But Are They Saving Enough?

But Are They Saving Enough?

Thank you to Mr. Niu for providing so much interesting data on the federal Thrift Savings Plan (TSP) (“Doing the Math,” January/February 2023 issue). However, I question the reliance on past accumulation as the measure of “success” for the program and propose that the better “million-dollar question” is whether current employees are saving enough to meet their target retirement goals.

For example, Table 1 summarizes TSP participants by accumulated account balance, which to no great surprise is very strongly correlated to the number of years of contribution—meaning that it is likely that most of the listed participants are not currently eligible to retire. A more complete understanding of the overall effectiveness of the program would further segregate the data by age and contribution rate.

In addition, the accumulations over the past 20 to 30 years have been in an environment of generally falling interest rates (and thus perhaps greater-than-usual equity returns). Given that interest rates bottomed out at near zero until only very recently, there is a significant risk that future returns will underperform the past results shown in the chart.

One of the success measures cited—without critical evaluation or analysis—is the conventional wisdom that an 80% replacement ratio is an appropriate target. The 80% replacement ratio derives, at least in part, from the idea that retirees want to maintain their pre-retirement standard of living. To simplify the discussion, I assume that “standard of living” includes income taxes as desired expenditures; thus, if pre-retirement saving and Social Security taxes (a form of forced retirement saving) approach 20% of pay, an 80% post-retirement replacement ratio would be an equivalent standard of living.

If most of the participants in the TSP are contributing only up to the 5% needed to get the maximum match (plus the 7.65% OASDI-HI contribution), then the target replacement to maintain the same standard of living might be closer to 88% or 90%—assuming that there are no assets or savings outside the TSP. In general, the greater your saving rate, the lower your target replacement ratio. A greater saving rate (including paying down principal on any debt) also gives you more flexibility in the timing of your retirement.

It is also worth noting that another assumption implicit in the target replacement ratio concept is that the retirement income can be relied on as stable and inflation-protected for life. Because individuals with account balances have to self-insure against timing, sequence of return, and asset management risks (among others), they will need to target a higher replacement ratio during their working years to compensate for that risk.

Thus, the million-dollar question I’d like to ask: Are the current participants of the TSP saving enough for their own future financial security?

Steve Alpert
Ossining, N.Y.

Steve Niu responds:

Thanks to Steve Alpert’s right-on-the-money question, “Are current federal employees saving enough on average?” It demands a Part 2.

The FERS retirement plan is not a free DB plan. Federal employees are required to contribute each year to earn their FERS pension annuity. Employees hired after 2013 (aka FERS-FRAE) are required to pay 4.4% pay, those hired after 2012 (aka. FERS-RAE) need to pay 3.1% and those hired before 2013 pay 0.8%. Replacement Ratio (RR) can be calculated for the average employee as 100% minus 4.4%/3.1%/0.8% (FERS-FRAE/FERS-RAE/FERS) minus 6.2% (Social Security) minus 1.45% (Medicare A) minus TSP (5%) = 82.95%/84.25%/86.55% minus other work expenses, etc. (Just one input into the “other work expenses” category: Commuting and parking. Before the pandemic, less than 1% federal employees worked offsite. Now, 45% are working 100% remotely, and 45% telework several days a week. 10% are onsite every day.)

Other personal savings and/or retirement incomes are necessary to achieve a RR greater than 80%.

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