Costs and Benefits of the Federal Employee Thrift Savings Plan

With so many of our clients living and working in the DC metro area, it is no surprise that we have significant experience dealing with the Thrift Savings Plan (TSP). For those who are unfamiliar, the TSP is a retirement savings vehicle (comparable to a 401k) for federal government employees. The TSP has both strengths and weaknesses, which inform our strategy in advising clients on how to manage TSP assets, as we discuss below. The number of participants in the TSP (over 4.5 million) far outstrips the number of employees of even the largest U.S. companies, meaning that the plan can benefit from economies of scale but also must structure its system to accommodate a huge number of transactions and requests. While no employer retirement plan is as large as the TSP, many plans, especially from other large employers, share some of the same characteristics, so several of the considerations here apply to non-TSP plans as well.

Strengths:

• Low Cost Funds. Annual administrative expenses for TSP funds average less than 0.04% of the amount invested. By comparison, the fees for passively-managed investment funds or index funds generally range between 0.05% and 0.25% per year, depending on the asset class, and the fees for actively-managed funds often exceed 1%.
• High Diversification and Passive Management. All of the three equity funds in the TSP–the C fund, S fund, and I fund–aim to match the performance of a broad index, meaning that they are very well-diversified within their particular asset class and that the fund managers are not trying to beat the market by picking the winning stocks and avoiding the losing stocks for any given time period. The C fund seeks to match the performance of the S&P 500 (which consists of 500 U.S. large company stocks). The S fund seeks to match the Dow Jones U.S. Completion Total Stock Market Index (approximately 3,300 U.S. small and mid-sized company stocks). The I fund seeks to match the MSCI EAFE (Europe, Australasia, Far East) Index (approximately 900 international large company stocks from 21 different countries, excluding the U.S.). 
• Unbeatable Bond Fund. The TSP offers two bond funds–the G fund and the F fund. While the F fund aims to match an index just like the equity funds mentioned above, the G fund is truly unique. It consists of a nonmarketable U.S. Treasury security, which is guaranteed by the U.S. government. This means that the G fund never loses money–its investors receive modest interest payments without any risk of the principal going down, which is unlike any other bond fund on the market.

Weaknesses:

• Missing Asset Classes. While the TSP offers very good options for investing in U.S. large company stocks, U.S. small and mid-sized company stocks, international large company stocks, and bonds, there are several other types of asset classes that we like to use, which the TSP is missing. This includes emerging market stocks, international small company stocks, and real estate. They also do not enable investors to specifically target investments in value stocks, which, based on long-term historical averages, can augment a portfolio’s returns over time.
• Cumbersome to Manage. As might be expected with so many participants, TSP accounts can be difficult for investors to manage, relative to other retirement plans. For example, whether various forms related to the plan can be completed online depends on the particular government agency for which an investor works, and if paper forms must be completed, they are notoriously slow to be processed and are automatically rejected by the TSP in case of errors. In light of security concerns, if investors forget their PIN for logging on to the TSP website, they must request that a new PIN be sent by mail, which generally takes up to 2 weeks.
• Inflexible Withdrawal Options. One of the biggest drawbacks to the TSP, especially once an investor has retired and needs to begin drawing from retirement savings, is the limited options for taking withdrawals from TSP accounts. TSP participants have the option of taking a lump sum withdrawal, setting up monthly payments from their accounts, or converting all or part of the account to an annuity. If you opt for a lump sum withdrawal, you can either take a full or partial withdrawal, but you have the option of a partial withdrawal one-time only. If you choose monthly payments, you can request a specific dollar amount or a payment based on your life expectancy, but if you need to change the amount of the withdrawals, you can only do so during the “annual change period” in December of each year. So, what happens if you have already taken a partial withdrawal once, set up monthly payments, and then incur a significant expense or series of expenses (e.g. for an unforeseen medical issue) that necessitate withdrawing more funds from your account? Your options are limited, and you may need to withdraw the full amount from your account to access the needed funds. Furthermore, if you have both traditional and Roth TSP savings, all withdrawals are taken proportionately from the two accounts–there is no option to alter the percentage taken from each account, even if there would be an advantage in terms of tax strategy or estate planning to do so.

Like most retirement plans, there are pros and cons to the TSP, so we try to devise a strategy for each of our current or former government employee clients that takes advantage of the former and tries to minimize the latter, depending on their specific needs and the nature of their portfolio.