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How Good is TSP--the Federal Employees Retirement Plan?

The Huffington Post The Huffington Post 3/03/2016 James W. Russell

In a recent article, Helaine Olen found something good in Marco Rubio's campaign: his advocacy that employees without workplace retirement plans be allowed to join the federal employees Thrift Savings Plan.
A former financial advice columnist, Olen in her wonderful book Pound Foolish revealingly exposed the hucksters of the financial self-help industry. They make their money, and lots of it, not from following their own financial advice but rather by telling others what to do. When the wary Olen is impressed by a financial plan, such as TSP, it says something.
What impressed her most was that TSP charged very low administrative fees of only .029 percent of account balances, much lower than other 401(k)-type plans like it which charge as much as 2% or 69 times more and thus take much more out of savings accumulations and future retirement income. It was, in her estimation, a model plan that should be accessible to more than federal employees.
The Rubio campaign, for its part, seems to have backed off on the proposal, probably because of opposition from the financial services industry's Investment Company Institute and the Republican-affiliated Heritage Foundation.
But is TSP that good?
The federal government established it in 1986 to replace part of the traditional pension benefit that its employees had. The idea was to move from a wholly traditional defined benefit system-- the Civil Service Retirement System--to a tripartite mixed system in which retirement income would come from Social Security--federal employees previously did not participate in it--a reduced traditional defined benefit pension, and a new defined contribution savings and investment plan, the TSP. The new Federal Employees' Retirement System created the three legged stool that retirement planners then advocated: Social Security, a workplace pension, and savings.
Over the nearly 30 years since it was established, TSP has proven to offer a widely varying income supplement to the FERS defined benefit and Social Security components. The variance depends upon the differing fates of participant investment strategies and how much employees choose to invest. One percent of salary is automatically invested with a 1% employer match. The maximum is 10% with a 5% employer match. (It's unclear in the Rubio proposal whether the employer match would be available for nonfederal employee participants.)
It is important to keep in mind that in nearly all cases TSP has provided the smallest source of federal employee retirement income. It is a supplement of varying size to the secure Social Security and pension sources, not a standalone retirement plan.
As a solution to the growing retirement crisis, opening TSP up to private sector employees without plans, Rubio's original proposal, would be better than nothing. It would not though provide, even in combination with Social Security income, enough retirement income. Without the pension component, private sector TSP members would face the same retirement income problems of other 401(k)-type participants, who on average receive not more than $5,000 annually from these accounts.
This is the fallacy of believing that just getting all employees into retirement savings and investment plans, even those now being created by close to half the states to address the retirement crisis, will alone be sufficient.
If all employees had something like FERS, not just its TSP component, that would significantly solve the retirement crisis. But private employers who switched to 401(k)-type plans are unlikely to bring back the defined benefit pension component; nor are employers who never had a retirement benefit in the first place likely to create new defined benefit pension plans.
The only logical solution to fill the retirement income vacuum created by private sector employers increasingly substituting since the 1980s 401(k)-type savings and investment plans for secure pensions is to increase Social Security contributions and benefits. It would be better to route extra savings through Social Security than through savings and investment plans such as TSP to produce more retirement income. A compromise position could be for every employee being in an expanded Social Security system along with something like TSP.
TSP, whether for federal employees alone or as a model for 401(k)-type plans in general, has room for significant improvement.
There is no question its fee charge of .029 is admirably very low. But concentrating exclusively on its low fees alone misses a large part of the retirement plan picture.
The whole point of a retirement plan is to have retirement income. Building up savings is only the first step in generating that income. The savings then have to be transferred into a financial vehicle that delivers retirement income.
That's where the annuity phase of retirement plan income comes in. To be good for employees, a retirement plan has to have a favorable annuity available as well as low fees.
TSP purchases annuities for its retirees from Metropolitan Life, a private insurance company. According to the latest figures, if participants opt to have fixed income for the rest of their lives, they will receive 6.5% of their balance. A participant with, say, $100,000 would receive $6,500 per year.
TSP's 6.5% payout rate compares very favorably with the private insurance annuity industry average of 4.8% but not favorably with nonprofit annuities issued directly by defined benefit pension plans, which are in the 8-9% range.
TSP could thus considerably improve the income of its retired federal employees by directly issuing nonprofit annuities out of its own revenues or indirectly through the creation of a subsidiary nonprofit insurance company--a captive insurance company in industry parlance.
In answer to the original question of how good is TSP, the answer is a qualified pretty good as a supplementary retirement plan--but with room for significant improvement of its annuities; and not at all good as a standalone retirement program or even in combination with Social Security at its present level of benefits.

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