Many investors remain complacent with their portfolios. This can be due to many factors including restraints on time, knowledge, or a lack of available information. Although I am not an advocate of timing the markets, understanding how your investments work and taking calculated actions can produce a more productive portfolio.
Guaranteed Rate Plus Dividends
TIAA Traditional offers a guaranteed component of 3.0% for most accounts and pays a dividend on top of the guarantee. The interest rate will not fall below the guaranteed rate (hence the name). For example, an investor who earns an annual interest rate of 4.5% can look at this interest rate in two components: the 3.0% guaranteed in addition to the dividend of 1.5%. Keep in mind, the guaranteed rate is typically 3.0%, but can vary according to the type of account and when the account was opened.
Vintages
Investors earn an interest rate according to when money was placed into TIAA Traditional. TIAA can change the interest rate for new money placed in TIAA Traditional on a monthly basis. Periods of time with the same interest rates are called vintages. New money into TIAA Traditional can come in the form of contributions or transfers. Also, interest earned from TIAA Traditional “rolls forward” into the new vintages. With this in mind, each investor in TIAA Traditional has a different interest rate according to the weighted average of the vintages (when money was placed into TIAA Traditional). Each investor will also have an accumulation in every vintage from the time money was contributed into TIAA Traditional. Please note, TIAA-CREF also may change the interest rates of past vintages annually the end of each February.
Vintage Impact
In order to offer a guarantee, TIAA Traditional is invested in many long-term investments, of which, many may be illiquid. In a time of falling interest rates, this works great for investors in TIAA Traditional. Vintages tend to maintain higher interest rates for a long period of time when compared to falling rates. The opposite is true in a rising interest rate environment. TIAA Traditional vintages tend to have trouble keeping up with rising interest rates due to the illiquid investments locked into paying out lower interest rates.
Restrictions
For those of you with TIAA Traditional within a Group Retirement Annuity (GRA), Retirement Annuity (RA), or a Retirement Choice (RC) contract, there are restrictions that prevent you from moving your accumulation out in a lump sum. Due to these restrictions TIAA Traditional vintages within a GRA, RA, and RC contracts pay a higher interest rate than other accounts.
However, investors with a Supplemental Retirement Annuity (SRA), Group Supplemental Retirement Annuity (GSRA), or Individual Retirement Account (IRA or Roth), are able to transfer money into and out of TIAA Traditional in a lump sum. If you transfer money out of TIAA Traditional in a lump sum and then move it back within 120 days, you receive the same vintages up to the amount you had originally invested. If you transfer money out of TIAA Traditional and wait over 120 days to transfer an accumulation back, you will receive the new vintage rate.
Increase Your Interest Rate
Investors can “upgrade” your interest rate within TIAA Traditional in a rising interest rate environment by moving money out of TIAA Traditional for more than 120 days and subsequently moving the money back after that time period to obtain the higher vintage rate on the entire amount. Again, this will only apply to the accumulation you have in a SRA, GSRA, or IRA.
Example
Scenario 1
In this example, Rebecca is an investor with $100,000 in TIAA Traditional in her Group Supplemental Retirement Annuity (GSRA) earning an average interest rate of 3.5%. If Rebecca leaves the accumulation of $100,000 in her account over a one year period she will earn approximately $3,500 in interest (simplified for this example). Even if interest rates go up significantly, Rebecca will only have a small amount of new money invested in the new vintage. Thus, her interest rate may shift slightly higher, but the overall effect on her average interest rate will be insignificant.
Scenario 2
In this example, Rebecca starts out with $100,000 invested in TIAA Traditional in her GSRA earning 3.5%. However, Rebecca notices that interest rates have increased and the new vintage for TIAA Traditional in her GSRA account is paying out 4.5%. Rebecca, being a savvy investor, moves 100% of her TIAA Traditional into the CREF Money Market for 120 days. If we assume that CREF Money Market is also earning 1.5% due to higher interest rates, Rebecca would earn $375 over that 120 day period. On day 121, Rebecca moves 100% of her accumulation in Money Market back to TIAA Traditional. She will then earn the higher vintage of 4.5% on all of the accumulation (assuming it remained the same). At the higher interest rate, Rebecca would earn over $3,000 for the remainder of the 8 months in the year. Again, simple interest is used for the purposes of this scenario.
Results
The result in Scenario 2 is there was an opportunity cost lost while her money was sitting earning a lower interest rate in CREF Money Market and could have been earning the higher interest rate in her “old” TIAA Traditional vintages. However, she is able to break even at just over a year and then continue to earn the higher interest rate of 4.5% in the new vintage. Assuming Rebecca is a long-term investor, as most participants are with TIAA, she will end up with a much higher accumulation over time with the higher interest rate. Eventually, the “old” vintage rates will catch up to the higher interest rates, but not until Rebecca’s accumulation is much higher than it would have been had she not taken action.
Rule of Thumb
The TIAA Traditional Annuity should not be day traded. With any investment strategy, rules provide a clear path and discipline. The first trend I look for is a very clear rising interest rate environment. When the accumulation is sitting in money market, it is important to move the accumulation back to TIAA Traditional at the targeted higher interest rate.
For my clients, I look for the new vintage to be at least 1% higher than their current average interest rate. There is an opportunity cost lost of interest when the accumulation is sitting in the money market. A new vintage of 1% or higher than the current average interest rate will limit the amount of time to cover the opportunity cost to close to a year.
Conclusion
With current economic conditions, a convincing argument for a rising interest rate environment is easy to make. It is important for investors to be vigilant and understand the mechanics of how their investments work. This article attempts to provide a glimpse into how I work with clients and share a nugget of information not easily provided by TIAA to help all investors.
