By George Ray

Let’s pretend we’re boy scouts for just a moment. The motto of the Boy Scouts of America is ‘Be Prepared’. With the increasing call to change how the rate of the Government Securities Fund (G Fund) in the Thrift Savings Plan (TSP) is calculated, how should you prepare?

Before we discuss this, let’s first agree that changing how the G Fund rate is calculated is a very ‘touchy’ subject and one in which both Feds and non-Feds have very passionate opinions. It’s the elephant in the room that is finally getting talked about. Jessica Klement, the Legislative Director for the National Active and Retired Federal Employees Association (NARFE) had this to say about the proposed formula change, “What it does is it renders the G Fund useless.” The TSP’s own spokeswoman Kim Weaver said the agency opposes “any change” to the G Fund’s rate of return. “Such a change to the G Fund would do significant damage to TSP participants’ ability to save and invest for their retirement,” she said. And TSP officials have also stated that ‘such a change would make the G Fund virtually worthless for TSP investors, as account growth would not keep pace with inflation nor be competitive with stable value funds. The G Fund would then only be serving the purpose of a money market account.” And that’s where the problem begins.

What’s the problem with the G Fund?

Anytime you make an investment, you accept a certain level of risk. Even putting your money in your bank entails risk since at any time the bank could go under, taking all your money with it. In the US, this is highly unlikely in most circumstances because protections are offered by the Federal Deposit Insurance Corporation (FDIC). The FDIC promotes public confidence in the US financial system by identifying, monitoring, and addressing risks that could cause an institution to fail. (If that doesn’t sound like a mission statement, I don’t know what does.) Seeing the FDIC logo on the door of your bank as you walk in gives you comfort that your account is protected. The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category. Imagine instead if you had to read through the bank’s balance sheet and other financials to determine if this bank was a safe place to put your money? And check the bank regularly to determine if you should keep your money there? That would be crazy. Most consumers have little experience or knowledge on how to evaluate the true risks of an investment. Even experienced investors are often wrong in their assessments. And the understanding of risk is where we must go next in our discussion.

When investing, the amount of risk that an investor is willing to accept should be commensurate with the return on the investment he’s making. Essentially, if you take a bigger risk, you should expect a bigger return. For example, if I start my own business, I’m taking a big risk and expect it to pay off handsomely for me and my family. Although it should work that way, it doesn’t always. Often an investor misjudges the amount or type(s) of risk and experiences a lower return or even a loss.

When TSP participants ‘invest’ their money in the G Fund, they are making an investment that has an extremely low amount of risk. In fact, the fund is often called the ‘safe’ fund by plan participants who know that they can never lose their money by putting it into the G Fund. Since you can’t lose the money you invest in the G Fund (even TSP officials refer to it as a ‘stable value’ fund), you could consider the G Fund to be an almost riskless investment, a risk-free investment.

A risk-free investment that provides a positive investment return sounds like a darn good investment to most people. Are there any other riskless investments? There may be, but the most common one that’s widely used as a benchmark is the interest rate on the three-month US Treasury bill. It’s frequently cited as the risk-free rate that investors use to compare with the return on potential investments. The three-month U.S. Treasury bill is a useful proxy because the market considers there to be virtually no chance of the government defaulting on its obligations. The large size and deep liquidity of the T-bill market also contribute to the perception of safety.

So now to the problem with the G Fund rate. As of April 2018, the TSP G Fund interest rate is 2.75%. The rate is calculated monthly, based on the average yield of all US Treasury securities with 4 or more years to maturity. But in the ‘real world’ (I know I’m going to get some flak for saying it that way), the price and yield of those longer-term securities fluctuate in value with changes in interest rates. The TSP’s G Fund rate does change, but much more gradually and again with no chance for a loss of principal. The fund is also very liquid allowing participants to make changes when desired (with some trading restrictions on moving out of the fund, but none on moving into it). It could be argued that the TSP’s G Fund has the risk profile and liquidity of a government securities money market fund. What’s a current rate for April 2018 on a US government securities money market fund? Well, the largest fund is the Fidelity Government Money Market Fund (SPAXX) which has a one-year return of .71% So, could it be argued that the G Fund, with its risk and liquidity profile similar to a government securities money market fund, is offering a rate of return on almost riskless investments that exceeds other large well-known (like Fidelity) and similar funds by providing a return that is almost four times as large? Can I sign up for that investment? No, I can’t, which leads us to the why of the problem.

Why is it a problem?

So, Federal employees and retirees, our military and its retirees, former employees who will be eligible for a deferred retirement, and even folks who worked for the government for a short time but will never get a pension could have their money invested in the G Fund getting a much better rate of return than in a comparable type of retail investment fund. Even former employees who kept more than a $200 balance in the TSP could transfer their IRAs or consolidate money from former employer-sponsored plans (like 401ks) into the TSP and get this rate. But, I can’t. And most of America can’t either. We’re relegated to getting .71% from Fidelity’s government securities money market fund if we want to limit our risk in the same manner.

But you say ‘Wait a minute, George. Different companies offer different benefits to their employees all the time. Some offer no retirement plans. Others offer a retirement plan with lots of bells and whistles. Some subsidize their employees’ health insurance at higher rates than others. If you want the benefits that the employer is offering, you just need to go to work for them. Why shouldn’t the Federal government be able to offer its employees benefits that may not be available to other employers? It helps recruit new employees to the government.” And, you’re absolutely correct about all of this.

But, should only Federal employees and retirees be able to get this kind of a deal? Why shouldn’t corporate America be able to access the G Fund and its rate in their 401(k) plans for their employees’ savings? And if the rate is not commensurate with the level of risk that’s being taken, is somebody subsidizing the return, which shouldn’t really be that high? The extra return must come from somewhere. Who’s subsidizing the rate? Could it be the same taxpayers who aren’t allowed access to the fund? Let’s suppose your bank is offering a rate on CDs that’s four times as much as my bank and it also has the same FDIC insurance protecting it. If your bank goes bust, you’ll still get your money back and you’ve earned more interest while the bank was still there to pay you. So, I want your rate too. I’m standing at the door trying to get into your bank, but the door is locked. And when my friends heard about the deal you’re getting, they also came to get the rate, and now there’s an angry mob building outside.

Is it as big of a problem as it’s being portrayed?

So, what is an angry mob to do? Someone from the back shouts ‘To the Capitol, everyone. Let’s let our Congresspeople know about this injustice’. (I can already hear the cynics laughing at that for many reasons. For one, our representatives have access to the TSP and most have lots of money in it.) But, Congress has proposed changing the formula used to calculate the G Fund rate. One proposal wants the calculation to track the three-month US Treasury bill rate, which swings much less with interest rate fluctuations versus the four-year rate. This would be a compromise as it would bring the rate down, but still not commensurate with the extremely low risk in the G Fund. Another proposal would lower the rate to follow the four-week T-bill which would drop the rate currently below 1% annually (slightly above a money market rate). This may be more realistic.

What will happen? We don’t know. But we do know one thing, there will be a fight. I’ve held off writing about this because I don’t like to get into fights. I certainly don’t mean to start one. I’ve been trying not to be for or against this as I’m writing. I was just hoping to provide more exposure to both sides of the issue. I’ll let you decide how I’m doing, but in the end, there may be lots of folks who are unhappy with me anyway.

But there are people who have taken sides. They must. NARFE’s mission is to represent Federal employees and retirees by being their voice. As mentioned above, they have to declare, ‘it renders the G Fund useless’. But does it? No, not really. It will just make it into a stable value money market fund that’s designed to provide liquidity to most retirees like is already available in most corporate 401(k) plans throughout the US—no different. Most corporate plan participants aren’t decrying the uselessness of their money fund in their plan. They adapt. You may need to also (more about that at the end).

The Thrift Saving Plan must also put up a fight as it does have another problem (their own elephant in the room that they would probably rather I not mention, but I want to get all sides of this on the table). The TSP Board continues to promote its low costs. They advertise to Feds who are retiring and leaving service that keeping their money in the TSP is much more inexpensive than distributing it out to another financial institution, with much higher account and management fees. And they are correct (much to the chagrin of the for-profit financial institutions which must charge higher fees to make a profit). But many Feds still leave the TSP after retirement because getting access to your money hasn’t been as easy as it can be with other financial institutions. That will be changing with the implementation by the TSP folks of the TSP Modernization Act. But let’s be honest, who cares if it’s easier to get access to your money in retirement if the G Fund rate (where most of your retirement money will be sitting) drops to a money market rate. Then there’s less of an incentive to keep your money in the TSP where it used to be able to earn a ‘safe’ rate that you couldn’t get anywhere else. Costs are allocated among account holders so if the number of account holders drops, then the costs for everyone still in the plan go up. This causes more participants to leave which increases the costs for those remaining. And around and around we go. The biggest effect of higher percentage costs will be felt by employees who can’t take their TSP money anywhere else. Retirees will still be able to leave for greener pastures. This could have something to do with why the TSP wants to keep the G Fund formula from changing so that it can continue to pay a higher rate than outside funds with similar risk and liquidity features. Can you see the elephant now?

What are some potential solutions?

I was always told that if you’re going to bring up a problem, you should also bring some solutions to the table. Nobody likes a whiner. There are a number of ways that the G Fund could be ‘fixed’. Here are a few scenarios that I’ve come up with, starting with the most unlikely and unwieldy first. I’m certain there are more (and probably better) ones. And there are likely many pros and cons of each scenario that I’ve completely missed. That’s why this should be a discussion – a calm one, please.

Solution 1:

Adjust the G Fund rate to align with government money market rates starting on a specific date. Any money already in the G Fund prior to the start date of the new rate will continue to get the old rate calculated as it is today. Any new money contributed or transferred to the G Fund after that date will get the new (lower) rate.

Pros:

This would limit the amount of money to a specific pool that would be eligible for a higher rate, thus limiting the Federal government’s (and taxpayers') cost. It also follows similar moves to lessen the pain of this issue, much like creating new classes of FERS employees (RAEs and FRAEs) to quell the angst of existing employees having to contribute more to the FERS pension than the original promise that was made when they were hired.

Cons:

The worst-case scenario is everyone in the TSP stampedes and moves all of their money into the G Fund to forever capture the 4-year treasury rate which exacerbates the problem. Then they could start contributing new money into the other funds in order to gain diversification. This solution would also seriously limit the ability to re-allocate these ‘frozen’ funds which would have lots of Federal organizations, unions, the SEC, etc. up in arms. So Solution 1 doesn’t seem like a very good one.

Solution 2:

Limit the percentage amount of the money that an individual participant can place in the G Fund based on their expected retirement date. For example, someone who is 30 years away from retirement could only put 20% of their TSP money in the G Fund. As you get closer to retirement (older), the percentage you’re allowed to invest in the G Fund could increase so that prior to retirement the fund could accept 100% of your money in the TSP if you choose.

Pros:

This is a similar solution to the existing Lifecycle (L) Funds which allocate money weighted on the participant’s expected retirement date. It could help younger participants by forcing them to direct more of their money away from a lower yielding investment into funds with potentially higher returns (and yes, higher risk).

Cons:

It would be unwieldy to implement alongside the existing L Funds (the number of which are expected to double when the TSP adds the new 5-year spacing between funds versus the existing 10-year spacing). Also, forcing someone to limit the percentage of the fund does not ‘holistically’ consider other investments that the participant may have outside of the TSP-- maybe they have very risky investments elsewhere, and would like all of their retirement savings in the G Fund.

Solution 3:
Allow the current G Fund rate calculation to be used only by retirees. Existing employees would be forced to accept the new (lower) rate on their G Fund investments until they retire.

Pros:
It would seem relatively easy to administer. Workers get one rate. Retirees get another. But not so fast.

Cons:
It would be more unwieldy than that. Would the rate only be provided for those who retire with a government pension (CSRS or FERS)? What if the retiree comes back to work as a re-employed annuitant? Would he accept a significant rate drop on his retirement savings rate in the G Fund? Or would this be an exception to track? How would employees feel about this idea?

Solution 4:
I’ll call this one the ‘Bite the Bullet’ solution because the G Fund rate formula gets changed immediately for everyone, employees and retirees, for now, and forever.

Pros:
It would be the easiest solution. No transitions. No limitations to moving funds. No special processes need be set up to track existing accounts. No special rules or exceptions will need to be created. And no special rules will be necessary to fix all the errors resulting from choosing solution 1, 2, or 3 (does anyone remember the Federal Erroneous Retirement Coverage Corrections Act, FERCCA, that was needed after FERS was introduced? We really don't want to go down that road again, do we?).

Cons:
Millions of angry Federal employees and retirees who want their G Fund rate back. Oh, my.

So how can you prepare?

With all that’s been said, it seems more and more likely that a revision of the G Fund rate formula will occur. Although it’s a tough pill to swallow, and I know you would rather not see it happen, I hope you can more clearly see the other sides of this issue. Particularly how everyone else envies your good fortune and wants to crash your party (including Congress who wants to use the money recovered to lower the deficit).

So, let’s be boy scouts about it. Let’s get prepared. How do we prepare, you ask? Well, let’s imagine that they took the FDIC away. Now the banks aren’t protected. Is your bank safe? How can you figure it out? You’ve got three choices:

Blindly follow everyone else and put your money in the bank where they’re putting theirs. At least when the bank goes under and you lose all your money you can feel comfort that you weren’t the only one who lost. Or maybe you can blame someone else other than yourself.
Sit down with the financials from the bank and comb through them. See where and how they’re investing their depositor’s money. Talk with the bank manager and employees. Talk to their vendors to make sure they’re getting paid on time. It’s a bit of work, but in the end, you may feel much more comfortable with your decision and proud of taking responsibility for it.
Or hire someone who knows what he’s doing. Someone you trust to tell you where to put your money. This will save you the mental cost and effort but will likely cost you real dollars to get good advice.

Now take those three choices and think about which would be best for you when it comes to your Thrift Savings Plan investments. My suggestion is to educate yourself on the funds and learn more about risk. Without a ‘safe’ fund to provide you with a return that’s really too high for the amount of risk you’re taking, you’ll now have to educate yourself and pay attention to the funds and the markets as most other consumers who have access to an employer-sponsored retirement plan must do. Now, I know that there are many employees who already have a firm grasp on the TSP, its funds, investment concepts, and risk. I talk with them during my sessions. I applaud you. You’re doing it right, and I’m not trying to insult you. For those Feds, the change won’t be welcomed, but it won’t be that hard either.

For those who may have chosen to abdicate their responsibility previously by simply stashing their retirement money away in the ‘safe’ fund, it’s going to be more challenging. You may want to take a closer look at the Lifecycle (L) Funds now. They offer a straightforward approach to managing risk with the possibility of higher returns over your lifetime. Or maybe get someone to help you. But if you want to earn your retirement plan merit badge, you’ll need to be prepared.