Update: This proposal has been approved and will go into effect March 1, 2020.
The Federal Retirement Thrift Investment Board (FRTIB) has proposed a change to the rate used to calculate the annual increase for annuities in the Thrift Savings Plan.
Currently, when a TSP participant elects to receive an annuity with an increasing payment option, the increase in the amount of his or her monthly annuity payment each year is based on the annual change in inflation as measured by the Consumer Price Index (CPI). Increases cannot exceed 3% per year.
The FRTIB has proposed changing the cost of living adjustment (COLA) to a flat rate of 2% per year.
Why is the Change Being Proposed?
The FRTIB notes that the Federal Open Market Committee (FOMC) has set an inflation target of 2% and implements that target over the medium term. As measured by the CPI, inflation has averaged 1.95% annually over the last 20 years which is the expected result given the FOMC inflation target. In other words, the CPI formula is resulting in an average of about 2% already.
The FRTIB says there are two benefits to using the flat rate.
First, the FRTIB anticipates that fixing the rate at 2% will result in a higher initial monthly annuity payment on average:
Assuming an inflation rate of 2%, a participant’s initial monthly annuity payment will, on average, likely be 10 to 15% higher than it would have been under the variable rate. Although this increase comes at the expense of a smaller amount of inflation protection (i.e., protection only up to 2% per year as opposed to 3%), using a fixed rate makes it less likely that participants will pay for more inflation protection than they need.
Second, the flat rate makes for a more predictable pattern of income in retirement. As the FRTIB notes:
Annual changes in a COLA based on the annual change in inflation can vary from year-to-year. This volatility can lead to participant uncertainty about how much, if any, their benefit will increase each year. However, the fixed rate has the added benefit of producing a predictable pattern of income.
There may be some cost savings benefits as well. The FRTIB described the current annuity situation in the proposed rule change with its annuity vendor:
When a TSP participant elects to receive some or all of his or her account balance in the form of an annuity with an increasing payment option, the TSP purchases the annuity for the participant from its annuity vendor. Although the actual change in inflation varies from year to year, the annuity vendor’s pricing for this variable increase rate assumes an annual increase of 3% when calculating monthly annuity payments even when the calculated COLA turns out to be below 3%.
What Happens Next
The proposed rule change was published in the Federal Register on December 17, 2019. It is open to comment until January 16, 2020.
Should the change be formally adopted, it would go into effect on January 18, 2020 as currently written.
The FRTIB said in the notice that it will regularly review the COLA to ensure that it continues to be beneficial for TSP participants.