The Thrift Savings Plan (TSP) is well on the way to opening a mutual fund window for federal employees participating in the TSP. This new option will become available in the summer of 2022.
The mutual fund window will provide a wider range of options for TSP investors. At least initially, many, probably most, TSP participants will choose to continue using the current system of investing for their future retirement income.
The proposed rule is in the Federal Register and was published on January 26, 2022. Comments must be received on or before March 28, 2022 in accordance with the Federal Register notice.
Will TSP Investors Use the New Mutual Fund Window?
There are several reasons many investors may hesitate to use the new system.
There will be many new options for investing in a wide variety of investment vehicles through the forthcoming mutual fund window. Choosing how to invest for future retirement income is not easy. The easier choice is to stick with the widely diversified core TSP funds that already exist. These funds give investors a choice of companies in the S&P 500 index (the C Fund); small companies (the S Fund), international companies (the I Fund) and Lifecycle Funds.
The majority of participants opt for the C Fund and the G Fund. The G Fund is often thought of as the safest fund as the share price has never gone down. It also lags behind the core stock funds when the stock market is going up as it has generally down in recent years.
Relatively small percentages are put into the S and I Funds. As of December 31st, 59% of investor assets were in the G and C Funds–perhaps the safest choices while still investing in a portion of the stock market.
11.2% of participant funds are in the S Fund and 3.8% of assets are in the I Fund. 22.8% of participants’ assets are invested in the Lifecycle Funds.
In other words, federal employees investing to have a larger income in their retirement years are conservative in choosing how to invest their money in the TSP.
Pros and Cons of More Investment Options
The mutual fund window will offer the chance for greater returns for investors. Using the new window option means venturing beyond a system that is inexpensive, easy to use, offers the comfort of having worked well over many years, and does not require having to make decisions about opening investments from a large number of mutual funds that have their own expenses to pass on to investors.
Some TSP investors will jump at the chance to use the mutual fund window. Whether they believe they have a chance to increase their return with different funds, satisfy a desire to support their political beliefs by choosing funds that reflect their political and social philosophy, or seek greater diversification with a wider range of funds, the mutual fund window will provide these opportunities.
A FedSmith survey published in August 2021 found that 60% of the more than 1,500 readers participating in the survey said they would not invest in any of the thousands of new mutual funds that would be available through the mutual fund window. We will find out if that still holds true when the mutual fund window becomes available next summer.
What is a Mutual Fund Window?
A mutual fund window is a self-directed brokerage account that gives investors the ability to buy shares of mutual funds selected by or for their retirement plan. Unlike the core funds, the investments available through a brokerage account are not ordinarily vetted by a plan fiduciary to determine whether they are prudent investments.
In 2009, Congress passed legislation that authorizes—but does not require— the Federal Retirement Thrift Investment Board (FRTIB) to offer a mutual fund window for TSP investors. In effect, Congress authorized a mutual fund window for the TSP instead of adding more funds to the TSP’s statutorily mandated menu of core funds.
What Are the Expenses for a Mutual Fund Window?
The mutual fund window will open up a number of investment opportunities or options to investors. Some TSP participants have expressed an interest in more options being available.
However, these new mutual fund options will come with additional fees. These fees and expenses fall into four general categories:
- An annual maintenance fee of $95,
- A per trade fee of $28.75,
- Fees and expenses imposed by the specific mutual fund(s) in which the participant chooses to invest, and
- A fee designed to guarantee the mutual fund window will not indirectly increase the share of TSP administrative expenses paid by participants who choose not to use the mutual fund window.
The proposed rule published in the Federal Register on January 26, 2022, only includes the last category of fees and expenses.
At the same time, TSP investors who invest only in the TSP core funds will not be charged these extra fees.
Keeping Expenses Low for Core Fund Investors: $150 in Additional Fees for Mutual Fund Window
Under the current system, all TSP investors pay a pro-rata share of the TSP’s administrative expenses. These administrative expenses are paid through a reduction in the unit prices of the TSP’s core funds.
Because the TSP does not control the share prices of the mutual funds, the current system for allocating administrative expenses will not work with the mutual fund window.
The FRTIB is proposing to collect an annual fee of $55 from mutual fund window users to guarantee that the availability of the mutual fund window does not indirectly increase the share of TSP administrative expenses borne by participants who choose not to use the mutual fund window.
This $55 fee is in addition to the annual $95 fee referenced above. In short, the annual fees for using the mutual fund window will be $150. Investors using just the existing TSP funds will not be subject to these additional fees.
The FRTIB proposes to redetermine the amount of this annual fee every three years using the actual average mutual fund window account balance and the expense ratio, as of the date the redetermination is made.
Limits on Transfers
The Federal Register notice advises investors that the mutual fund window is intended for TSP participants who are experienced investors. It is not suitable for all TSP participants.
While there may be legitimate reasons for a participant to invest in undiversified funds, such needs can be met through limited portfolio allocations. Because of the increased risk associated with the breadth of options offered through the mutual fund window, the FRTIB is proposing several restrictions on transfers and allocations between the TSP core funds and the mutual fund window.
There will be several restrictions on using the mutual fund window.
- First, the TSP is proposing to require an initial fund transfer of at least $10,000 to the mutual fund window.
- Second, this initial investment may not exceed 25 percent of the participant’s total TSP balance. Together, these two restrictions would require a participant to have a minimum TSP balance of $40,000 before becoming eligible to use the mutual fund window.
- Third, subsequent transfers to the mutual fund window would be limited to amounts that do not cause the portion of the participant’s TSP balance that is invested through the mutual fund window to exceed 25% of their total TSP balance.
In addition, the current restriction on the number of trades per month will remain in effect.
TSP investors are now allowed two inter-fund transfers in a month. After that limit is reached, they can only transfer money into the G Fund. Any transfer between the TSP core funds and a participant’s mutual fund window account will count toward the existing monthly limit on inter-fund transfers.
Summary
Adding a mutual fund window is a significant change to a retirement investment plan that has been called a model for the rest of the country to follow. A mutual fund window creates more investment options, has higher expenses that will impact investment returns, and will create more risk (and potentially more reward) for investors.
These changes may create a system that has too many complications for the average investor, or it may create a system that leads to a more lucrative retirement system for those who participate.
