I’m regularly asked where are the biggest opportunities in the tax-exempt sector. My answer is the biggest opportunity for change right now lies in one key segment of the 403(b) market: private higher education. There is a huge opportunity for higher educational institutions to modernize their plans by engaging qualified financial professionals
It’s A Matter of Perspective
Higher education institutions have not historically used financial professionals to help them with their plans. In recent years, though, many have begun to understand the value that financial professionals can bring to the table.
Like many other not-for-profit organizations, private higher education organizations historically followed the typical 403(b) retail model, providing employees access to annuity and mutual fund options from several providers through individual meetings with financial professionals or provider representatives at the workplace. While these personal interactions have served individuals, there have historically been no relationships between financial professionals and plan level decision makers.
Many institutions of private higher education were reluctant to upset the apple cart when implementing changes for the final 403(b) regulations effective in 2009. A variety of financial professionals with various preferences toward providers and products continued to maintain individual relationships with employees who were vocal about maintaining the status quo. As a result, administrators made very few structural changes and simply adopted compliance monitoring procedures to satisfy the regulations.
Private higher education administrators soon learned that monitoring compliance across several unrelated service providers was difficult, if not at times impossible and often resulted in violations of the Internal Revenue Service (IRS) code. The challenges of coordinating loans and monitoring hardship distributions across multiple service providers are just the tip of the iceberg. Other violations have been occurring too. For example, some providers are paying out balances less than $5,000 (per the small account force-out option) when the participant’s total balance across all providers exceeds this limit. Additionally, contractual differences between different service providers in the same plan are creating discrimination concerns. For Employee Retirement Income Security Act (ERISA) plans, some auditors have been charging large fees for the extra work to consolidate reporting across multiple providers.
Plan Modernization Trends
The data in the 2017 Plan Sponsor Council of America (PSCA) 403(b) survey shows private higher education plans are slowly trending away from multiple providers to single providers—likely in response to the burdens of working with more than one service provider. The number of higher education 403(b) plans using a single service provider grew slightly from 12.6% to 13.1% with the vast majority still using multiple providers.
Investment option overload
Financial professionals can also demonstrate value by reviewing the number of investment options offered. Private higher education institutions are known to have very large menus of investment options for their participants. Historically this has been the result of due diligence processes that do a good job of adding options, but rarely eliminating them.
The average number of investment options for 403(b) plans is higher than for 401(k) plans with 23-26 options on average, according to the PSCA surveys. Higher ed stands out significantly with an average number of options between 30 and 45 — and this has been trending down over the past couple years. Studies, including one done by Columbia University1, have shown that too many investment options can have a detrimental effect on participation and overall savings rates.
Investment Policy Statement (IPS) as a best practice
While it’s a generally accepted best practice to have an IPS, only a little over half (58 percent) of plans in the PSCA survey have one in place. Another 1 in 5 (19 percent) said they didn’t have one at all.
More telling in the breakdown of the unpublished data behind the survey, over 61 percent of those with an IPS were ERISA plans. An IPS is a best practice for an ERISA plan, but they often aren’t necessary in a non-ERISA environment where the employer is typically hands-off. Yet, according to this data, nearly half of non-ERISA plans have an IPS. ERISA plans without one take note.
We believe this area clearly needs improvement.
Capitalizing on the trends
Clearly private higher education 403(b) plan sponsors are in the process of reviewing and making changes to their plans. They need high quality retirement plan professionals to help. Because higher education institutions have not historically used financial professionals at the plan level, the first step is to establish those relationships.
How can financial professionals help?
- use their investment analysis skills to help pare down the investment options to a more reasonable number
- show their value by helping plans adopt and follow an IPS to help fiduciaries in the event investment related decisions are questioned.
- demonstrate understanding of the marketplace through familiarity with the emerging trends.
- Iyengar, Jiang, Huberman “How Much Is Too Much?” Columbia Business School, 2003
This document is intended to be educational in nature and is not intended to be taken as a recommendation.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.