I’m a big fan of the Thrift Savings Plan’s new L Funds, which became available as an investment option
for participants Aug. 1. But the reason for my enthusiasm may surprise you. I’m actually rather reluctant to
recommend that you use the L Funds exactly as they are intended. Not that the intended use would be a
horrific mistake — it would be a great improvement over the strategies, or lack thereof, being employed by
many participants. But using the L Funds “by the book” could lead you to leave a great deal of income
untapped over the course of your retirement.
The L Funds offer investors a choice of five asset-allocation models, each designed to correspond to a
different time horizon — the length of time between now and the time you expect to begin withdrawing
money from your account for retirement income. The farther you are from beginning withdrawals, the
more aggressive the L Fund investment allocation is. That is, the more heavily weighted it is in TSP’s
stocks funds as opposed to its fixed-income investments. As time passes and the withdrawal period
nears, the L Fund allocation gradually shifts toward the next more conservative allocation model.
I don’t usually advise my clients to invest this way. I don’t usually define an investor’s time horizon solely
by the point in time at which he will begin taking regular withdrawals from his portfolio. Equally, if not more
important, is the time span over which the money is expected, or at least hoped, to last. While it is
appropriate to shift assets into more conservative, liquid investments when the need for cash approaches,
it is not appropriate to do the same with assets that will not be needed until the more distant future. By
shifting the entire account to a low-volatility allocation at the beginning of retirement, an investor who will
only withdraw a small fraction of the account balance early — in a retirement that may last 30 years or
more — will hobble the bulk of the portfolio and unnecessarily sacrifice a great deal of potential return.
Based on the results of probability analysis I recently conducted on the L Fund’s recommended asset
allocation models, I recommend that, in many cases, it will be beneficial to participants to consider using
the L Fund with their time horizons shifted from the point of retirement to some measure of life
expectancy, say age 90 or 100.
Consider the following example. I conducted a simulation analysis using a hypothetical retiree, age 62,
who intends to begin taking regular TSP withdrawals during the coming year. The current TSP balance is
assumed to be $350,000, the retiree has $20,000 per year in taxable pension income and is subject to
taxes as a single Virginia resident. All factors in the analysis are assumed to increase annually with a 3
percent rate of inflation.
The most conservative L Income Fund is recommended by TSP for participants such as this one who
plan to begin immediate withdrawals. It is allocated most heavily in TSP’s fixed income G Fund at 74
percent; with 6 percent in the F Fund, 12 percent in the C Fund, 3 percent in the S Fund, and 5 percent in
the I Fund. Following my analysis, based on life expectancy, I would recommend the hypothetical retiree
in this fund take initial maximum withdrawals of $13,500 if he is male or $13,000 if she is female.
Remember that in this scenario, the retiree’s entire TSP account is invested in the most conservative L
Fund allocation throughout retirement.
TSP recommends the most aggressive L 2040 Fund for participants whose withdrawals begin 2035 and
later. It is allocated most heavily in TSP’s three stock funds with 42 percent in the C Fund, 18 percent in
the S Fund and 25 percent in the I Fund; and the remainder in the fixed income funds, with 5 percent in
the G Fund and 10 percent in the F Fund. My recommendation is that the hypothetical retiree also
consider initially investing in this fund, since his or her retirement might be expected to last 30 years or
more, until 2035 or later. My analysis shows in this case the retiree’s maximum initial withdrawal rate
could increase to $19,000 per year for a male and $18,000 for a female.
This happens in spite of the fact that regular income withdrawals are to be taken from a more volatile
portfolio, including instances where assets must be liquidated during down markets to fund the
withdrawals. By taking advantage of the longer time horizon to invest more aggressively, the retiree can
expect more income over time and, thus, can also take larger initial withdrawals.
This retiree should, at least, consider investing the account in the allocation specified for the L 2040 Fund
at retirement and allow the allocation to migrate gradually toward the L Income Fund during retirement.
While I think that the TSP’s definition of time horizon could use improvement, the L Fund asset allocation
models, themselves, should be of great use to many participants. Even those participants who will not
invest in the L Funds can use these models for guidance in implementing their own investment strategies,
both inside and outside of their TSP accounts.
Written by Mike Miles
For the Federal Times
Publication August 8, 2005