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Commentary

What Changes to the Thrift Savings Plan Mean for Investors

Some funds in the retirement plan for federal employees are shifting from a conservative glide path to a more typical one.

The Thrift Savings Plan--the defined-contribution retirement plan for federal employees--is the largest retirement plan in the United States. It has rock-bottom fees and a simple investment lineup, which is great for participants.

Yet as good as it is, the TSP has also historically had an unusually conservative glide path for its target-date funds, which could hurt participants who expect their retirement portfolio allocations to look like typical retirement plans' allocations. Recently the TSP Lifecycle funds, as its target-date funds are called, have started to shift into a much more typical glide path. Participants in the largest defined-contribution plan in the U.S. need to understand what this means for them.

The Stakes Are High
Although it is only available to federal employees and only one plan, the TSP is enormous, and the design of its glide path can have a real effect on retirement security in the U.S. There are almost 5 million participants in the plan, more than the populations of 28 states. It holds more than $550 billion in assets--more than four times the assets that the largest private-sector pension plan sponsor has in its defined-benefit and defined-contribution plans combined.

So, the decisions that the TSP (with advice from its consultants) makes for its participants matter. And it's made an odd one over the years, because in addition to size and cost, the other way the TSP stands out is that, until this year, its Lifecycle (or L) funds followed an unusually conservative glide path. That may be in part why only 20% of participants' balances were in the TSP's Lifecycle funds as of the start of this year, although that number will surely rise, as the TSP started automatically enrolling people in the Lifecycle funds as of 2015. (For comparison, Vanguard estimates that around half of participants are in a target-date fund.)

How the Old and New Glide Paths Stack Up
The old TSP glide path started at a typical 90% equity allocation for the youngest participants, but it quickly ramped down total equity to arrive at just a 20% equity allocation by retirement age. This matches the minimum of any glide path we examine in the 2019 target-date landscape report and is well below the average allocation of around 35% to equity at retirement target-date funds' average.

After a much-needed analysis of the glide path, the TSP's Lifecycle funds will start to look a lot more like other target-date funds. The analysis refreshed some demographic assumptions, most importantly that workers’ salary growths would be much higher over time, as they changed roles and moved up the federal workforce ladder. (I would add that this would also likely be true for federal employees who pursue careers in the private sector but leave their retirement savings in the TSP.) Every salary raise is great, but assuming people want to replace their final standard of living, these raises create a larger retirement liability. That, in turn, argues for a higher equity allocation in an effort to lift the portfolios’ return potential.

The new glide path will be much more aggressive. For the cohort of federal employees expected to retire in 2060, the TSP will now start at a 99% equity allocation. Moreover, the glide paths will end at a 30% equity allocation rather than 20%, and somewhat increase their allocation to international stocks. To avoid huge shocks, there will be an immediate bump up in equity allocations, and then a half-decade transition period to gradually switch the Lifecycle funds to the new, more-aggressive glide path.  

Both old and revised glide paths continue to rely heavily on the government's G Fund for their bond allocations, a special security that the Treasury makes available to the TSP. This security pays a prevailing interest rate on government debt to TSP participants, without any interest-rate risk--sort of like a super-charged stable value fund.

How Should Pensions Affect Glide Paths?
One way to rationalize the previous glide path was that government workers covered by the TSP all have access to a government pension plan if they work for the federal government for five years. Social Security and pension payments could easily cover 70% income replacement for most federal employees who stay in federal service their whole career. (We are only focused on federal employees hired after 1986 who are eligible for Social Security and the pension plan.) Therefore, to achieve 100% income replacement, these employees could take less risk, although their base of guaranteed income would allow them to take more.

On the other hand, there’s a compelling argument that such high-income replacement rates from a pension and Social Security mean that TSP participants should be more aggressively invested: Because pensions provide monthly, predictable payments, in many respects they play the role of bonds in investors’ portfolios. In turn, federal employees should be able to take more risk and invest more heavily in equities than workers without pensions.

The change to TSP makes it look a lot more like other target-date funds, and for most of its participants, that’s probably a good thing. Millions of people may want to rethink whether they want to enroll in the TSP's Lifecycle fund. For those that were already there, they might want to think through whether they are comfortable with the more-aggressive glide path.