Results of the recent Thrift Savings Plan participant survey are encouraging.
It appears that participants appreciate some of the features that make TSP an excellent retirement
savings vehicle: the low costs, the convenience of payroll deduction and the tax benefits, for example.
I was disappointed, however, with two areas of the survey results. Responses indicate significant interest
in additional TSP investment options and in adding a Roth 401(k) option, which would allow participants
to invest after-tax earnings into an account that grows tax-free and can be withdrawn in retirement without
taxes being applied. Participants invest pretax earnings in the current TSP funds, although they must pay
taxes when the money is withdrawn.
The survey shows that both of these changes are highly cost-sensitive and that enthusiasm falls sharply
as costs rise, but it’s not a cost-free world and a price would surely have to be paid.
I field questions from Federal Times readers that confirm this interest in adding a Roth account option to
TSP. This, and the interest in adding investment options, highlight a kind of “conflict of interests” that
plagues many TSP participants. This is a conflict between that in which a participant happens to be
interested and that which happens to be in their best interest. Ideally, the two should be aligned. In reality,
they rarely are.
As a financial planner, I spend much of my time helping clients to discern between their chosen interest
and their true interests — what they’d like to do and what they should do — fantasy and reality.
Unfortunately, much of the public’s interest is motivated by advertising and other indirect forms of
marketing. Sometimes, it’s inspired by misinformation or misunderstanding.
It should be obvious by now that there is much more profit to be made from promoting an investment
product or service than from buying one. Even the survey responses indicate that a TSP participant is far
more likely to consult a family member, friend or co-worker for financial advice than they are to consult a
professional adviser. This, too, is likely to contribute to the problem of misdirected interest.
In the case of a Roth account option for TSP, there appears to be broad interest, although only certain
participants are likely to benefit from the change: those who are already contributing or plan to contribute
the maximum amount to their TSP accounts in a given year and who would like to contribute more. Based
on TSP statistics, this number is a fraction of the number who express interest in the option.
And adding a Roth option poses another risk. Making a Roth contribution is choosing to pay taxes now,
rather than later. If your effective tax rate rises sufficiently between the time you make the contribution
and the time you withdraw the money, you win. In all other cases, you lose.
Additionally, there are sure to be costs associated with offering the Roth option — costs that all
participants will bear. Ultimately, some, and I believe many, of the participants who show interest in
adding a Roth account option to TSP will find their interests compromised by the change.
Participant interest in adding other investment options to TSP is persistent. Whenever I hear this request,
the first word that comes to my mind is: “Why”?
Invariably, one of two reasons is given — either that it will allow participants to better diversify their
portfolios or that it will allow participants to realize larger investment returns. Both of these arguments are
weak, at best, particularly for participants nearing or already in retirement.
With the exception of developing foreign economy stocks and foreign bonds, the current raft of TSP funds
effectively and efficiently covers the world economy. Real estate? It’s in there. Commodities? They’re in
there. Every component of the domestic economy and much of those of developed foreign nations are
represented, either directly or indirectly, through the TSP’s existing five funds.
Adding a real estate fund, for example, doesn’t help to diversify your portfolio, but to concentrate it in an
economic sector that’s already represented. This type of concentration tends to increase overall portfolio
risk without corresponding increase in expected returns. More risk without more return? That’s not
something likely to further your interests.
And, what about the cost? Adding more funds is only a good idea if the expected benefits outweigh the
expected costs. Participants must use the new fund in ways that produce performance improvements that
exceed costs — not likely given the way participants currently manage their accounts.
It’s interesting to note that my two top priorities for TSP improvements aren’t even mentioned in the
survey results. They are better participant education and greater withdrawal flexibility in retirement.
Greater withdrawal flexibility would eliminate the only solid reason for participants to leave TSP for an
inferior IRA. Such flexibility would be a win for the participant and a win for TSP as a whole. Better
education about the realities of retirement planning and investing would help to bring participants’ chosen
interest into alignment with their true interests, and I can’t think of a more valuable improvement than that.
Written by Mike Miles
For the Federal Times
Publication February 12, 2007