The federal government’s Thrift Savings Plan is sometimes offered as a model retirement savings vehicle that could be adopted for private sector workers, for state and local government employees, and even for Social Security personal accounts. The TSP has a simple structure built around a small number of widely diversified investment options that carry practically no administrative costs. The TSP offers a “target date” investing approach in which the plan automatically shifts federal employees’ savings from stock to bond funds as they approach retirement. And at retirement, the TSP offers annuities that let workers convert their lump sum savings into a monthly benefit that last for life. What’s not to like?
A lot, according to Joanne Butler, a former House Ways and Means Committee staff and, prior to that, a colleague of mine at the Social Security Administration. The TSP has now been in place for 30 years, having started in 1987, and 47,000 federal employees have participated over the full three decades. “Here’s the troubling part,” Butler says. “The average account balance for those 47,000 people is $346,000.” If those federal employees “withdrew just $30,000 for their income, their nest egg of $346,000 would last them about eleven years. The retiree also would receive Social Security benefits plus a small federal annuity benefit – let’s say that bumps the retiree up to about $35,000 a year. It’s still not much.”
Sure, it’s not much if you assume that workers save for only 30 years and that they receive only $5,000 per year in federal pension and Social Security benefit. But none of those assumptions are even close to true.
The TSP was enacted in 1987 as part of federal employee pension reforms that shifted newly hired government workers from a traditional defined-benefit pension plan to a combination of the TSP savings accounts, a scaled-down traditional pension called the Federal Employees Retirement System, and Social Security.
To start, the average TSP participant with “only” $346,000 in savings has only participated in the plan for 30 years. A more realistic working lifetime in today’s America is closer to 45 years. Adding an additional 15 years of 3 percent real interest bring it to $539,000 in today’s dollars, even assuming no additional contributions. Using financial advisors’ “4 percent rule” for retirement withdrawals, the TSP by itself would pay out about $21,500 per year.
Federal employees also receive a FERS benefit equal to 1.1 percent of final salary multiplied by their years of service. The average federal employee who has worked at least 35 years has an annual salary of $99,000. So let’s call this a $38,000 pension. Federal employees also receive Social Security, which would add another $23,500 at age 65. So this full-career federal employee would retire on about $83,000 per year, equal to 84 percent of their final salary. Any financial planner would say that’s more than adequate.
When the TSP is added to other savings, the numbers add up to a very decent standard of living in retirement.
And this tells us about our options to improve retirement saving for all Americans. The key to the TSP is to get people signed up and saving and to invest those savings widely across sectors at the lowest possible cost. There’s no magic: you still have to contribute and if you try for higher returns you’re going to accept some risk.
But its attempts at investment “magic” that have caused such problems elsewhere in the retirement sector. State and local government traditional pensions attempt the impossible: to provide generous benefits at low costs while protecting retirees and contributors against risk. But it can’t be done. Worse, the complexity of these plans let stakeholders avoid tough choices regarding contribution increases or benefit reductions. As a result, multi-trillion dollar unfunded liabilities are pushed to the future, only making the problem worse.
I’m a skeptic that Americans face a “retirement crisis.” While 401(k)s aren’t popular, they’re getting the job done: more Americans are saving in 401(k)s than ever participated in traditional pensions, and the benefits the typical new retiree today receives from private retirement plans far exceeds what was paid out in the past. And over time, 401(k)s have become more “TSP-like”: more workers are automatically enrolled; investment options are simpler, with most savers using automatic target-date funds; fees are lower, thanks to low-cost index funds.
There are gaps in retirement saving adequacy. Some are tough to fill with any kind of personal savings program. For those, a stronger Social Security safety net is needed. But for ordinary working Americans who simply aren’t saving enough, we need to expand access to 401(k)s and get workers signed up.
Sen. Orrin Hatch, R-Utah, has legislation to create Multiple Employer Defined Contribution Plans, which help small businesses overcome the financial costs and regulatory hurdles that prevent many from offering a 401(k). And making automatic enrollment mandatory, as a condition of the federal tax preference given to retirement plans, would sign up the many Americans who are offered a 401(k) at work but simply fail to sign up. And for those who still aren’t offered a 401(k), allowing them to participate in the TSP, as Sen. Marco Rubio, R-Fla., has proposed, might make sense.
Retirement saving isn’t as complicated as we sometimes think. The federal TSP is a good model of how to get people saving, help them invest, and keep costs low.
Andrew G. Biggs (@biggsag) is a resident scholar at the American Enterprise Institute. In 2014, Institutional Investor Magazine named him one of the 40 most influential people in the retirement world.
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