PERSONAL FINANCE<br/ >Risk & Reward
But the game is not as kind to everyone. A 41-year-old Postal Service high roller tried the same moves and wound up a loser. After moving his entire balance several times during the year, he lost 5 percent of his $40,000 nest egg in 1998. Thrift plan officials certainly don't encourage market timing. In fact, they don't give any advice to the 2.3 million employees participating in the plan. In any case, hard-core market timers are a rare breed in the federal workforce. Most TSP participants pick an investment strategy and stick to it. The 1998 study of investment behavior that revealed the two market-timing junkies also found that only 155 of the more than 2 million investors regularly engaged in market timing, shifting their money between the G and C Funds at least eight times during the year.
But if more federal workers wanted to guess the market's moves and play with their retirement funds, nobody would stop them. After all, it's their money. That's the advantage of the TSP and other similar retirement plans-they allow investors more control over their funds. But with that responsibility comes more risk, especially given the roller-coaster stock market of recent months. Even investors who follow financial planners' advice have to assume risk in the TSP-risk that older workers under the Civil Service Retirement System, who are guaranteed pensions of as much as 80 percent of salary, do not have to take. But with risk comes the potential for greater reward.
This month, TSP investors will get the opportunity to risk even more in the hope of greater rewards. They will get two new action-packed stock investment options, a chance to stash even more money in their accounts each year and the power to change their investment choices whenever they want to. In addition, new federal employees will be able to open TSP accounts as soon as they're hired, and participants can move money from previous employers' 401k plans and some other retirement accounts into their TSP accounts. These changes come just five months before the TSP opens up to the nearly 2.5 million members of the uniformed services. And a movement is afoot, with President Bush's endorsement, to provide the 150 million Americans who pay into Social Security-including 1 million federal employees in the Federal Employees Retirement System-with the option to invest some of their Social Security taxes in some version of the Thrift Savings Plan.
"In a defined benefit plan [like the old Civil Service Retirement System], all you have to do is retire from the company and you get something-you get the defined benefit. In a defined contribution plan [like the TSP, which came into being with the newer Federal Employees Retirement System], earnings and contributions could actually exceed the defined benefit," says David Wray, president of the Profit Sharing/401k Council of America, based in Chicago. "For most people, a defined contribution plan can provide a much larger benefit. If you compound 5 percent or 10 percent of pay over 40 years at, say, 8 percent, you're going to have a very substantial retirement benefit, whereas a defined benefit is capped. In a diversified portfolio, you might get 100 percent replacement pay if you compound that over a long period."
Market Risk
The 1 million federal employees in FERS have a three-pronged retirement package: a base of Social Security, a modest government annuity and the Thrift Savings Plan. The federal government automatically contributes 1 percent of salary per year into each employee's TSP account, and then matches 100 percent of the first 3 percent of employee contributions, and 50 percent of the next 2 percent. The 700,000 employees in CSRS get a substantial government pension, but no Social Security. CSRS employees are allowed to contribute to the TSP, but they receive no contributions from the federal government.
Employees' main risk in a defined contribution plan like the TSP is that they can lose money, particularly over short periods of time. "Stock market and interest rate volatility mean that workers who follow an identical investment strategy but who retire a few years apart can receive pensions that are startlingly unequal," wrote Brooking Institution fellow Gary Burtless in a recent paper on Social Security reform for Boston College's Center for Retirement Research. "For example, workers retiring in 1969 would have received a pension equal to nearly 100 percent of their pre-retirement earnings, while workers retiring just six years later in 1975 would have received only 42 percent." Thrift Savings Plan investors saw that principle in action in 2000, when investments in the C Fund lost 9.14 percent of their value. It was only the second time in the C Fund's 12-year existence that it has ended a year with negative returns. The first one was in 1990, when the C Fund fell 3.15 percent.
The 2000 loss, followed in early 2001 by more losses, came on the heels of a five-year period in which annual gains in the C Fund's value ranged from an impressive 20.9 percent to an astounding 37.4 percent. Given that, a TSP enrollee who was heavily invested in the C Fund would have done better to retire at the end of 1999 than at the end of 2000. The last year has reminded federal workers that taking responsibility for their own retirement savings also means bearing the brunt of market losses, but Wray cautions that investors shouldn't get overly worried. "The way to make money in a [defined contribution plan] is to make time work for you," Wray says. "There has never been a 20-year period in the market where people have lost money from the first day of the period to the last. Pick an allocation plan and stick with it. Don't change it. Don't get excited." Given the market's disappointing performance in 2000 and the opening months of 2001, TSP investors probably aren't too excited about getting two more ways to invest in the stock market through the TSP: the I and S funds. The I Fund tracks international stocks while the S Fund tracks small- and mid-size stocks. The stock indexes that the S and I Funds track lost ground in 2000, dropping 16 percent and 14 percent respectively. In past years, however, the S Fund's index has posted gains as high as 43 percent and the I Fund's index has gained as much as 33 percent.
During the first few years of the TSP, employees flocked to the safety of the G Fund, which invests in government securities. The G Fund never has posted a loss, but its monthly gains always have been between 0.4 and 0.8 percent. In December 1991, 12 months after restrictions on TSP investments were lifted, 83 percent of employees' contributions went to the G Fund. That dropped to 27 percent by February 2001. In 1991, 4 percent of employees' contributions went to the F Fund, which invests in government bonds. The F Fund has remained relatively constant, accounting for 6 percent of contributions in 2001. The rising star of the TSP has been the stock market-indexed C Fund. Between 1991 and 2001, the percentage of contributions in the C Fund skyrocketed, from 13 percent to 68 percent, as employees grew more comfortable with the idea of investing in the more volatile, and more profitable, stock fund. Even after losing nearly 10 percent of its value last year, the C Fund still holds about 60 percent of the TSP's $100 billion in assets. As of December, employees had invested $60 billion in the C Fund, $34 billion in the G Fund and $4 billion in the F Fund.
Even though the C Fund is riskier than the G or F Funds, it is a much safer option than many aggressive mutual funds and individual stocks. The C Fund tracks the Standard & Poor's 500 index. The S&P 500 includes the stocks of some of the largest corporations in the country, including McDonald's, Coca-Cola and Ford. Barclays, a worldwide investment firm, manages the C Fund on behalf of the TSP board, trying to mirror the performance of the S&P 500 as closely as possible. Barclays also will be the manager of the I Fund and the S Fund. Taken as a whole, the five funds will provide broad coverage of the domestic and international stock, bond and Treasury markets, TSP board officials say.
To employers, the advantage of defined contribution plans such as 401ks (named after the section of the Internal Revenue Code that allows them) and the Thrift Savings Plan is that they relieve employers of long-term commitments to retirees. In defined benefit plans such as Social Security or CSRS, employers or the government collect a percentage of employees' income, manage the funds and eventually deliver employees' retirement benefits. In a rapidly changing business environment, employers would rather not promise to manage employees' money in order to deliver benefits 35 years in the future.
What's more, federal employees, at least, have shown themselves willing, even eager, to become their own retirement managers and to put their money into riskier investment options. A decade ago, just 60 percent of FERS employees had active Thrift Savings Plan accounts; by February, 86 percent did, according to the Federal Retirement Thrift Investment Board, which runs the TSP. Federal employees also are putting a higher percentage of their paychecks in the plan. In 1998, the most recent year for which the Thrift Board has statistics, FERS employees contributed an average of 6.9 percent of their salaries to the TSP, with nearly 40 percent contributing the 1998 maximum of 10 percent. Ten years earlier, only about 15 percent of employees contributed the maximum.
Today, the average FERS contributor has $47,378 in the thrift plan and the average CSRS contributor's account holds $29,378. Some high-end contributors have balances of $600,000 in their accounts. Soon, they'll be able to raise their contributions. The annual limit on the percentage of pay that FERS enrollees can put in the TSP will rise from 10 percent to 11 percent in May, while the limit for CSRS enrollees will rise from 5 percent to 6 percent. The limits will keep increasing each year until 2006, when the percentage limits will disappear completely. Once the percentage limits are gone, the only limit on total annual contributions will be the Internal Revenue Code, which this year caps investments at $10,500. In keeping with the general trend toward giving people increasing ability to invest for retirement, in March, several members of Congress introduced a bill to raise the IRS limit to $15,000 by 2005. Without that increase, the IRS, which adjusts the limit by $500 or less each year, would not raise the limit to $15,000 until 2010 at the earliest. The Comprehensive Retirement Security and Pension Reform Act also would increase the amount people could put in individual retirement accounts each year and make several other changes to encourage retirement savings.
Until this month, employees could only make changes to the way their thrift plan contributions were allocated among funds twice a year, during the summer and winter open seasons. Now, employees can change the way future contributions will be invested whenever they want to. Changes will be posted to employees' accounts within two business days. TSP officials say the new process is meant to give employees more control, not to encourage market timing. Interestingly, when private sector 401k plans started allowing investors to make changes any time they wanted, rather than just quarterly, investors actually made fewer changes to their accounts. "When people have a deadline, the deadline seems to force them or encourage them to take action," the 401k Council's Wray says. "When they can do it whenever they want, they say 'I can always change it later.'"
The ability to shift future TSP allocations around at any time makes the TSP more like most 401k plans. But most 401k investors can see how the market affects their accounts on a daily basis. TSP accounts only are updated at the end of each month. Four years ago, the thrift board planned to adjust accounts daily, as 401k plans do. The move to daily valuations was to be part of a $29.5 million computer modernization. The board hired American Management Systems, of Fairfax, Va., to conduct the modernization, giving the contractor until May 2000 to create the new computer system. The new system also was supposed to allow the board to issue participant statements quarterly, rather than twice a year; to speed loans, withdrawals and interfund transfers; and to allow participants to complete more transactions on the Web.
The modernization turned out to be more complicated than AMS officials anticipated. A year after the original modernization deadline, the contractor still is struggling with a host of glitches. The TSP board doesn't expect the system to be ready to run until 2002, two years behind schedule, and AMS' cost estimate for the system has nearly tripled to between $81.5 million and $87 million. So investors will have to wait for some of the features that will make the plan more comparable to 401k plans.
Growth Prospects
With 2.3 million participants, the Thrift Savings Plan already is by far the largest defined contribution plan in the country. Last year, Congress took a step that could double its size, opening the plan to the 2.5 million members of the country's seven uniformed services. Uniformed personnel will begin participating in January 2002, following an open season this fall during which they can establish accounts. TSP officials say the expansion won't increase expenses for civilian employees already participating in the plan.
While the military's entry into the TSP may double the plan's size, an even bigger increase is on the horizon: the possible addition of Social Security recipients. Just as the TSP is the largest defined contribution plan in the country, Social Security is the largest defined benefit plan, covering 150 million people. Observers have predicted that sometime in the next 40 years, the government no longer will be able to meet its Social Security commitment. Numerous reform proposals purport to address this problem. One of them would turn a portion of the Social Security system into a defined contribution plan modeled on the Thrift Savings Plan.
Some people even have suggested that the thrift board could run the defined contribution portion of Social Security. Under the proposal, American workers and their employers would continue to pay about 10.6 percent of salaries toward Social Security retirement benefits, but 2 percent to 5 percent of that would be placed in individual accounts. Workers would be able to choose to do nothing with those accounts, letting that money be invested in government securities-much like the TSP's G Fund. Or, they could choose to invest the money, probably in a limited number of funds such as the TSP's C, F, I and S Funds. The remaining 5.6 percent to 8.6 percent of Social Security funds would go to a reduced defined benefit.
David John, a senior policy analyst with the Heritage Foundation, supports the TSP proposal. "The TSP system is there and it works," he says. "It is a fairly simple thing. And it is a reassuring thing to tell the American public that their money would be managed in the same way as federal employees' money is. That's a strong selling point." But Laurel Beedon, a senior policy adviser with the AARP Public Policy Institute, says the proposal shifts too much responsibility and risk to employees. In a commonly used metaphor, Social Security is one leg on a three-legged stool for retirement, with the other legs being employer-provided pensions and personal savings, including 401k and TSP accounts. Eroding some of Social Security's leg makes people too reliant on their personal savings, Beedon says. "You would be taking away part of that stable base. Even the feds keep Social Security as a base," she says, referring to FERS. "The beauty of the TSPis it's the whipped cream on top of the sundae."
President Bush has endorsed the basic concepts of the TSP proposal, saying in his first address to Congress that Social Security "must offer personal savings accounts to younger workers who want them."
Rep. Constance Morella, R-Md., is wary of the Social Security reform proposal. Morella is concerned about the additional administrative expenses of such a plan. Federal agencies currently bear many of the TSP's administrative costs, including education and initial enrollment. It's not clear who would pick up these costs should the plan be opened to Social Security recipients. While she's pessimistic about shifting the risk and responsibility for Social Security from the government to workers, Morella sees a positive message in the use of the Thrift Savings Plan as a model for reform. "I hope it lets federal employees know they have a very good, sound system," she says.
