The retirement system that public school teachers can use to augment their traditional pensions has a baffling array of investment options, high fees and a chronic lack of oversight, the TIAA-CREF Institute says.

By Walter Hamilton, Los Angeles Times
March 2, 2011

With public-employee pensions under attack by budget cutters, teachers may have to rely more on their own savings to pay for retirement.

But a new study indicates that the retirement system used by California public school teachers to supplement their traditional pensions is larded with high fees that eat into employee nest eggs.

And the state’s teachers must wade through more than 3,000 investment options offered by six dozen financial firms, a baffling array that makes it hard to pick good investments, according to the analysis by the TIAA-CREF Institute, a research arm of investment firm TIAA-CREF.

To critics, the study underscores a chronic lack of oversight in the state’s mammoth system of public-school 403(b) plans, which are tax-deferred saving vehicles similar to 401(k) plans.

“It’s literally a Wild West when it comes to 403(b)s,” said Steve Schullo, a former teacher and a member of the Los Angeles Unified School District’s retirement committee. “Nobody’s watching, and there’s no accountability with California.”

Only about 30% of eligible employees participate in the country’s public-school 403(b) plans, but they have still managed to amass $183 billion in assets, according to Spectrem Group, a research firm. Public schools typically do not make matching contributions.

But 403(b) plans could gain importance in the years ahead, given that traditional pensions are at risk of being cut by fiscally challenged state and local governments. Many experts say public employees will have to shoulder an increasing share of their retirement savings burden, much as private-sector workers do with the help of 401(k)s.

“If you’re someone who wants to see an end to pensions, you should want what teachers transition into to be the best possible plan,” said former teacher Dan Otter, who runs the website 403bwise.

The problem, however, is that California’s 403(b) system differs markedly from 401(k) plans and from many other states’ 403(b) plans.

A private employer typically hires one firm to administer its 401(k) plan and scrutinizes the handful of investment options that goes into it. States with low-cost 403(b)s run their plans in a similar fashion, experts say.

By state law, however, California has an “open access” system, in which any investment firm can offer a public-school 403(b) plan. The state and individual school districts exercise minimal oversight of the plans, critics say.

The TIAA-CREF study compared open-access plans in California and Texas with closed-access plans in Arizona and Iowa, which maintain close oversight of 403(b)s.

Despite the large number of financial firms participating in open-access plans — theoretically, spurring competition among providers — investment fees are significantly higher.

The average annual fee is 2.11% in California and 1.71% in Texas, the study found. That compares with 0.87% in Iowa and 0.8% in Arizona.

Many of the investments in California 403(b)s are high-fee annuities, hybrid investment and insurance products, according to the study. For example, the average annual charge for a variable-rate annuity is 2.53% in California but only 0.74% in Arizona.

“If [California is] not the No. 1 cost market, it’s very close to the top,” said Bruce Corcoran, a TIAA-CREF managing director.

TIAA-CREF manages $453 billion in investment assets, including less than $1 billion in California public-school 403(b) plans.

Additional charges, such as sales commissions and so-called surrender fees imposed on investors who sell their holdings within a specified period, also are common in California.

About 80% of the fixed-rate annuities in California, and 97% of the variable-rate annuities, impose early-redemption charges, according to the study. There are no such fees in Arizona or Iowa.

“The data suggest that teachers in open-access states face a lower likelihood of a secure retirement simply because they are subjected to a more complex fee structure and higher overall fees,” the study says.

Despite the criticism, the California Teachers Assn. supports the open-access model, saying it allows teachers to pick from a wide selection of investments. The union focuses on educating teachers about how to pick low-cost investments, said spokesman Jonathan Goldman.

Open access “is not as much of a problem as is the lack of education,” he said.

Ricardo Duran, a spokesman for the California State Teachers’ Retirement System, which manages the teachers’ traditional pensions as well as a 403(b) known as Pension2, said in an e-mail that the pension giant, known as CalSTRS, also tries to educate teachers.

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