Tuesday, January 22, 2013

We the Feds Part II – Special Interest Rates for Federal Employees

How would you like to have had a money market account in the zero interest rate environment of the last few years that paid better than 2 percent? How would you like to buy bonds that will adjust to higher interest rates with no decrease in principal value? If you are an ordinary person, saving and investing, planning to buy house, hoping to fund a college education or contemplating retirement, you don’t have these options because you are not a federal employee. You can stash your money in an interest bearing account that pays 0.01 percent. Or you can package a bundle of long term treasury bonds that yields 2-plus percent, but the package will lose value, and result likely in an overall net loss when the Federal Reserve Board reverts to standard monetary policy with higher interest rates a year or two down the road.

The federal employee option that you don’t have is referred to as the G Fund in the Thrift Savings Plan (TSP).  The TSP website describes the G Fund thus.

“Fund principal and interest is guaranteed by the U.S. Government. This means that the U.S. Government will always make the required payments. In other words, your G Fund investment is not subject to credit (default) risk. The G Fund interest rate calculation is based on the weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity. As a result, participants who invest in the G Fund are rewarded with a long-term rate on what is essentially a short-term security. Generally, long-term interest rates are higher than short-term rates.”
The one, three, five and ten year returns for the G Fund, compared to the same timeframe returns for a commercially available government money market fund, are given in the following table.  Note  that for the last three years, the G Fund offered 2.2 percent better annual returns than the money market fund.



G Fund and Money Market Comparison
TSP G Fund Annual Return
Money Mkt Fund Annual Return
G Fund Premium
10 Year Avg.
3.60%
1.70%
1.90%
5 Year Avg.
2.70%
0.50%
2.20%
3 Year Avg.
2.20%
0.01%
2.20%
One Year (2012)
1.50%
0.01%
1.50%
Through 12/31/12, sources:


All federal employees whose job puts them into a pension plan can save in the TSP. The TSP is a tax advantaged retirement savings program. At the same time, participants can withdraw money via ridiculously low cost unsecured loans for up to 5 years for any purpose, and up to 15 years to finance the purchase of residential real estate.  Approach a loan officer seeking a 1 or 2 percent unsecured loan at your local bank or credit union. Or ask her to secure a loan using a retirement account as collateral.  She will laugh. But if you are a federal employee, ask your special banker and she will say, yes sir.

I retired from the federal government under the Civil Service Retirement System (CSRS) program, which provides for inflation-protected retirement annuities paying as much as 80 percent of the average of an employee’s high three earning years. After backing out retirement and Medicare contributions that are no longer deducted when converting from a work check to a retirement check, and adjusting for the tax advantages of being retired, CSRS retirees can walk away from work with essentially no loss in take home pay. So you would not think CSRS annuitants would need any special help.  Yet, over the last three years my extra G-Fund kick has been worth about $35,000.  I am not planning to take a penny out of my TSP account before the law requires when I turn age 70 and one half. During that eleven years I expect to roll up another $150,000 or so of risk free interest rate advantage. Over my remaining life expectancy I'll be gaining a quarter of a million dollars. 

Yours truly is not an extreme example. My TSP balance is smaller than many employees who were hired post-1984 under the Federal Employee Retirement System (FERS) program. Unlike myself, these more recently hired Feds earn matching TSP employer grants. Also, for many years FERS employees were permitted to contribute higher percentages of their salary to the TSP than CSRS employees. If they are diligent savers, FERS employees can build TSP balances to more than a million dollars, which means they can grow their annual interest income G Fund advantage to about $25,000 by time they retire.
 
An outsize interest income advantage has persisted from the program's inception and has a large and growing fiscal impact.   As of October 2011, the system wide G Fund balance was approximately $150 billion, up by about $25 billion over the previous year. The fund is growing rapidly because of new participants, big federal salaries and external injections; baby boomer participants nearing retirement are taking advantage of the option to roll in IRA accounts and private sector 401(k) account balances they built when they worked for other employers.  

Applying the recent 2.2 percent premium, the projected budget impact of the special G Fund benefit will be about $70 billion over the next decade. That’s $70 billion that will be passed to your children and grandchildren, debt they will service again, and again, and again. What we have here is a seemingly small, but poorly understood matter, which like many budget matters that could be managed by a competent executive, has a very large impact.

Obama has made no commitments to reduce spending in any way, shape or form.  He sasses and demeans the messenger when reductions are proposed. There is no high-profile process in place in the executive branch (such as the Grace Commission during the Reagan administration) to identify savings opportunities.  So you can pretty much take that $70 billion burden straight to the US debt bank. But do not despair.  The silver lining for you taxpaying suckers (I mean patriotic individuals) out there is, if you are nearing retirement, all you need to do is find a job, most any job, with the federal government and stay employed for a pay period or two to minimally fund your TSP. Then retire! Your weeks of federal service entitle you to rollover your lifetime balances from other retirement funds and get on board the G Fund gravy train! Then stick it to your children. That’s fairness in the world of Obama. Enjoy!

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