Wednesday, February 08, 2017

That TIAA Loan Lawsuit & My Opinion

TIAA is being sued for a loan scheme that benefits TIAA, not participants and my opinion is that TIAA is in the wrong. This doesn't mean they broke the law, but they lose the moral and ethical credibility they had accumulated by using a technique that the rest of the 403(b) industry uses, but most 401(k) plans did away with long ago.

Here is a link to the lawsuit.

According to Plansponsor:

"A new lawsuit argues the practices used by the Teachers Investment and Annuity Association (TIAA) to credit portions of interest payments made by participants on loans taken from their own retirement accounts back to the firm—rather than to the borrowing participant—violate the Employee Retirement Income Security Act (ERISA)."

I have first hand experience with this particular loan scheme. A client of mine was also taken advantage of by it several years back, though I did not learn of it until recently.

The Basics 

In most 401(k) plans when a loan is taken, the money for the loan comes directly from the balance of the participant who is taking the loan. In effect, they are borrowing the money from themselves. They pay interest, but that interest is paid back to their 401(k) account (it's this interest that is double taxed when withdrawn, not the entire loan payment, as is commonly misreported), so they are paying interest to themselves. The interest rate doesn't really matter because it's all going back to the participant anyway.

TIAA's loan process works differently (or at least it did, they've made changes to some, but apparently not all plans). When a participant took a loan from my client's 403(b) program they were not taking a loan from themselves, instead they were taking a loan from TIAA (technically TIAA's General Account). TIAA would secure this loan by liquidating assets in the 403(b) and placing them into an escrow account that is invested in an interest bearing annuity (the TIAA Traditional normally). The amount of the escrow would be 110% of the loan amount and as the loan is paid back, the money in the escrow account is released back to the participant's account to be invested (though my experience is the money is deposited to the CREF Money Market account where it earned very little interest). While the mechanics might look the same, there is a subtle difference.

TIAA Gets A Cut Of Your Loan Repayments 

The TIAA loan process is designed so that they earn a portion of the interest that you pay. TIAA loans you the money and might charge a rate of say 4.50% (the lawsuits cites several different rates from 4.17 - 4.42%) while placing your own money in an interest bearing account that might be paying 3%. The participant's net interest rate is then the difference between what is being paid in interest (3%) and what is being charged (4.50% for example) or 1.50%. In the lawsuit, TIAA was getting a spread above 1% for risk-free loans (remember, the participant over-collateralized the loan, so there is no possibility of default). In a normal 401(k) loan you might pay a higher interest rate, but at least you are paying that interest back to yourself, the net spread is 0%, but with TIAA it might 1% or more. This is in my opinion no different than stealing.

I was unaware that TIAA was doing this until TIAA failed to win a bid for a client of mine and had to transition the assets to a new provider, TIAA refused to move the loans due to the collateralized loan issue.

TIAA will likely fight this and claim it's a standard industry practice, this is no defense in my opinion and schemes like this should be illegal. There is no reason a recordkeeper should be earning money on plan loans other than the cost to actually process and monitor the loan (normally participants pay a loan origination fee).

I've looked up to TIAA over the years as one of the good companies in the industry and I still support the company in many ways. But this is one issue (there are more that I won't get into, but...Nuveen acquisition) where I stand against TIAA and call for them to do the right thing.

If you have TIAA as a recordkeeper you need to inquire as to how they handle loans and begin the process to change to the normal 401(k) style loans immediately.

Scott Dauenhauer, CFP, MPAS, AIF

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