Joel Schofer's Career Planning Blog

Will the Government Ever Get Rid of the “Free Lunch” of the TSP G Fund?

Posted on December 29, 2019

They say there’s no free lunch, but in the Thrift Savings Plan there is a free lunch, and it’s called the G Fund. Will the government get rid of this free lunch?

The G Fund Free Lunch

What is this free lunch? You can read about it on this page in the Rewards section:

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 government is paying you a higher interest rate than it should. That is the G Fund free lunch.

Why is the Free Lunch at Risk?

The government periodically considers getting rid of it. For example, you can read about it in this article, which is discussing the President’s FY19 budget plan/request. Here’s the relevant portion:

The plan also proposes reducing the statutorily mandated rate of return for the government securities (G) fund to be based on either the three-month or four-week Treasury bill, at a projected savings of $8.9 billion over 10 years.

“G Fund investors benefit from receiving a medium-term Treasury Bond rate of return on what is essentially a short-term security,” the White House wrote. “The budget would instead base the G-fund yield on a short-term T-bill rate.”

TSP spokeswoman Kim Weaver said changing the G Fund’s yield, which is currently 2.75 percent annually, would have a disastrous effect on participants’ ability to save for retirement. If Congress changed the G Fund to track the three-month Treasury bill, the yield would decrease to 1.46 percent, and for the four-week bill it would drop to 1.43 percent.

“Such a change would make the G Fund inadequate and ineffective from an investment standpoint for TSP participants who are saving for retirement,” Weaver said in an email. “More than 3.6 million TSP participants (69 percent) have all or some of their account balance invested in the G Fund. Of those with money in the G Fund, 2 million (39 percent) hold the G Fund as their sole investment choice.”

For a TSP participant who has just retired and is invested entirely in the L Income Fund, which is designed for people who have begun taking annuity payments, they would run out of money at age 84 instead of the current projected age of 92, Weaver said.

Jessica Klement, staff vice president for advocacy at the National Active and Retired Federal Employees Association, said the change would make G Fund investments “useless” and likely force TSP administrators to divest from it entirely.

“[The new rate] would not even keep up with inflation,” she said. “So if you wanted to keep your money in a mostly secure fund, you would not be getting any return, and you’d actually be losing money. And if you took your money out, there would be no other safe, secure investment for those nearing or in retirement.”

What Does This Mean For You?

Right now, it means nothing. This is all just discussion about something that might happen in the future.

What you do need to understand, though, is that the G Fund serves a specific purpose in your portfolio. As the TSP site says:

Consider investing in the G Fund if you would like to have all or a portion of your TSP account completely protected from loss. If you choose to invest in the G Fund, you are placing a higher priority on the stability and preservation of your money than on the opportunity to potentially achieve greater long-term growth in your account through investment in the other TSP funds.

It is alarming that Ms. Weaver from the TSP said, “Of those with money in the G Fund, 2 million (39 percent) hold the G Fund as their sole investment choice.” Those 2 millions people are sacrificing long-term growth for the safest and most conservative investment available in the TSP.

There’s nothing wrong with that if you’re doing it because you are very conservative, near retirement, or the G Fund serves as the bond portion of a larger, more diversified portfolio that has more risky assets like stocks or real estate.

The sad reality is that most who are solely invested in the G Fund are that way because it used to be the default option for those starting a TSP account, and they never switched it to a more aggressive investment option. Under the new Blended Retirement System, the default investment switched from the G Fund to an age-appropriate Lifecycle fund.

What’s the Bottom Line?

The G Fund gives you a free lunch, paying you a higher long-term interest rate while you are investing in short-term securities. The government periodically talks about getting rid of that free lunch.

If you are invested in the G Fund, make sure you are doing it purposely and are aware of its conservative nature. Its emphasis is on preserving wealth rather than growing wealth.