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The Basics
A government retirement plan that gets it right
The federal Thrift Savings Program is held up as a model for Social Security reform, and with good reason -- it's got most private 401(k) plans beat. See what makes it tick.
By Timothy Middleton
Have you ever heard of a government program that works better and more economically than the private sector?
Now you have: The federal Thrift Savings Program is possibly the finest 401(k)-style plan in the nation. More to the point, the 3.4 million federal employees who participate have proved themselves to be competent and conservative long-term investors.
Not that those workers aren't skeptical of the plan themselves. "Maybe you would like to comment on the advantages or more likely disadvantages of government employees putting their savings into the TSP," a federal employee wrote to me in a recent e-mail.
Beating the pants off Social Security
The e-mailer isn't the only one who wants to know. President Bush has injected the plan into the national debate over private Social Security accounts, citing it as an example of what he'd like to make available to all Americans. Critics, including organized labor and the AARP, have gone on jihad against privatization. Some have worried that workers would piddle away their savings on risky investments.
The actual experience of the TSP indicates otherwise. Rather than going broke, TSP participants are beating the pants off of Social Security's investment performance with no more risk than displayed by private pensions in general.
For now, the rest of us can only admire the TSP's intelligent design and thrifty management. Simply copying it would virtually guarantee a richer retirement purse for Social Security beneficiaries.
Indeed, if you want to disparage the plan and its participants, then accuse them of being too cautious for their own good. They put too much into low-return fixed-income portfolios and not enough in equities. But that is true of retirement investors in general.
Breaking down the plan
The Thrift Savings Program was launched in 1987. It's operated by the Federal Retirement Thrift Investment Board, a group of Wall Street and pension-industry veterans appointed by the president and confirmed by the Senate.
It offers five investment portfolios:
G Fund: This is, in effect, an intermediate-term government bond fund. It invests in specially issued Treasury securities. "The G Fund rate formula is the same as that used to calculate the interest rate for investments of the Social Security Trust Fund," notes Tom Trabucco, the thrift plan's spokesman. The fund is managed by the plan itself.
F Fund: This is an intermediate-term high-quality bond fund that tracks the Lehman Aggregate Bond Index. Like all of the portfolios except G Fund, it is an index fund that is managed by Barclays Global Investors, the world's largest indexing firm.
C Fund: This fund is indexed to the Standard & Poor's 500-stock index ($INX) of large-capitalization stocks.
S Fund: This portfolio is indexed to the Wilshire 4500 Index of small and mid-cap companies.
I Fund: This fund is indexed to Morgan Stanley's Europe, Australasia, Far East, or EAFE, Index of large-company foreign stocks.
All of these funds outperform other index funds because their expenses are almost unbelievably low -- 6 basis points, or 0.06%, on all the funds (except F Fund, which has an expense ratio of 5 basis points). Private index-fund investors pay at least three times as much in expenses, and many pay 10 times more.
Barclays was selected through competitive bidding. The thrift plan itself employs fewer than 100 people.
| TSP performance, in percent | | G fund | F fund | C fund | S fund | I fund | | 2004 | 4.3 | 4.3 | 10.8 | 18.0 | 20.0 | | 10-year annualized | 5.8 | 7.7 | 12.0 | 11.8 | 5.5 |
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Source: TSP
Here's how federal employees actually invest in the plan.
| TSP assets | | Portfolio | Net assets | Percent of total | | G Fund | $58.845 billion | 38 | | F Fund | $10.111 billion | 7 | | C Fund | $65.697 billion | 43 | | S Fund | $10.032 billion | 7 | | I Fund | $7.324 billion | 5 |
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Note: As of 12/31/2004
Source: TSP
Last year, the Social Security Trust Fund delivered an investment return of 4.3%, the same return as the G Fund. A TSP participant who invested in the same proportion as the plan's total assets would have earned a return of 8.8%.
Too conservative now, but help is on the way
More equity exposure would have produced even better returns, but TSP participants are neither more nor less conservative than retirement savers in general. They put a plurality of plan assets into the S&P 500, and few investment advisers would quarrel with that allocation.
The only thing they would quarrel with is the heavy allocation to G Fund, which over time will be the plan's lowest-return option. U.S. government bonds are the least-risky type in the world, and yield correspondingly little.
This summer, TSP will unveil a series of life-cycle funds with maturities every 10 years beginning in 2010. Each will be a mixture of the existing funds, with the longer-term portfolios tilted more toward equities and the shorter-term funds toward fixed income. Over their lifetimes, therefore, they should substantially outperform the current blend.
A generous match, supplied by taxpayers
The employer match -- paid with our tax dollars, of course -- is extremely liberal: dollar for dollar on the first 3% of income contributed and 50 cents on the 4th and 5th percent. In addition, every federal employee hired after 1983 gets a 1% contribution, whether they contribute or not.
This is the match for civilian federal employees. Members of the armed forces do not receive it. They could, if the service secretaries were willing to pay for it from their budgets, but they are not. Our current enthusiasm for America's soldiers wanes when their hair turns gray.
The e-mail writer complained that he couldn't track the value of his account because the funds are non-public. But he's mistaken. The savings plan operates a Web site where the net asset values of the funds are published every trading day.
Spicing up the plan with a dash of real estate
The biggest design problem with the TSP is that it doesn't offer such useful diversifiers as real-estate investment trusts, natural-resources equities, emerging-markets stocks and foreign-government bonds.
It's obvious why it does not: These are more-volatile investment categories. The average real estate mutual fund plunged 7.5% in January, for example. They are also relatively small marketplaces and thus more expensive to index.
So, if I were a federal employee, I would supplement the TSP with a private account limited to these more esoteric investments. In the aggregate, they would make up perhaps 15% of my total retirement assets.
But even without these options, the TSP is a prudent and well-managed retirement program. And if it or something identical were offered as part of Social Security, Social Security would be greatly strengthened as well as greatly changed. It would be transformed from a semi-welfare program to a genuine individual-retirement account, which is what most people think they are buying when they pay Social Security taxes.
In coming weeks I'll be examining a number of private-sector 401(k) plans. (And feel free to drop me an e-mail at timothy@middleton.net if you'd like me to look at your company's plan.) Some of them will probably offer fuller investment options, but none of them will be this cheap.
Uncle Sam isn't perfect. This time, however, he got it right.
At the time of publication, Timothy Middleton didn't own any securities mentioned in this article.
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