The House Budget Committee’s recent proposal to cut the interest rate paid to TSP investors by the G Fund is misguided and destructive. Not only is it a blatant attack on your interests as a TSP participant, but it is based on faulty logic, and will undermine the value and stability of the largest employer-sponsored defined contribution retirement plan in the United States.
As a fiduciary advisor responsible for the financial well-being of a large number of federal employees, annuitants and their families, I am gravely concerned about the inevitable effects of this ill-conceived proposal. In fact, this idea is so bad for participants, that I suspect it either wasn’t very carefully thought through, or is intended to serve special interests – like those of the large financial services firms that see fat profits in convincing unsuspecting participants to roll their TSP balances into IRA accounts – rather than taxpayers.
Here, in summary form, are what I consider to be the most important problems with the proposal:
It Will Make the TSP Uncompetitive
The G Fund is the only safe alternative available to TSP investors. As a captive group, participants are not free to shop around for a better rate of return. Using an open-market benchmark – like the prevailing risk-free, or money market, rate of return – is inappropriate for evaluating or adjusting the G Fund’s rate or return. The appropriate benchmark for the TSP is another defined-contribution plan from a very large, established and stable US employer that also offers a defined-benefit pension.
The 401k plans of many large, established US companies offer their participants stable-value fund alternatives, like the G Fund, that pay rates of return on guaranteed principal that exceed, not only the prevailing risk-free rate of return, but also the prevailing rate of inflation and the rate of return offered by the G Fund. The 401k plans of IBM and New York Life come to mind as reasonable plans to use for comparison. TIAA-CREF also offers participants in its plans an essentially risk-free rate of return that exceeds that of the G Fund.
It Will Increase Investment and Financial Planning Risk
Reducing the interest rate on the G Fund will reduce the overall expected rate of return and/or increase the overall risk of loss for every participant with any allocation to the G Fund. This effect will apply to each and every L Fund since they all contain an allocation to the G Fund.
Reducing the interest rate on the G Fund will force TSP participants, who are relying on this money to feed, clothe and house themselves, and their families, in retirement, to take more risk with their accounts to try to compensate for the loss of return from the G Fund. More investment risk will ultimately lead to more financial plan failures in the future, and fewer federal employees who are able to support themselves in retirement. This is counterproductive to the purpose of the TSP and will adversely affect the financial security of all participants.
It Will Discriminate Against Older Participants
Reducing the return on the G Fund will immediately reduce the financial security of every participant, but it will hurt older participants – those most vulnerable to a change – most.
Since reliance on the G Fund for safe income production tends to, and should, increase with age, reducing the interest rate on the G Fund will disproportionately affect older participants – indirectly discriminating against them.
It Will Lead to Lower Workforce Attrition Rates
Reducing the interest rate on the G Fund will force participants to delay retirement, work longer, and lead to lower workforce attrition rates. As the G Fund rate of return falls, so does the rate of return on any portfolio that includes it. Lower expected rates of return will, in turn, mean that lifetime TSP withdrawal rates must be lower. Participants who recognize this fact will have to work longer to compensate for this effect. Those that don’t will suffer the consequence of running short of retirement income prematurely.
Its Costs Will Exceed its Benefits
This proposal is estimated to produce a savings of approximately $32 Billion over 10 years – a mere drop in the federal spending bucket. It will have a significant negative impact on the lives of many millions of current, former and future federal workers, however. Everyone who has, or will have a TSP account will suffer from this proposal, if it becomes law. This is hardly the hallmark of effective and efficient legislation.