Keith Reed, who teaches fifth-graders in Joshua Tree, Calif., says the free pizza in the teachers’ lunchroom came with a potential cost. JENNIFER WHITNEY FOR THE WALL STREET JOURNAL
Hidden financial ties exist between some administrators hired by school districts for their teacher retirement plans and the companies whose investment products those administrators promote, The Wall Street Journal found.
The ties can encourage administrators to promote higher-fee investments that leave teachers with smaller nest eggs than they might otherwise have had.
The Journal’s findings come as the Securities and Exchange Commission is investigating whether schoolteachers are getting a fair shake from the companies they work with when they save for retirement. The agency has requested information from companies marketing retirement-income products to teachers and from those providing administrative services, the Journal has reported.
Keith Reed, a 58-year-old fifth-grade teacher in Joshua Tree, Calif., says he has learned the hard way how the deck can be stacked against teachers’ retirement savings.
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The school district where he works hired an outside administrator, SchoolsFirst Plan Administration LLC, a unit of SchoolsFirst Federal Credit Union, to handle its employees’ retirement accounts. That administrator’s representatives would show up in the teachers’ lunchroom bearing pizza or doughnuts.
“They always bring food,” Mr. Reed said. “It makes you feel as if you are in a relaxed atmosphere and that they are looking out for you.”
Mr. Reed said he eventually concluded that neither the school district nor its retirement-plan administrator was working for the teachers’ benefit. After attending a workshop run by the California Teachers’ Association union in 2013, he said he was shocked to learn how much in fees he was paying on his retirement account, which he had started investing in during the early 1990s. He also learned that, sometimes, investment advisers defray administrative fees in return for the opportunity to pitch products to teachers.
Mr. Reed switched from investments that charged about 2% a year to choices that cost around 1/10 as much. “The adviser in the lunchroom is there to make a buck,” he said.
Larry Meltzer, a spokesman for SchoolsFirst Credit Union, a member-owned cooperative that includes school-district employees, says that its retirement advisers “always act in the best interests of our members.”
At issue is what is called a 403(b) plan. It is similar to the 401(k) offered in the private sector. But teachers with 403(b) accounts are far more likely to have high-cost investments, according to state securities regulators.
Many of roughly 20 teachers interviewed for this story said they assume their school districts have bargained on fees and are acting in their best interests. But unlike 401(k) plans, whose overseers have a fiduciary duty under federal law to put participants’ interests first, federal law puts no such onus on the vast majority of school districts and outside firms that administer 403(b) accounts.
As a result, some third party administrators offer teachers investment options mainly from companies willing to pay them to promote their products, including by defraying some or all of a plan’s administration costs.
According to a report from the Investment Company Institute, a mutual-fund trade group, more than half of the assets in 403(b) plans are invested in annuities—insurance contracts that often provide monthly income for a lifetime. Though teachers and others value annuities for their guaranteed payouts, many annuities carry high costs that consume a significant portion of an investor’s returns over time.
Annuity buyers can pay as much as 3% of invested assets in fees each year. In contrast, fees on 401(k) accounts average less than 1% annually, according to BrightScope Inc., a firm that tracks retirement-plan data. For $100,000 invested for 25 years at 6%, an extra 2 percentage points in fees would cut 38% from the final account value.
Across the country, 403(b) plans held $1.06 trillion in assets at the end of the second quarter, according to ICI. How this large chunk of retirement money is invested has implications for postwork life for teachers and other school workers, and it is increasingly drawing scrutiny.
In addition to the SEC probe, New York state’s Department of Financial Services is investigating a dozen life insurers to determine whether they or their agents are selling teachers potentially high-cost and inappropriate investments, the Journal reported in October.
Like a 401(k) plan, a 403(b) is voluntary and allows workers to contribute up to $19,000 a year, or $25,000 if 50 or older, to tax-advantaged investment accounts.
More than 200 school districts in California have retained SchoolsFirst Plan Administration to administer workers’ 403(b) plans. The districts don’t pay it for those services, said Mr. Meltzer, the SchoolsFirst spokesman. Rather, SchoolsFirst is paid by the companies approved by school districts to provide investments to workers.
Middlemen like SchoolsFirst routinely help teachers and other school employees choose investments. That is where the possible conflicts can arise.
In Mr. Reed’s California school district, a unit of Nationwide Mutual Insurance Co. makes additional payments to SchoolsFirst when teachers invest in a higher-cost Nationwide program called ProAccount, both SchoolsFirst and Nationwide say. The administrator’s website doesn’t disclose the payments; the administrator tells teachers about the fee arrangement if they ask, Mr. Meltzer said.
Nationwide pays SchoolsFirst 0.05% of the assets teachers invest in ProAccount, Mr. Meltzer said. SchoolsFirst doesn’t receive commensurate compensation for investment in other options.
This fee arrangement represents an undisclosed conflict, said Dan Alexander, founder of RetireAware, a company that analyzes retirement plans for risks and conflicts of interest. “If you’re a third-party administrator, you should not be paid off by an asset manager,” he said.
Both Nationwide and Mr. Meltzer disputed that the arrangement constituted an incentive for SchoolsFirst to steer clients to invest in ProAccount, saying it is there to defray SchoolsFirst’s costs in administering ProAccount. “Our salaried retirement advisors are not compensated for suggesting this option,” Mr. Meltzer said.
Managed mutual-fund accounts such as ProAccount layer annual fees on top of money-management fees. Annual costs in ProAccount begin with a 0.6% program fee for portfolio management. When mutual-fund expenses are factored in, that brings the total cost to between 1% and 1.2%, depending on the fund, a Nationwide spokesman said.
Mr. Meltzer said less than 5% of SchoolsFirst participants use ProAccount, which entails the investors being placed into funds based on age and risk tolerance. He adds that advisers sell it only to teachers who specify they want the option.
Tom Baumgarten, the superintendent of Mr. Reed’s school district, the Morongo Unified School District in Twentynine Palms, Calif., said in an email that SchoolsFirst officials have told the district that “they openly discuss all options to participants.”
On its website, SchoolsFirst lauds Nationwide, saying: “Their experience, expertise and performance with mutual funds and other retirement products is considered outstanding.”
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SchoolsFirst however doesn’t note that the all-in costs of the main Nationwide offering—averaging $141 a year per $10,000 invested, according to data website 403bCompare.com—are double those of some other investment companies.
Nationwide regulatory filings describe the company’s practice of paying third-party administrators fees for assets placed in ProAccount. These can be as much as 0.25% of assets annually, the filings say.
Low-cost investment providers such as Vanguard Group and Fidelity Investments say they don’t pay fees to third-party administrators to promote their products as other higher-cost providers sometimes do.
Even though investment companies may pay the administrators’ monthly costs of handling teachers’ plans, SchoolsFirst and other third-party administrators have presented themselves as independent of those companies, the Journal found in several instances.
Calling themselves third-party administrators, the middlemen firms often imply they are independent and choose providers solely for quality, said Dan Otter, founder of 403bwise.org, a nonprofit that educates teachers on 403(b) plans and advocates for low cost investments.
School districts often require teachers to meet with 403(b) or other benefit program administrators to verify personal information. The meetings become an opportunity for the administrator or investment-company representatives to sell other products, said Mr. Reed, the Joshua Tree teacher.
Kenneth Ford, a financial planner in Warwick, N.Y., who is paid by clients rather than by the investment companies, said school districts should be required to disclose clearly all fees associated with teachers’ retirement accounts, allowing people to compare offerings.
“We have to check out the food quality in the school lunchroom, but nobody wants to do the quality check of the financial vendors,” he said.
Write to Anne Tergesen at anne.tergesen@wsj.com
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