Congress to New Federal Employees: Diversify Your Portfolios!

Amidst the flurry of last-minute legislating, the 113th Congress passed and the president signed the Smart Savings Act (H.R. 4193), which makes an important change to the enrollment process for the Federal Employees Thrift Savings Plan (TSP). TSP is the defined contribution (DC) retirement-savings plan for employees of the federal government, similar to 401(k) plans offered in the private sector.

Several years ago, TSP implemented automatic enrollment for new federal employees at a default contribution rate of 3 percent of salary (though employees can change the contribution rate or opt-out of participating entirely). For new employees who do not select an investment option, TSP has been directing contributions by default into a fund composed of U.S. Treasury debt (known in the plan as the “G Fund”). This feature of TSP has been concerning to many, because Congress and the Department of Labor have encouraged private-sector DC plans to adopt default investment choices that contain a mix of equities and bonds, reflecting widely accepted theories of appropriate asset allocation for retirement savings. In fact, plan sponsors receive some protection from fiduciary liability if they designate a balanced fund (a fund that seeks to maintain a stable ratio of stocks and bonds) or a target-date fund (a fund that adjusts its allocation toward more conservative asset classes as the target-retirement year approaches) as the default for their employees.

As we have written, automatic features can be a powerful force to increase participation in and contributions to retirement-savings plans, but poorly chosen defaults can and do harm to the retirement prospects of participants. For example, over the past five years, new federal employees – who are often many decades away from reaching retirement – had their retirement contributions automatically directed into government bond funds at a time when equity markets were experiencing an historic rally. Those who stayed with the G Fund missed this rally completely.

The Smart Savings Act changes the TSP’s default investment to an age-appropriate target-date fund (known in the plan as an “L Fund”), bringing TSP in line with the practices that have been adopted by many automatic-enrollment plans. This newly passed legislation ensures that future TSP enrollees have a default investment fund that is more appropriate for most participants.

This new TSP policy is the latest in a remarkably productive conclusion to this session of Congress with regard to retirement security issues. In the scheme of the major challenges that remain – including the Disability Insurance program, the Old-Age and Survivors portion of Social Security, access to workplace retirement plans, and the availability of lifetime income, to name a few – these are small steps. But hopefully this series of legislation is a sign of more progress to come.