V I E W P O I N T

Thrift Savings Plan (TSP) Private Accounts:
What's good enough for Congress is not what American workers will be receiving.

Americans responding to the President's initiative on Social Security have made one point abundantly clear: a large majority do not want to trade the guaranteed, inflation-adjusted lifetime benefits they have earned through Social Security for risky private investment accounts. This is not surprising at a time when 401(k) accounts and IRAs are still recovering from the bursting of the technology bubble, and when traditional pension plans are increasingly failing.

Many private account plans, including the options endorsed by the President, attempt to address this opposition by designing private account plans that minimize investment risk, even though such accounts typically provide lower rates of return and less control over investment decisions to workers. Most of these plans envision a system of accounts that mirror the Thrift Savings Plan (TSP) available to federal employees. The rationale often used by these proponents is that American workers should have the same opportunity to save for retirement available to Members of Congress.

Despite the rhetoric, the accounts modeled after the TSP (Thrift Savings Plan) under consideration for Social Security differ from the pensions available to Members of Congress and other federal employees in one fundamental way that will seriously shortchange American workers: the Thrift Savings Plan does not replace Social Security for federal workers; it is a supplement to a full Social Security benefit , in addition to a traditional defined benefit plan. The result, a reasonable balance of Social Security, employer-sponsored pension, and individual savings, mirrors the traditional “three-legged stool” that makes up the ideal retirement funding mix.

Most Americans are not aware of this important distinction. Federal workers are not required to give up a single penny of their Social Security benefit as a trade-off to money in their TSP account when they retire. This allows Members of Congress and other federal employees to receive both a full Social Security benefit as well as the full amounts accumulated in their Thrift Savings accounts when they retire. Most privatization plans do not operate in this way . Non-federal workers who opt into TSP-like private accounts will be required to “offset” their contributions into the private accounts by accepting dramatically lower Social Security benefits. Instead of fully participating in both retirement plans, average Americans will only receive half a loaf – they will be allowed to take on the risks of a private account without the same backstop of full Social Security that protects the federal workforce.

A second major difference relates to contributions. Employees participating in the TSP may contribute up to 10% of their salaries (up to the statutory limits). Each employing agency contributes to an employee's account a mandatory 1% of salary, regardless of the employee's own contribution. Each agency also matches the employee's contribution up to 5% of salary (100% match for the first 3% contribution, plus 50% match for the next 2%). No private account plans contemplate mandatory employer contributions to the accounts.

The TSP is not risk- free 

The use of the TSP model as a way of reducing the inevitable risk of private investments has significant limitations. TSP-type account plans represent a collection of index funds in which workers can invest. While investing in index funds can be less risky than investing in the stock of a single company, there is nothing magical that shields the investor from risk. Below is a chart showing the ups and downs of the TSP's funds over the past decade.

When the market goes down, by definition so do index funds. Federal workers who began planning retirement a decade ago, intending to retire when their account balances reached a certain level, have yet to reach their target.

While fluctuations in index funds can play havoc with a federal worker's retirement plans, the impact is mitigated by the fact that they still have full Social Security benefits, as well as a traditional employer-sponsored pension, available at retirement. The problem would be more acute for workers without traditional pensions, who rely on private accounts to replace their reduced Social Security benefits.

The G Fund is a Government Securities Investment Fund; the F Fund is a Fixed Income Index Fund; and the C Fund is a Common Stock Index Fund. These 3 funds have been offered by the TSP from its beginning, so the investment returns reflect their actual performance within the TSP. The S Fund is a Small Capitalization Stock Index Fund and the I fund is an International Stock Fund. Those 2 options were added to the TSP in May 2001. The returns shown reflect the actual performance of the S and I Funds for May 2001 and subsequent months. For the first four months of 2001 and for prior years, the returns shown for the S and I Fund reflect the performance of the Wilshire 4500 and EAFE indexes (without deduction of any administrative expenses, trading costs, or investment management fees), respectively. [www.tsp.gov/rates]

Providing a U.S. Treasury bond option to the private account investment menu, as the President has suggested to address this issue of risk, raises its own questions. Lower risk also means lower returns. Retirees in the 1970's who attempted to keep up with the raging inflation of the time with incomes generated by assets with locked-in rates of return – such as corporate or Treasury bonds – found themselves unable to keep up with skyrocketing prices. In addition, it seems incongruous for the President to encourage risk-averse Americans to invest in government bonds he has called “just pieces of paper” and riskier than converting Social Security into a system of private accounts. If he is correct that these investments may not be honored in the future, providing them as an investment option, or as a major component of a default “life-cycle” investment fund, could leave millions of future retirees with private accounts filled with unenforceable promises.

As the TSP example above shows, looking at markets averaged out over the long-term masks the dramatic fluctuations accounts experience on a daily basis. For this reason, any system based on private accounts will necessarily place a tremendous burden of “timing” on future retirees. Workers with exactly the same salary histories will inevitably be subject to dramatically different incomes from their private accounts based entirely on their date of retirement. Retiring at the “wrong” time could leave workers with significantly less retirement income than they had planned.

A profile of three retirees by T. Rowe Price is a telling example. These retirees had identical starting balances in their accounts ($500,000, which is dramatically higher than any reasonable projections of what the accounts will earn), and took precisely the same size withdrawals. Everything about them was identical, except for their dates of retirement. After 25 years in retirement, the person who retired in 1995 had twice as much remaining in his account as the person retiring in 1990. And the person who had the misfortune to retire in 2000, when the market was down, ran completely out of money after only 15 years in retirement.

If Congress ultimately mandates that a lifetime annuity be purchased with some or all of the account balance, as the President has suggested, an additional variable is added to this already complex calculation. Annuities cost money to purchase, and their costs change daily – in a pattern independent of the stock market. Workers will be faced with an ever-changing mix of variables as they attempt to select a retirement date that gives them a maximum account balance combined with minimum annuity charges.

Employers beware: who will pay the bill?

The administrative cost of private accounts is an issue not often explored, yet it is critical to how much money workers can expect to have at retirement. It is also a key issue that most employers appear not to have considered thoroughly. In example after example of foreign countries that have experimented with privatized retirement systems, the administrative costs have ballooned out of control. Retirees in Chile and Great Britain , for example, saw costs of as much as 20 percent decimate their account balances, leaving them without enough money to stay out of poverty in retirement.

Some proponents of privatization claim they can avoid this problem by mimicking the TSP plan design. But Francis X. Cavanaugh, one of the designers of the Thrift Savings Plan and its first Executive Director, has outlined a number of reasons the TSP model will not work in the Social Security context.

The TSP is the largest defined contribution plan in the country, with 3.5 million participants and $155 billion in assets. It is administered by just one employer, the U. S. government, with fewer than 200 individual federal agencies as participating employers. These agencies are a very homogenous group – all have very similar payroll systems and schedules. They transmit their payroll contributions electronically every two weeks using compatible payroll systems. Employees' contributions are deposited in their TSP accounts automatically when they are deducted from the worker's paychecks and are reconciled to the penny at that time.

The TSP program itself employs fewer than 100 people and has administrative costs of about 3% of earnings. That is because virtually all of the costs of administering the accounts – such as education, enrollment paperwork, and employee information tracking, for example – are handled by the agencies' human resources departments and paid for through each agency's budget. In fact, the vast majority of administrative costs of operating the TSP are borne by employers, masking the total cost of the program.

The Social Security Administration (SSA), on the other hand, covers 150 million workers, and processes 250 million wage reports every year. These wage reports are submitted by 5.7 million employers subject to Social Security, 98% of which are small businesses employing almost 50% of the workforce. These employers all have their own payroll systems and schedules. Only about 60 percent of employers currently file their wage reports electronically. Most make these deposits quarterly or annually. This results in a time lag of between 18 and 24 months from the time payroll taxes are withheld until they are credited to individual workers' records. Ten percent of initial wage filings do not match the SSA's records, and almost four percent of the discrepancies are never reconciled. SSA does not typically reconcile accounts unless the amounts are high enough to affect a worker's benefit level.

Converting this system into one incorporating private accounts will be a massive undertaking. Although the TSP model is promoted as a way of providing economies of scale, a system of collective investment does nothing to ameliorate the costs associated with tracking hundreds of millions of individual accounts. SSA estimates start-up costs of up to $2 billion, and Cavanaugh has projected ongoing administrative costs of $46 billion annually. SSA alone estimates it will need 34,000 new employees to administer the accounts. Fidelity Investments, an industry leader, estimates the staff need at 100,000 persons. In a time of shrinking budgets, it is not reasonable to assume the federal government will bear the entire cost. Workers will necessarily pick up some of it, which will significantly reduce their rates of return, but shifting much of the burden will be impossible in a system with millions of small accounts.

In this environment, it seems inevitable that employers will bear some portion of the cost. For example, a lengthy time lag between withholding of payroll contributions and investment in an account will simply not be tolerated for long by the public – all businesses will likely ultimately be required to convert to electronic payroll systems that transfer contributions upon receipt, a change that could prove costly to very small employers. Errors in a system based on fluctuating investment returns are also not likely to be tolerated, requiring potentially expensive investments by businesses.

Conclusion:

Private accounts patterned after the federal Thrift Savings Plan do not provide the same benefits to average workers currently enjoyed by Members of Congress and other federal employees. TSP-like accounts also do not eliminate the investment risk inevitable in a system of private accounts, and are unlikely help keep the costs of administering private accounts low. Private accounts, whether or not they are patterned after the Thrift Savings Plan, require a trade-off between guaranteed, inflation adjusted lifetime benefits and the speculative earnings from private investments, leaving workers with a less secure retirement and higher costs.

Department of Policy Research, May 2005

The National Committee is a nonprofit, nonpartisan organization that acts in the interests of its membership through advocacy, education, services, grassroots efforts and the leadership of the board of directors and professional staff. The work of the National Committee is directed toward developing a secure retirement for all Americans.