Nest Egg

en years ago, hard on the heels of the stock market crash of 1987, the government offered federal and postal employees a new option: They could take their retirement savings out of boring government securities and put them in stocks and bonds.

The initial response was underwhelming. Partly due to skittishness and partly due to restrictions on how much could be put in the thrift savings plan's common stock (C) and fixed-income bond (F) funds after their startup in January 1988, the two new funds began as poor cousins to the government securities (G) fund. In early 1991, when the restrictions were lifted, the G fund's $193 million in assets was 15 times the amount of the other two funds combined.

But since then, participants have steadily shifted both newly invested and previously invested money into the C fund. Helped by several years of roaring stock markets, the C fund became the largest of the three funds in June 1997. As of September, there was $27.9 billion in the C fund, $24.7 billion in the G fund and $2.8 billion in the F fund.

The TSP as a whole now has a record $55.5 billion and is growing by $1 billion a month. Participation rates also are at an all-time high. About 84 percent of employees under the Federal Employees Retirement System invest some of their own money in the plan (the rest have accounts holding only an automatic government contribution equal to 1 percent of their salary), while 56 percent of employees under the Civil Service Retirement System are investing. Four-fifths of investors now have some money in either the C or F funds.

In a world of bewildering investment options, the TSP stands out for its simplicity in fund choices and attractive features-low overhead costs, tax deferral of investments and earnings, and employer contributions of up to 5 percent of salary for those under FERS.

"I think it is relatively straightforward, and I have to say I think that is one of the reasons our participation rate is as high as it is," says Roger W. Mehle, executive director of the Federal Retirement Thrift Investment Board, which operates the TSP. "And I think that seeing the investments in the C and F funds continue to grow should indicate a growing comfort on the part of federal employees with the plan. I think for many federal employees it is the only avenue."

Market Timers

Even though the TSP has been operating for more than a decade, the board still is working to educate employees about the program. For example, agency TSP coordinators were told at a recent meeting that some CSRS employees still believe they cannot participate, even though they can. (Unlike FERS employees, however, they get no contribution from their agencies.)

Meanwhile, many employees think of the TSP as a mutual fund, which it is not. A better analogy is to private sector 401(k) programs, which also invest employees' money for retirement.

Starting in about two years, when a new computer system is installed, the TSP will become more like the best 401(k) plans. The new system will allow the creation of two more investment funds, tracking indexes of international stocks and small capitalization U.S. companies, and will allow investors to mix and match their withdrawal options when they retire.

The new system also will bring the TSP up to standards in the 401(k) and mutual fund industries by providing daily valuations of accounts. Under the current system, TSP accounts are calculated, and transactions are processed, monthly. Investors are limited to one interfund transfer per month.

Daily valuation will allow what some TSP investors long have been seeking-the ability to check their balances and transfer money as often as each working day.

Some financial experts don't think that's a good idea. "I suppose it will let people make changes and have the change occur instantaneously and that's valuable, but if it encourages people to be shifting around more frequently, that will probably lower their rate of return in the long run," says Mark Waldman, a Falls Church, Va., certified financial planner who advises employees about their TSP investments. "I think that's going to lead some employees either to try to game things, which they're not going to do well at, or to act on their immediate emotions, which are usually not a good guide to making investment decisions."

TSP investors haven't shown much talent for market timing. For example, after the C fund dropped more than 4 percent in March 1997, investors broke the long-term pattern of gradually moving money into stocks by shifting $113 million out of the C fund in April. By doing so, many of them missed the C fund gains of nearly 27 percent in the next four months.

The only extended period of shifting out of the C fund since the original investment restrictions were lifted ran from May 1994 through February 1995, when the stock market was flat. TSP participants who shifted a total of $175 million out of the C fund during that period missed the start of a three-year stock rally.

"This is a long-haul investment, it is not a trader's investment," says Mehle. "Look at the monthly returns of the C fund and you'll note the extreme variability of the returns-up, down, up, down. So you would be whipsawed if you tried to outguess the C fund, invariably taking your money out when it was at its low and putting your money back in when it's high."

Nonetheless, there is demand for more active trading in the plan. TSP investment clubs, some formal, some less so, are operating in many agencies. Mehle recalls receiving a letter from a group of employees who asked to make daily transactions, saying they had developed theories they wanted to apply.

"I'll bet you they number among the people in April who took their money out and missed the upswing thereafter," he says. "You have a handful of people like that. I'm concerned about those people, but after all, it's a free country."

Day of Awakening

While many employees are doing well under the TSP, others may be left behind. A recent General Accounting Office report said that FERS employees who receive only the automatic 1 percent government share could retire with TSP accounts only a tenth the size of those who invest 5 percent of their own salary and force the government to kick in its maximum 5 percent.

The average current account balance for FERS employees who invest some of their own money is about $30,000, but the average balance for those who get only the automatic government amount is only about $3,300. (The average CSRS account is about $18,500.) At the last look at individual account sizes nearly a year ago, several investors had accounts near $300,000.

Some retirement experts on Capitol Hill and in employee organizations believe a day of awakening may be ahead when employees who haven't been saving through the TSP-or haven't been saving enough-are going to realize that their retirement benefits won't be equal to what employees under CSRS will receive.

When the TSP was designed in the mid-1980s as part of the legislation creating FERS, legislators focused on making FERS comparable to CSRS in terms of replacing a percentage of the annuitant's final salary. Unlike CSRS employees, those under FERS are eligible for Social Security benefits, ranging from 56 percent of pre-retirement earnings of low-income employees to 28 percent for high-income employees. But at the same time, the civil service annuity portion of FERS is considerably less generous than that under CSRS.

In general, that means to make FERS benefits comparable to those under CSRS, FERS employees must invest 5 percent of salary, forcing the maximum government match. "You have the Social Security tilt [in FERS], that's true," says Sandra Sue Adams-Choate, assistant general counsel for legislation of the American Federation of Government Employees and vice-chair of the Employee Thrift Advisory Council, an organization of employee and retiree groups that monitors the plan. "Well, it doesn't make up for the difference. It just doesn't."

Adams-Choate concedes that the stock market has done better in recent years than financial experts may have anticipated when FERS was designed. "I suppose with hindsight you could say given the sort of performance of the plan of the last eight years or whatever you don't need to max out, you could do a little less," she says. But in the future, "it could be the other way too," she notes.

Employees at higher salary levels seem to be getting the message. Among FERS investors, nine-tenths of those earning above $60,000 save 5 percent of salary, compared with 72 percent of those earning $30,000 to $35,000. Nearly half of those at the higher level save the FERS maximum of 10 percent, versus less than 30 percent of those in the lower range.

Mehle says the FERS employees most at risk are those in the middle grades. "Those are the ones who must save," he says, "because if they don't save, their replacement rates will not be equivalent to CSRS. The low-paid people will be [because they will get a higher percentage of Social Security benefits]. We are concerned about the middle people."

The Federal Retirement Thrift Investment Board, though, does not advise employees on how to invest; it only tells them what the options are. That approach sometimes frustrates individuals who are looking for more guidance, but there is little pressure from Congress or elsewhere for it to change.

"From our perspective, it's the employee's money and the employer has no right to interfere," says George Nesterczuk, staff director of the House Civil Service Subcommittee. "With that comes the responsibility of the employee to choose wisely."

However, Nesterczuk says the board might be remiss in not at least mentioning that employees might want to get professional advice. "The board doesn't talk about it, but I don't see why not," he says. "It's a significant amount of money and they [employees] should get some advice."

The board's information policy became an issue last summer when Standard & Poor's, in an open letter to Congress, said that although private-sector savings programs are encouraged to provide investment information to enrollees, "federal employees may not be afforded these same protections." S&P added that it was available to "aid federal agencies in helping their employees maximize the value of the Thrift Savings Plan for their retirement."

In a response that also was sent to Congress, the board replied that employees are guaranteed access to information on the program but that the board "does not and will not furnish investment advice or opinions, but only investment information and education." The board had previously rejected a bid by S&P to provide information that the board considered duplicative of its own publications.

Is Bigger Better?

Apart from such tangles, the board keeps a low political profile, commenting on legislative proposals when asked and seeking technical fixes to the TSP when needed. The most significant legislative initiative of recent years was its request to create the two new funds.

Bigger things may be ahead for the TSP, though, even if the board doesn't take the lead. This fall, Congress passed a provision sponsored by Sen. Ted Stevens, R-Alaska, to create another open season for CSRS employees to switch to FERS. But President Clinton line-item-vetoed the measure, calling it "a hastily conceived, undebated provision" that would cost agencies $850 million in additional retirement costs over five years.

On the House side, Civil Service Subcommittee Chairman John Mica, R-Fla., has toyed with the idea of creating a new retirement system for newly hired employees that would stress the TSP and investment of government contributions in private markets. "A more flexible and more portable retirement system is the future," Nesterczuk says. "The TSP is the model. It's working well. We don't have to look for new models, we can just build on the TSP."

Both the idea of a new open season and a new retirement system are on the shelf for now, but they are likely to reappear.

The overall trend toward greater individual control of retirement benefits might bring a demand for more variety of choices in the TSP, Nesterczuk says. "Over time, as people rely on it more and more and Social Security's future looks tenuous, people will look at the TSP as a more dominant feature of their income security. Younger employees especially might be looking for greater investment options, including the option to invest in individual stocks," he says.

The board, even with its new computer system, would not be able to handle that. Accommodating such a range of options likely would mean contracting with brokerages.

Mehle, for one, is not eager for such a future. "Heaven knows what would happen in a system like that, to have brokerages calling on federal employees, attempting to have every employee get a brokerage account, with a huge number of securities choices possible, all loaded with commissions," he says. Mehle believes that once the two new funds are available, the TSP will be offering diversity comparable to that available in private-sector 401(k) programs.

"I'm a believer, frankly, in a rather more limited number of choices," he says. "Mutual funds are fond of making every single investment that you can imagine available to people. To get a broad diversification in the marketplace you don't need 25 choices. More is not necessarily better."

Even if the investment options in the TSP don't expand, the number of people allowed to invest through the program might. The new computer system will be designed to handle a large influx of new enrollees if necessary.

The military services have been working on options for allowing TSP participation by uniformed personnel, either across the board or only for those covered by the less generous military retirement system for those who entered service since 1986. The Pentagon reaction so far has been cool, but not because of any perceived shortcomings of the TSP or a belief that military personnel would not fit in well.

Instead, Defense Department officials worry that the military retirement system would be vulnerable to cuts on Capitol Hill if it were opened to review. They have ruled out proposing TSP participation for the military for now.

Another group looking longingly at the program is federal retirees, many of whom retired before the TSP came into existence or who had only a few years to build up savings in it. While annuitants can continue to manage accounts that they take with them into retirement, they cannot open new accounts or add money to existing accounts.

"Many, many of them still write us to ask to participate," says Al Golato, vice president of the National Association of Retired Federal Employees. "They're getting an annuity, not a pension. An annuity is in effect deferred compensation for services rendered. If you use that concept, then why not [let them participate]?"

Similar requests come from former federal employees who receive benefits for becoming disabled on the job. They, like retirees, cannot open new accounts nor make new investments. However, since retirees and disability beneficiaries are not on agency payrolls, such changes would require revising the TSP's basic design as a payroll savings plan. And there's a political argument similar to the one being raised regarding military participation: It could appear that anyone who can afford to make such investments must be receiving a generous benefit.

Regardless of what happens, it's clear that the TSP is on a roll. "We've even had suggestions that the public be able to contribute to the TSP," says Mehle. "Everybody wants to ride a winner."

Eric Yoder is a Washington journalist.