The Price of 403(b) Enrollment

The True Cost of Using Financial Predators to Drive Participation

Why don’t Vanguard and Fidelity send representatives into K-12 lounges and classrooms to sell their 403(b) products? After all, it’s what their competition does. The reason is actually quite simple: It makes no economic sense for companies that charge rock bottom prices to do this. It actually doesn’t even make sense for high-cost companies like Equitable Financial and National Life Group who dominate the K-12 market to sell this way. But they do it anyway. Why? How do these companies make it pencil out financially? It’s the expensive and dirty little secret that K-12 employers better wise up to. The high-cost vendors make enrollment work by relying on predation.

How Are K-12 403(b) Products Currently Sold?

We are often told that the value of high-cost sales agents trolling the hallways of our nation's schools handing out sandwiches and Starbucks cards is that they are "doing the hard work" of signing up new participants. The costs for their products are higher to compensate them for this work. The participants pay substantially higher costs and suffer dramatically lower account balances over their careers, but "at least someone got them started" is how the argument goes. The 403(b) industry casts these sales agents, who often have little experience, almost no financial background, and who are hired based on their sales prowess as the heroes of our nation's educators. I'm calling bullshit.

It's not a profitable economic opportunity to sign up new participants in multi-vendor K-12 public school 403(b) plans, as currently structured. Enrollments are subsidized by predatory ancillary sales and mostly unneeded exchanges. Anyone claiming otherwise is gaslighting or stretching the numbers to fit a narrative. Let's talk about the economics of signing up new employees.

Why Doesn’t It Make Economic Sense?

The new enrollee into a 403(b) plan is a loss leader. A loss leader is a product or service sold below cost that draws you in with the hopes of getting you to spend more money. The most well-known loss leader is the rotisserie chicken at Costco. The price is only $4.99 even after years of inflation, yet the price remains the same; how can that be? Costco loses money on the chicken as an incentive to draw you in to spend money on other, higher-margin products. 403(b) sales representatives nor the companies they work with make much money signing up a new teacher for a 403(b) account. The enrollment is done at a loss to maintain access to the other participants (who they can convince to move their existing 403(b) accounts), gain a foothold with that new educator, and, most importantly, sell non-403(b) products that make the representatives and the companies they work for a lot of money. For some companies, it's only profitable because of dramatic turnover among representatives who work on commission. In fact, it’s often the representative that is being preyed on.

The bottom line is that nobody would be roaming the halls and sitting in teacher lounges without the promise of the ability to sell other financial products and the potential to move existing assets to new products. If a public school employer of a multi-vendor 403(b) plan restricted exchanges to only products that did not pay a commission and forbade representatives from cross-selling financial products, you would see a dramatic reduction in the number of representatives working in the field. That should tell you something.

How High Cost Companies Make it Work

The carrot to get our nation's educators to sign up for a 403(b) is the ability to sell a whole host of other financial products that are not likely in their best interest and with no oversight by the school employer. Another carrot is the hope that the representative can convince current participants to move their money to a new provider (called an exchange) to generate a new commission. In other words, our nation's teacher's retirement accounts are being sucked dry by the very people charged with helping them save for retirement. Make it make sense. 

When a school district allows a multi-vendor 403(b) environment, they are not increasing enrollment and providing financial advice. Instead, they are usually inviting financial predators onto their campus to sell products that no one in the district has approved or endorsed. Such policies make the 403(b) representatives significant amounts of money (or at least the companies they work for; often, the representatives are also victims).

Enrolling a new participant takes time. The actual enrollment is quick and easy once you've done it a few times, but it's difficult enough that the average new participant will find it frustrating. The actual expenditure of time for the representative is finding the employee they help enroll. There are a myriad of prospecting methods, but one that we often see is a representative quite literally occupying the teacher's lounge. Whether they offer breakfast, lunch, treats, or make themselves available, there is a cost for their time. 

Case Studies/Examples

Let's test how much money a representative might make over five years selling various 403(b) enrollment products. Let's assume that the average educator this representative works with will contribute $4,000 annually through ten contributions of $400 each. 

There are six options this representative could offer that are compensated:

1. A-Share Style Mutual Fund Programs

2. A-Share Mutual Funds - top breakpoint achieved

3. Fee-based accounts primarily investing in Mutual Funds

4. Variable Annuities - annualized flow

5. Variable Annuities - upfront commission

6. Fixed and Fixed Indexed Annuities

How much money would the representative make under each option? Let's explore.

A-Share Style Mutual Fund Programs

We'll assume the representative receives an upfront commission of 5.75% on every dollar invested. On average, a sign-up will generate $23 on each contribution. Over the course of twelve months, they would earn a total of $230. They will also receive what is called a 12b-1 fee, which pays for ongoing servicing and usually runs 0.25%.

The representative would take home around $1,255 over five years before any of their costs.

A-Share Mutual Funds - top breakpoint achieved

Most people are unaware that A-Share mutual funds can have their upfront commission reduced if the purchase or cumulative purchases exceed certain levels. The upfront commission can even be reduced to zero. An educator must make significant contributions to get to a zero percent upfront commission. 

To give you an idea of how much, what follows are the breakpoints for the American Funds:

Contributions Commission

Less than $25,000 5.75%

$25,000 - $49,999 5.00%

$50,000 - $99,999 4.50%

$100,000 - $249,999 3.50%

$250,000 - $499,999 2.50%

$500,000 - $749,999 2.00%

$750,000 - $999,999 1.50%

$1,000,000 and above 0.00%

Only some educators will ever contribute enough to reach most of the breakpoints. Most employers do not realize that breakpoints can be offered at the employer level for many mutual fund companies and platforms. Suppose a school employer works with the mutual fund company to allow the breakpoints at the employer level. In that case, all employees may qualify by using their combined contributions. Achieving $1 million in aggregate contributions is much easier than individually. This turns a commissionable A-Share, where the rep takes 5.75% off the top, into a type of no-load option. There is a 1% Contingent Deferred Sales Charge (surrender charge) on every purchase if that purchase is sold within 18 months to compensate the mutual fund company for paying a 1% commission to the representative selling the mutual fund.

I'm not advocating school districts' contract with A-share mutual fund salespeople, only showing that they may get a better deal if they already contract with them.

We'll assume the representative receives an upfront commission of 1.00% on every dollar contributed. On average, each sign-up will generate $4 on each contribution. Over the course of twelve months, they would earn a total of $40. They will also receive what is called a 12b-1 fee, which pays for ongoing servicing and usually runs 0.25%.

The representative would take home $305 over five years before any of their costs.

Fee-based accounts primarily investing in Mutual Funds

Suppose a participant wants to use a mutual fund based account but pay fees instead of commissions for compensation. In that case, they might choose a mutual fund platform from Planmember Services (red rated vendor), Lincoln Investments (red rated vendor), GWN (red rated vendor), Kades-Margolis (red rated vendor), or Aspire (Green rated vendor without an advisor). Many of these platforms allow advisors to charge up to 2% annually in fees on top of the mutual funds chosen. We are going to use a fee of 1.5%. Let's be clear: 1.5% is too expensive to pay over your career, but since it's a fairly standard fee in the 403(b) universe, we'll use it to demonstrate likely compensation for a representative recommending such a product.

Fee-based is a compensation method that pays very little at first. In year one, the total compensation is only $34. This compensation method takes patience but begins to generate a nice income stream after just a few years. The compensation for all five years looks as follows:

Year Yearly Cumulative 

1 $34 $34 

2 $94 $127 

3 $154 $281 

4 $214 $494 

5 $274 $768 

The representative would take home $768 over five years before any of their costs.

Variable Annuities

Variable annuities do not generally reduce the value of a contribution through an upfront commission; instead, they have a higher fee structure and a surrender charge (Contingent Deferred Sales Charge). There are two primary compensation methods for variable annuity representatives: annualized flow and traditional.

Annualized Flow

Some insurance companies compensate their insurance agents on the cumulative value of contributions made by the participant in the first year. This method is called annualized flow.

The new participant wants to save $4000 over ten payrolls in our example above. Instead of paying a commission from each payroll contribution, the insurance company will aggregate the expected payroll contributions over one year (annualized) and pay a commission rate on that total amount. 

In our example, the educator will contribute $400 from each of ten paychecks over the next 12 months, for a total of $4,000. $4,000 is the annualized flow (or premium). The insurance company will then apply a commission structure, perhaps 6 or 7%. One prominent variable annuity purveyor pays 6% on the first $2,000 in annualized contributions and 7% above $2,000. 

Under this annualized flow structure, the salesperson would see an immediate commission for signing up that teacher of $260. The higher commission rate doesn't apply to contributions after the first year; instead, they might receive 2% of contributions in year two and beyond, with a higher percentage on any increase.

When all is said and done, if an educator does not increase their contributions, they will compensate the representative about $580 over five years before their costs.

Traditional

Not all variable annuity products use the annualized flow method. Instead, they pay an upfront commission to the agents in the 6 - 7% range. The participant does not see the commission come out of their contribution (as does the mutual fund A-share participant) and is subject to a Contingent Deferred Sales Charge (surrender charge) on each contribution that may last as long as 12 years to compensate the insurance company (for the already paid commission) if the participant surrenders their policy early.

Under this scenario, the agent will earn $975 over five years before their costs.

Fixed (Equity) Indexed Annuities

One of the largest Fixed Indexed Annuity providers (National Life Group, AKA Life of the Southwest - red minus rated vendor) had their commission schedule posted online by a distributor. The old schedule sheds light on the compensation these annuity representatives receive for selling indexed annuities. This company's main 403(b) product would pay a 10% commission on annualized flow in the first year, followed by a 7% commission on the annualized flow for years 2 - 5. A smaller commission is paid in years 6 - 10 of 3.5% on an annualized flow. 

This structure creates a significant conflict of interest for the agent as it encourages them to switch the deferral product at least every five years due to the dramatic fall in compensation. It also pays the highest commissions, which may cause a representative to recommend this product over others. Commissions in indexed annuities have generally fallen in the past decade, so 10% is likely higher than what agents selling products today can earn.

The salesperson would see a commission for signing up a teacher of $400 in the first year. That entire commission is usually paid within 30 days of receiving the first contribution. The salesperson continues to receive high commissions (but lower than year 1) of 7% on premiums in the next four years, bringing their total commission over five years to $1,520 before any of their costs.

Summary of Gross compensation over five years:

Type 5 Years 1st Month 1st Year

A-Share Upfront Commission Mutual Fund Net: $1,275 $23 $235 

A-Share $1mm+ Breakpoint Mutual Fund Net: $324 $4 $45

Fee-based accounts with Mutual Funds Net: $768 $.50 $4

Variable Annuity annualized flow: $580 $260 $260

Variable Annuity upfront commission: $1,300 $26 $260

Indexed Annuity annualized flow: $1,520 $400 $400

All of the numbers above assume that the representative's employer doesn't take a cut of the commission. However, most do, sometimes a substantial portion. In addition, in each case, the representative has other costs of doing business they may need to pay for out of pocket, such as the marketing cost of attain these new customers. Someone has to pay for those donuts.

Only the annualized flow method of compensation provides meaningful immediate compensation, it doesn't seem probable that one could build a business by only enrolling new participants using the other methods. Even the annualized flow method would require enormous numbers of sign-ups in the early years and then constant switching of products to keep the income stream going. The annualized flow method also happen to be the worst possible product options for educators.

Is Signing Up Individuals A Sustainable Business?

Public school employers continue to allow predatory financial services companies access to their employees. This access is often predicated on the belief that enrollment will drop if they don't let these representatives on the campus. These employers fail to reason that the representatives are not on campus to increase or maintain participation; they are there to extract retirement dollars from their employees. 

The above numbers are evidence that building a business based purely on new enrollments is a poor business model. The representatives are not on campus to increase enrollment; they are there to promote ancillary financial products that the employer does not approve of and to induce employees to move from one vendor's product to another, neither of which increases participation. This method might maintain the participation rate, but at what cost?

The most lucrative model above, selling indexed annuities to new enrollees, isn't sustainable as a business model, even with the excessive commissions built into it. Few representatives could feed their family purely by signing up new participants.

There is no evidence that the multi-vendor model increases participation, but it does increase the rate at which money moves between vendors (called an exchange). The entire point of representatives claiming that they are integral to enrolling new employees is to maintain their access to employer sites to promote other financial products they sell and to convince employees to move money from one vendor to another, a process that rarely results in the employee having a better product but always generates a new commission.

This relationship of representatives to school districts is no different than that of a vampire. The employees' retirement plans are sucked dry by predatory sales representatives masquerading as helpful financial advisors. The real money is not in signing up new participants; it's getting access to existing participants and selling them new products, often similar to the ones they already own.

Where Does The Real Compensation Flow From?

Where does the rest of the compensation originate if representatives can't live on enrollment commissions alone? There are myriads of ways, which is what most employers have failed to understand about the people roaming their campuses.

Exchanges

The most significant source of income for representatives who prey on school employees is an "exchange." An exchange is when a current participant moves their money from a 403(b) product within the employer plan to another 403(b) product within the plan.

Rollovers

Retiring educators are often solicited to rollover their 403(b) money to an IRA to generate another commission for the representative.

Switch the Flow

Since annualized flow only rewards the sales representatives in the first one to five years, switching where the contributions flow to another product or vendor will generate a new annualized flow commission higher than they would have received as a renewal on the previous product they sold.

Cash Value Life Insurance

Life insurance is often the product of choice for agents selling indexed annuities to educators. Getting someone to sign up for an Indexed Universal life insurance policy can generate commissions from a new educator in the thousands of dollars. These policies rarely live up to the hype.

Supplemental Insurance Products (disability, life, cancer, etc.)

These products may or may not be appropriate, but they are almost always way more expensive to purchase from the employer representative than individually.

Mortgages

Can anyone explain to me why your 403(b) enroller is hawking mortgages? Does the employer realize this?

Debt Elimination schemes

I've seen some whoppers in this area. Referrals to these services create massive commission opportunities while rarely helping the educator. None of these programs are overseen by the school employer, who is unaware they are even being offered.

Credit Repair & Credit Monitoring

More commission opportunity with no oversight and no relationship to the 403(b).

Recruiter

Believe it or not, the 403(b) market has spawned several multi-level marketing companies (Appreciation Financial, Premier, and ValuTeachers). Recruiting is one of the ways to make money, and the people they are trying to recruit are current educators. Imagine inviting an individual onto your campus to help with enrollment, and instead, they convince your employee to leave and join them in selling financial products.

Anything else they can think of selling

Non-qualified annuity products, long-term care insurance, IRAs, Roth IRAs, Brokerage accounts, 529 plans, wills and trusts, COVID tax credit scams, and anything that can generate an upfront commission… will be sold to educators.

What K-12 Employers Should Do

A public school employer must ask themselves if it's worth inviting a group of salespeople onto their campus whose agenda is not building participation in the 403(b) program but their own cash flow. 

When an employer allows predatory salespeople on campus, they effectively endorse the 403(b) product(s) and everything else they sell. Public school employees deserve better. 

This approach is lazy (requires nothing from the employer), expensive (the worst 403(b) products), contrary to the employee's best interest, and ineffective. Inviting commission-based representatives on campus to sell financial products to educators has not been successful at what it purports to do: increase participation. We know how to increase participation and lower costs for public school employees, auto-enrollment into quality products and higher pay. It's simple and works every time it's tried. It's obvious why the industry is dead set against auto-enrollment, single-vendor plans, and unbiased education; they would lose an outlet to sell their predatory products.

It's time for employers to wise up and begin protecting their employees from predatory sales practices. The price of enrollment is too high.