Answer: It compares very, very well. Indeed, in "The Coming Generational Storm" (MIT Press, $17) Professor Laurence J. Kotlikoff and I suggest that it could be the model for privatizing Social Security.
Failing that, virtually every 401(k) and 403(b) plan sponsor in the country should take a close look at the Thrift Savings Plan. Then they should ask a simple question.
Why isn't our plan more like the TSP?
Let's start with the basics. The Thrift Savings Plan is one of the elements in the retirement security of federal employees. The Thrift Savings Plan, like private sector 401(k) plans, is a defined contribution plan. Federal employees are allowed to contribute up to $11,000 of their income, tax deferred. They can select from a small menu of investment options. They also receive an employer contribution equal to 1 percent of annual pay.
The plan currently has 5 investment options: the Government Investment Fund (G), the Fixed Income Investment Fund (F), the Common Stock Investment Fund (C), the Small Capitalization Stock Fund (S), and the International Stock Fund (I). The options are based on major indexes and are managed by Barclays Global (the major force in Exchange Traded Funds). Currently, the investment options have annual expense ratios of 6 or 7 basis points.
Yes, you read that right. Fund expenses are six or seven one-hundredths of one percent.
This is about one third the cost of Vanguard Index funds. It's about one-tenth as expensive as the leading managed funds with the most assets.
Fidelity Magellan and American Funds Growth, the two largest 401(k) equity funds, according to Pensions and Investments magazine, have expense ratios of 0.62 percent and 0.70 percent, respectively. PIMCO Total Return and American Funds Bond fund, the two largest 401(k) fixed income funds, have expense ratios as low as 0.68 percent and 0.65 percent, respectively.
Most funds used in 401(k) accounts have costs about twice as high as the largest funds---about 1.2 percent. In the worst case, many 403(b) plans are burdened with annual expenses of more than 2.00 percent because they are based on insurance products. These plans are available to teachers and state employees.
In fairness to private companies, it should be recognized that the Thrift Savings Plan is gigantic, with $159 billion in assets and 3.4 million participants. It can achieve massive economies of scale compared to plans for relatively small organizations. Starting August 1st the TSP will begin to offer five new lifecycle (L) funds with maturities ranging out to 2040. These funds will be built with different allocations of the 5 index funds but will have a materially higher expense ratio, 0.6 percent.
To test the impact of fees over a working lifetime, I used an accumulation model that starts with a 25 year old worker who saves 10 percent of gross income. (Remember, this is just an exercise!) The worker enjoys a gross return of 9 percent and annual raises of 4 percent in an economy where inflation averages 3 percent. The worker also hopes to accumulate enough in savings to replace about 60 percent of earning power when retired. To do that, his nest egg will need to be 17 to 25 times his final target income.
A Federal worker whose plan has negligible plan expenses would accumulate 17 years of needed final income by age 56. A worker in a typical 1.2 percent annual cost plan would only accumulate 13.8 years. And a worker in an expensive 2 percent cost plan would accumulate only 12.7 years. Workers in high cost plans would accumulate 26 percent less than workers in the Thrift Savings Plan.
The gap gets worse, not better, for those who work longer. By age 67 the worker in the high cost plan is at a 40 percent disadvantage to the worker in the Thrift Savings Plan.
Some readers will say high expense plans will compensate by delivering superior performance. The answer to that is simple: check history.
Learn more about the TSP and its options.
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.
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