ATTENTION Read­ers: This chap­ter is an early ver­sion of my new book just released, March, 2015. For an update of all the Chap­ters includ­ing this Chap­ter 4, go to the home page and scroll down. On the right are direc­tions to get the full story in 11 Chap­ters and 17 appen­dices, resources, let­ters, books, pod­casts all in the free pdf book, “Fight­ing Pow­er­ful Inter­ests: Edu­ca­tor Chal­lenge Tax-sheltered Annu­ities and WIN!” (Click here for home page).

Forward to this Chapter: The Time Period for this Chapter is 2001. Read how the feds saved my 403b by relaxing one IRS rule that allowed two low-cost companies to sign up for LAUSD403b  list immediately in 2001. Most importantly, read about how my investing philosophy evolved from just no-loads to a couple of companies which both have high ethical standards of conduct that always look after our best interests. It doesn’t matter who you are an educator, truck driver, secretary, an engineer or a custodian working for Apple, if you using a 401k, 403b or 457b plan, the information on how to evaluate companies and advisers applies directly to you. Best of Fortunes, Steve

Chapter 4

TIAA CREF Signs LAUSD’s Hold-Harmless Agreement!

2001

Congress and the President simplified our 403b to make choices easier and cost-effective, a nice surprise for us. This new federal law deserves its own chapter, showing how common sense can prevail over provincial practice using outdated policies. This allowed two low-cost companies to sign on to Los Angeles Unified School District’s (LAUSD) 403b list.

When the Economic Growth and Tax Relief Reconciliation Act (EGTRRA, 2001) was passed the complicated Maximum Exclusion Allowance (MEA) formula was eliminated. The MEA was a major barrier for Vanguard, Fidelity, TIAA CREF (T/C) and other companies who were on the hook to insure teachers didn’t save over the maximum allowed by law. The 403b vendors had to agree to calculate each employees MEA. To no surprise the calculation demand was part of the phony hold harmless agreements.

Under the new rule employees could defer taxes to the extent they could afford without exceeding new annual maximums. The new measure added a provision for employees 50 and older—called a “catch-up” allowing $3000 over the standard maximums—to make up for paltry or no contributions in previous years.

The industry minions shrieked, “this will be just as complicated.” Oh Please! How many use catch-up features? Few of us could afford to save more than the now-simplified annual maximum anyway. If some did, it certainly wasn’t complicated.

Low-cost quality 403b choices increased at once—both T/C and Fidelity Investments signed with the district without delay. EGTRRA allowed all plans (401k, 403bs and 457b) more flexibility with transfers and contributing, thanks to the federal government. The complicated MEA was gone, a wonderful development for increasing quality and low-cost 403b choices.

Invesco’s 12b(1) Fees Came Back to Haunt—Almost

In 2001 my 403b with Invesco no-load merged with AIM Advisors Inc. and the fees increased. I wanted out. It was impeccable timing as T/C became available when I wanted to transfer anyway.

Invesco’s sudden increase in fees turned out to be a harbinger. Three years later according to a Los Angeles Times report (September 8, 2004), AIM and Invesco were fined for alleged improper and excessive churning (another word for excessive trading to generate commissions). As a result they agreed to reduce fees. It was the largest lawsuit for market timing scandals at the time. I received several hundred dollars from the settlement.

Always pay strict attention to costs, expense ratios and the seemingly small 12b(1) fee. I had to compromise by paying that small .25% fee to invest a 403b no-load. Surcharges are not normally levied when buying a house or car. Why should no-load mutual fund companies impose this marketing fee? In my situation the 12(b)1 led to the slippery slope of increased costs and a hefty fine—it didn’t matter that Invesco was a no-load.

When additional fees increase and an existing 12b(1) fee, it’s a clear warning. Transfer your money. Why pay more than Vanguard or T/C? Invest in Vanguard or T/C and be done with it. They do not charge 12b(1) fees. My decision to contribute to T/C saved me thousands of dollars in fees through the rest of my working career.

The next two sections illustrate healthy corporate ethics in detail—Low-cost financial service companies and their investing philosophies are as commingled as my green-thumbed mother working in her vegetable garden. When you understand the strategies of the high standards of these two companies you should appreciate these reasonable investing options.

TIAA CREF

Teachers Insurance Annuity Association – College Retirement Equities Fund (T/C). Why T/C? For a decade I wanted Vanguard as my 403b—it never materialized. Upon discovering T/C comprised the same ethics, low-cost and infrequent trading strategy as Vanguard, I was grateful. T/C remains the retirement institution for higher education and many nonprofit organizations since its creation by industrialist Andrew Carnegie in 1918.  Carnegie wanted the nation’s college, university, medical and research institutions’ faculty to have a secure retirement. T/C’s mission statement says it all. From the tiaa-cref.org website:

Serving the Greater Good

For 96 years, TIAA-CREF has been helping those in the academic, medical, cultural and research fields plan for and live in retirement…In keeping with our strong nonprofit heritage, we offer low fees, a long-term approach to investing…products and services provided by consultants who never receive commissions.Instead, they are compensated primarily on how well they serve you, not what they sell you  (Edited for space and underlined for emphasis). 

Look at the key words I underlined:

• “Greater Good”
• “nonprofit heritage”
• “low fees”
• “long-term”
• “consultants never receive commissions”
• “how well they serve you, not what they sell you”

Isn’t this the type of corporate culture you want for your investment dollars? You may find this investment philosophy and strategy right for you as I have. According to T/C’s website, ”profits are distributed to policyholders [that’s you and me] in the form of dividends over the lifetime of their association with TIAA….” Now we had a company matching Vanguard’s high standards of conduct with its low-cost structure, broad diversification where profits are credited back with no 12b(1) fees. Isn’t that cool?

In 2002 six years away from retirement, Dan and I lost 1.1 million from the tech bubble crash. We revamped our portfolio, diversifying into safer allocation. We sought balance with less risk. Our knowledge of the low-cost, indexing strategies of Vanguard and T/C led us shun actively-managed funds and invest in the indexed (passive) strategy (the active and passive strategies are discussed in many books, articles and investment discussion forums online. See the reference section for further reading). We invested in index mutual funds and bonds in these two great companies. I transferred my old 403b money from Invesco to Vanguard. I began contributing new money to T/C from 2002 until 2008, when I retired Instead of the risky and narrow technology sector funds which Dan and I loved (and lost) I steered all new contributions into T/C’s Equity Index (Total Stock Market Index equivalent), Global Equity (International Equivalent) and a bond fund. These funds are broadly diversified across the entire domestic and international stock markets. Bonds are a required allocation for investors to reduce the risk of stock market volatility as we get closer to retirement.

Vanguard’s Investing Philosophies and Corporate Culture

John Bogle created and introduced the first index fund to the public, Vanguard S&P 500 Index fund (VFINX) in 1976. He is eminently known as the father of the index fund and the passive strategy. Since then the number of index funds and their sister, exchanged traded funds (ETFs), have grown a thousandfold. In 1999 Fortune Magazine named Bogle one of the four investment giants of the twentieth century.

I found my epiphany at the popular Bogleheads.org investment forum and in John Bogle’s bookshe.  Bogle founded the Vanguard Group in 1975 and made it into the largest and most respected mutual fund company in the world ($2.2 trillion in assets and growing). At 85, he still pioneers efforts providing customers with low-cost, index investing, also known as the passive strategy. The Boglehead’s forum includes many savvy and gratis contributors eager to help and answer questions.  

Bogle’s investment strategy isn’t beholden to Wall Street’s values of charging enormous costs, encouraging reckless trading or selling “riskless” chronically low performing and expensive insurance products or TSAs. Mr. Bogle’s reasonable passive strategy fits our noncompetitive values, with infrequent trading while earning stock and bond market returns over the long-term. Bogle’s critics are those employed in the financial industry who put their interests over us and those overconfident regular investors who think they can beat the market averages by choosing the best funds and picking the best fund managers.

That did it: Dan and I found a like-minded savings mentor.“ Our own dim-witted overconfident thinking got us into deep trouble. We thought we had picked the best technology fund managers but ended up shredding our portfolio to pieces in the 2000-2002 tech wreck. No more active managed funds.

Vanguard’s corporate culture differs from other investment companies in three significant ways:

1. Vanguard has no shareholders. It is not publicly traded nor privately owned, unlike most of the other Wall Street investment firms and insurance companies.
2. The investors own Vanguard–,people who who buy its index fund shares.
3. It Vanguard has one masterr——the clients, not shareholders.

The Vanguard executives embrace genuine fiduciary responsibility as shown by the following three basic Vanguard principles (Vanguard.com website):

 1. “We’re owned by the funds that are owned by clients like you, so we have no competing loyalties. We don’t pay profits to a private owner or stockholders. We always keep your long-term interests in mind—even closing funds when necessary to keep away short-term performance chasers.

2. Your funds are at-cost. You pay what it costs us to run the funds. By investing at cost, you keep more of your returns working for you, giving you a great start on reaching your financial goals.

3. We help you focus on the long-term. We don’t get caught up in the emotion of Wall Street’s mood swings—and we tell you why you shouldn’t either. We follow a disciplined long-term approach through good markets and bad. That’s just another way we keep your interests first.”

Recognize the key descriptions below which reflect a company’s high standards (and fiduciary fee-only advisers too) who look after your best interests:

• “no competing loyalties” (no stockholders)
• “keep away short-term performance chasers” (regular investors who think they can beat the market with excessive trading)
• “long-term”(repeated three times)
• “at-cost”
• “keep more of the returns working for you”
• “low-costs”
• “don’t get caught up in the emotion of Wall Street’s mood swings”
• “disciplined long-term approach”
• “we keep your interests first”

This is delightful—Vanguard’s

employee bonuses are given for cost-saving ideas, which save money for the company and investors. Vanguard discourages speculation and trading by imposing a redemption fee lasting three months in some funds. Can you imagine Goldman Sachs, Wells Fargo, JP Morgan-Chase or any of the TSA insurance companies approving their millions upon millions in bonuses due to cost saving ideas for clients and discouraging trading? Not a chance. Vanguard and Wall Street’s corporate cultures are as disparate as Ghandi and Madoff.

Low-cost 403b Annuities

Since the early 1990s Dan and I avoided 403b annuities. Of the seven annuities sold to us, none were low-cost, all charged high surrender fees and our so-called “advisers” received hefty commissions. The sour taste of annuities was as entrenched as a rancher’s brand on her longhorns. Thus we erroneously thought all annuities were expensive and inappropriate in retirement plans.

Learning about T/C changed our misperception in two fundamental ways:

• First, annuities may have a place in retirement plans.
• Second (are you sitting down?) low-cost annuities do exist! I was surprised when I discovered the low-cost companies who offered them: T/C and Vanguard.

T/C’s annuities act more like no-load mutual funds than TSAs from the major insurance carriers. T/C 403b offers variable annuities which have subaccounts with mutual funds.

The huge differences with T/C are low-costs and no surrender fees. Investors can transfer at will in all options except for two (details in Appendix). Offering most of their annuity contracts with no surrender fees was unheard-of with other insurance companies. I paid a horrific 18% surrender fee to get out of two for-profit insurance company TSAs…ugh. Now you know why I appreciate and value T/C.

Both Vanguard and T/C sell annuities to retirees who want guaranteed income. There is nothing wrong with purchasing an annuity in retirement. It’s similar to buying a private pension plan. Annuities may be useful for retired people after amassing their nest egg. If I were to purchase an annuity I would choose T/C or Vanguard. Their annuities guarantee an income stream for life at a lower cost than the for-profit insurance carriers. One useful concept is to annuitize enough money to receive a monthly supplement to Social Security or a pension for the purpose of stable monthly income for basic needs. Any excess funds are available for travel, hobbies, emergencies, ets.

EGTRRA did not require LAUSD to publicise their offerings, thus, many members remain unaware T/C or Fidelity Investments were available in 2002. I wanted my union and colleagues to know.

Summary

The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) changed PreK-12 school districts’ 403b savings plan in one swoop. How fortunate for the investing public to have two great companies with identical organizational values we respect: long-term, low-costs, mutual fund/indexing strategy, looking out for the greater good, broad diversification and not-for-profit status while avoiding Wall Street. T/C became available for my 403b as a direct result of EGTRRA. No other company on the LAUSD 403b list of available companies could match their high standards of ethics.

Low-cost annuities with T/C have a place in retirement plans. I invested in T/C for my 403b during a time I wanted less volatility as I neared retirement. At retirement I rolled over my 403b into a “rollover IRA” at Vanguard. These great companies existed for the greater good and provided the small investor a fair shot at stock market gains.

Our colleagues in higher education benefited with a fine 403b retirement plan for almost a century. T/C decided PreK-12 teachers should be treated likewise.