The Thrift Savings Plan serves as something of a prototype for NEST. It has widened pension participation and demonstrated good returns, reports Maria Teresa Cometto

The most interesting defined contribution (DC) plan in the US is the Thrift Savings Plan (TSP) for employees of the federal government. With 4.4m members and $270bn (€202bn) in assets, it has all the features recommended by experts to maximise future benefits, including auto-enrolment and limited investment choices among low-cost index funds.

Auto-enrolment in TSP started in August for all new employees and so far it has been a success. Employees can opt out, but only 2% have chosen to do so. “It has increased the participation rate from 82.7% to 83.3% in only two months,” says Tom Trabucco, director of external affairs at the Federal Retirement Thrift Investment Board, the agency that administers the TSP.

But the other important elements of the plan - the simplicity and low fees - go back to the 1980s, Trabucco explains. The TSP was designed by the US Congress with the Federal Employees’ Retirement System Act of 1986, which established three levels of benefits for federal employees: an ‘income floor’ guaranteed by social security; the FERS annuity, which is a defined benefit plan where benefits are based on years of contribution and salary; and the TSP, which is voluntary.

“The Congress held hearings with pension fund consultants, experts and union leaders and decided that the best strategy was to keep the TSP very simple, limiting the investment choices to cover major asset classes,” says Trabucco. So the TSP started in 1987 with only three funds: one US stock fund, indexed to the S&P500; one US bond fund linked to the Lehman Aggregate Bond index (now Barclays Capital); and one fund invested only in US Treasuries and managed internally by the FTIB. The latter is called the G fund and is the default option for auto-enrolment - it is the most popular among all the TSP funds, with $116.81bn assets and 3.6m participants, among whom 2m invest only in the G fund.

In 1996 Congress added a US small cap fund and an international stock fund; and in 2005 it added the lifecycle ‘L’ funds, designed to change the allocation mix of investments among asset classes during the stages of an employee’s life. “We internally manage the lifecycle accounts,” explains Trabucco. “There are five retirement target-dates, from now to 2050, each with a different asset allocation that we implement buying our five core funds.” The lifecycle funds have $31.5bn assets and 723,000 members. Their asset allocation is very conservative: at the beginning of 2010 the L2010 fund - with a target-date expiring the same year - was invested 71% in the G fund: that is why in the heat of the financial crisis it lost only 5%. So the general criticism against lifecycle funds did not hit the TSP - all the same, Congress prevented the most prudent L fund from becoming the default option for auto-enrolment.

“We review investment choices approximately every five years, with the help of consultants,” explains Trabucco. Four years ago our adviser was a Chicago firm, EnnisKnupp, recently acquired by Hewitt Associates.” The four indexed funds are externally managed by BlackRock, with an extremely low expense ratio of 3bps. “Low management fees was one of the provisions of the original law,” stresses Trabucco. In September 2011 the deal with BlackRock will expire, and the FTIB will retender the contract.

‘No politics’ is another commitment from Congress: that is why the FTIB opposes including a socially responsible investment option in the TSP. “Our only care is for the economic interest of our participants,” says Trabucco. “From a financial perspective we don’t know the advantage of, for example, a terror-free fund or a fund promoting minority firms.”

The TSP does not offer investment advice to its members. “We give them only financial
education,” says Trabucco. “They do tend to chase performances, but they don’t switch funds very often.” Even in the middle of the financial crisis the number of participants who switched from the stock funds to the ‘guaranteed’ one was not that dramatic.