ELIMINATED BECAUSE THEY DO NOT ASSIST THE PARTICIPANT ONE BIT IN GROWING HIS/HER RETIREMENT INVESTMENT.

Govt 457 plans have additonal costs including trustee or custodial fees, record keeping requirements and 12b-1 fees.

I CHALLENGE YOU TO GIVE US THE NAME OF A STATEWIDE 457 PLAN THAT CHARGES A 12b-1 FEE.

Also 403(b) plans allow employees with 15 years of service to defer an additional 3k a year for up to 5 years above the maximum permitted under a 457 plan.

C'MON NOW LET'S BE PROFESSIONALLY HONEST. YOU KNOW OR SHOULD KNOW THAT SECTION 457 HAS A MORE GENEROUS CATCH UP PROVISON THAN 403(b). THE "DEFERRAL ACCELERATION FOR RETIREMENT" PROVISION ALLOWS FOR TWICE THE APPLICABLE REGULAR CONTRIBUTION LIMIT FOR EACH OF THE 3 YEARS PRIOR TO REACHING NORMAL RETIREMENT AGE.

School boards should focus their limited resources on more important matters such as the quality of the education provided and the cost to taxpayers instead of providing more perks to teachers since where I live 75-80% of the district budget goes for wages and benefits. Adding another benefit program only increases the administrative burden on school staffs and accounting personnel without providing any benefit to the students or taxpayers who foot the bill for the school districts.

Finally employees who do not like their choices in a 403(b) plan can make IRA/Roth contributions of 3k (increasing to 5k) to a low cost provider.

PLEASE TELL US WHAT IS THE BENEFIT TO YOU AS A TAXPAYER TO TELL YOUR CHILD'S TEACHER THAT IT IS OK FOR YOU TO PAY 2 PERCENT FOR A 403b ARRANGEMENT WHEN THE MARKET PLACE OFFERS NO-LOAD FUNDS. THE COST TO YOU AS A PARENT/TAXPAYER IS THE SAME WHETHER YOUR SCHOOL DISTRICT OFFERS THE HIGH COST ING 403b PLAN OR A NO-LOAD 403b PLAN VIA TIAA-CREF OR VANGUARD. YOU ARE SKIRTING THE ISSUE WHEN YOU TELL A TEACHER WHO DOES NOT LIKE TO PAY HIGH FEES..TUFF!...GO BUY YOURSELF A NO LOAD IRA. WHERE DOES YOUR ILL WILL AND ARROGANCE GENERATE FROM? OR DO YOU MAKE A LIVING SERVING HIGH COST PROVIDERS?