Is TIAA Traditional a Good Deal? - The Accumulation Phase
TIAA Traditional is a guaranteed annuity that is best understood by considering its two phases: the accumulation phase and the payout phase. In the accumulation phase, participants contribute money which grows at a guaranteed minimum rate of 3% for most contracts plus some additional amounts as declared by the company. The additional amounts are applied every year but different amounts are applied to different portions of the account. For example, additional 1% may be applied to money that was contributed in 2002 but only additional 0.5% to money that was contributed in 2010. Thus, different rates of interest are applied to different `vintages’ in each account.
The system of vintages makes calculating rates of return complicated. A few years ago TIAA began publishing ten-, five- and one-year rates of return. These are calculated consistent with the SEC’s guidelines for mutual funds as the annual growth of one dollar deposited ten, five- and one- years ago. This is helpful but it is not quite comparable to rates published for mutual funds. The problem is that the rates of return reflect the growth of only that particular vintage. For example, the ten-year return only reflects the growth of the money in the ten year old vintage. It does not apply to money contributed before the ten years or after. In the case of a mutual fund, the ten-year return applies to the entire balance as of ten years ago. Thus, a side by side comparison of TIAA Traditional returns and a comparable mutual fund is not possible.
I had a conspiracy theory. Because TIAA can assign different additional interest rates to different vintages, it has a great incentive to assign additional interest to the vintages that are `invisible’ in the ten- five- and one-year table of returns. For example, a four-year old vintage could be assigned very low additional interest, because the return on money deposited four years ago is not shown in the ten-, five- and one- year rates of return. Next year that vintage will be five-years old and so TIAA could assign high additional interest because it would be visible in the ten-, five- and one-year return table. TIAA is able to do this because they could pick and choose which vintage yields high interest.
The lack of data on historical interest rates for each vintage only fueled on my conspiratorial mind. It is impossible to find these historical rates on the TIAA-CREF website or anywhere on the internet. I requested the historical interest rate from TIAA-CREF as part of due diligence done on behalf of my institution’s retirement plan committee. A spreadsheet came back a few weeks later with all the historical rates, but it also had a message “Not for Further Distribution.” Why? I asked myself. This data should be on the internet. After all, there are 190 billion dollars invested in this product. Shouldn’t everyone have access to the historical interest rates? What are they trying to hide?
Alas, if they are hiding anything it is pretty good performance. I pitted TIAA Traditional against Vanguard Total Bond Index Fund (VBMFX) and Fidelity U.S. Bond Index Fund (FBIDX). The results are shown in the chart below. A participant putting away $100 a month starting in April 1990 would end up with almost identical amounts of money at the end of 2010 using any of the three investment options. The trajectory for TIAA Traditional is remarkably smooth compared to the two index funds. It appears that TIAA probably invests in the same types of investments that the bonds funds do, but TIAA smoothes out the fluctuations. In addition, TIAA does not seem to play any games with the additional interest rates. The “visible” ten- five- and one- year returns are no higher than the “invisible” eleven-, nine-, six-, or four-year horizons. I also compared the TIAA Traditional to Barclays Stable Income Market Index. This index begins only in July 1999. TIAA Traditional RA contracts slightly outperformed the index, while TIAA Traditional SRA contracts slightly underperformed.