the Thrift Savings Plan (TSP)

The Thrift Savings Plan (or TSP) is a defined contribution plan that launched in April 1987 with one available investment option – the G fund. When it was launched, there were many more Federal employees on the CSRS system than the new FERS system, as FERS was just under a year old having started in June of 1986. Both the TSP and the smaller benefit of the FERS annuity were reflective of a new paradigm in which employees and not employers bore more of the responsibility for funding retirement savings.

The TSP was, in essence, the Federal Government’s answer to 401k plan, and I compare the TSP to 401k plans in this post. The goal of the plan is simple – to provide a vehicle that allows Federal Government employees to save in a tax advantaged manner for retirement.

The original plan offered one choice when it came to type of retirement account, and that was an IRA-like account to which you could contribute a portion of your salary. Your contributions would grow without being taxed, and you also got a deduction for the amount you contributed since the contribution was removed from your salary. The catch was that when you withdrew your contribution, the amount would be taxed as income – so although you received an upfront deduction and avoided tax on the growth, you would ultimately pay taxes on the funds, albeit you’d pay in retirement when your tax rate would likely be lower.

The TSP added a Roth option to the plan in 2012, and the Roth option essentially reversed the tax advantages. More specifically, while you do pay taxes on amounts you contribute to the Roth option – since those amounts are still counted as taxable income – you won’t pay tax when you withdraw the amounts in retirement. Your specific circumstances and your plan will dictate which option is better for you, but this post provides a framework for you to think through the decision.

Since its launch, the Plan has added a number of investment options, most recently the life cycle funds in 2005. While the options are limited, those that do exist are broad-based and low-cost which are both plusses for investors. Management expenses for the plan itself are low, as well, which means that there is less of a drag on investment returns. If there is one criticism of the TSP, it is the lack of withdrawal options, but the governing board recently loosened those rules as outlined below.

Understanding the TSP is key to a successful Federal Government retirement, so with history of the TSP out of the way, let’s dive into details.

Contributing to the your TSP account

You make a contribution to your TSP account via deducting funds from your paycheck, and you’ll find forms to set that up here. There are limits to the amount you can contribute, and for 2019, the total amount that can be contributed to the TSP – regardless of whether you’re contributing to the traditional TSP or Roth TSP – is $19,000. Additionally, if you are 50 or older, you can make an additional catch-up contribution of up to $6,000.

When it comes to your TSP contributions, you have a choice about whether to make them to a traditional tax deferred TSP account or a Roth TSP account. As previously mentioned, the tax treatment on the two options differs and your personal financial circumstances will dictate which option is best for you. In general, the traditional option makes more sense when:

  • Your current tax rate is likely a good bit higher than you expect your tax rate to be in retirement
  • You are closer to retirement and expect to need the funds sooner. In other words, all else equal, age tilts in favor of the traditional option.

The decision can be complex, and ideally, you’ll determine which option is best for you by building your own financial plan.

The Federal Government will also contribute to your TSP account if you are covered under FERS, and the amount of the contribution depends upon your salary and how much you contribute. The breakdown is as follows:

  • Automatic 1% contribution – your agency will contribute 1% of your basic pay even if you contribute nothing.
  • Up to 4% in matching contributions – if you do contribute to your TSP, the government will match the first 3% of your contribution dollar for dollar. Beyond that, they will match 50% of the next 2% your pay you contribute.
  • Matching funds must be made to a traditional account – they cannot be contributed to the Roth account, so if you’re using the Roth option, you’ll have two TSP accounts.

To get a sense of how much that equates to in terms of savings, assume your base pay is $80,000. If you contribute 5% of your pay, you’ll be saving $4,000 per year and your agency will match another $4,000 for total savings of $8,000. Making the maximum contribution in 2019 would mean total savings of $24,000 if you were under the age of 50, and $30,000 if you are 50 or over. It might be difficult to save that much given all your other expenses, but the point is it is technically possible.

Investing in Your TSP

Once you have set up and funded your TSP, you now you face your next decision – how to invest. The TSP doesn’t have many investment options, but the good news is that the options it does have are broad-based and low cost and meet the needs for most investors. Here is a brief rundown of the options:

G Fund – the G fund is unique to the TSP because it invests in a treasury security issued specifically for the TSP. The rate of return is guaranteed, but over the longer term, the G fund will typically have the lowest return of any of the TSP options. The G fund is similar to stable value funds often found in 401k plans.

F Fund – the F fund is similar to the G fund in that it invests in bonds, but unlike the G fund, the return isn’t guaranteed. Despite the lack of a guarantee, returns are apt to be much more stable than the funds that invest in stocks, although bond returns have historically trailed stock returns over the long-term. The AGG exchange traded fund, which is meant to track the U.S. investment grade bond market, is a good proxy for the F fund.

C, S and I Funds – these are index investments that are meant to track large cap, small/mid-cap and international stocks respectively. As with all index funds, the goal is for the funds to remain fully invested and accurately replicate the market they are tracking. Fund management does not try to time the market nor pick winners and losers in terms of individual stocks or bonds. The SPY exchange traded fund is very similar to the C fund, and the same is true for the EFA ETF and the I fund. The S fund doesn’t have a close ETF analog.

In terms of risk, the C, S and I funds are riskiest as they invest in individual stocks as opposed to bonds. Within the stock funds themselves, the S fund and I fund have historically been a bit more volatile than the C fund.

How you build a portfolio from these investment options depends mainly on the return you need to meet your financial goals and how much risk you’re willing to accept. Projecting returns based on historical data and your weighting in each fund is fairly straightforward, but risk is a bit trickier to quantify. We’ve written a bit about how to think about risk in this post.

If you don’t have the time for or the interest in building your own portfolio, the TSP offers the L or Lifecycle funds. To invest in an L fund, you’ll typically choose the fund with the date that is closest to your retirement. Each L fund invests in some combination of the G, F, C, S and I funds, and the proportion of those underlying funds depends upon the retirement date you have chosen. The allocation of the underlying funds changes over time, and the closer you are to the date indicated by the L fund, the more conservatively invested the fund becomes.

Withdrawing from your TSP

TSP withdrawal options are complex, and what drives the complexity is the sheer number of options as well as the fact that the options are taxed differently. To understand your options, we’ve found it helpful to divide withdrawing your TSP account into a few broad categories and to look at a few general tax principles. The categories of withdrawals we use are as follows:

Currently Working for Federal Government, Need funds – the TSP is designed to help fund retirement, and we’ll provide the standard financial advisor disclaimer here that you really shouldn’t be withdrawing from your retirement account for non-retirement expenses. Having said that, you may find yourself in a situation in which you have no choice but to withdraw funds from your TSP. Fortunately, the TSP allows you to take a loan from your TSP and as long as you pay the balance back (plus interest), the loan is not taxable.

You can also take an in-service withdrawal, although if you are under 59 1/2, the withdrawal must be due to financial hardship. In the case of a withdrawal, any pre-tax contribution you take are taxable, and you may also have to pay a 10% early withdrawal penalty. As we stated above, you should try to avoid taking a withdrawal from your TSP to cover expenses pre-retirement, but if you must take a withdrawal and you think you’ll be able to pay back what you withdraw, a TSP loan is generally the better option. More information about these types of withdrawals, otherwise known as TSP in-service distributions, at this link

Separating from Federal service, Continuing to Work – if you’re leaving Federal service to work elsewhere, you’ll have the option of rolling over your TSP funds to an IRA or a Roth IRA, and if your employer has a retirement plan, you may also have the option of rolling your TSP funds into that plan. If you have traditional and Roth balanced, they will be rolled into separate accounts. Lastly, you’ll typically have the option of leaving your funds in your TSP account, so before completing a rollover, make sure you’re clear on why you want to roll the funds over and make sure you understand the fees associated with the account and investments you’re considering for the rollover. As for taxes, rollovers that are done correctly are not taxable. To avoid any confusion with the IRS, you should roll funds directly from the TSP to the institution that custodies your rollover account. Having funds sent to you, in your name, and then redepositing them in the new account can be problematic and lead to a large, unexpected tax bill.

Retiring

The primary reason for the existence of the TSP is to support you during retirement, and there are a number of different withdrawal options when you retire. You can find a detailed overview of TSP withdrawal options at retirement here, but a broad outline of those options is as follows:

  • Rollover
  • Partial Withdrawal
  • Periodic payments
  • Life annuity

Which option you choose depends upon your particular circumstances, and if you have completed a financial plan, you should have a good idea of which options best meets your needs. Here are high level details on each option.

  • Rollover – when you separate from service, you have the option of rolling some or all of your TSP funds to an outside account. If you’re completing a rollover because you’re retiring – and not going to work elsewhere – your two rollover options will be a traditional IRA account or a Roth account. Which type of account you choose will depend upon whether you’re rolling over funds from the traditional TSP or the Roth option TSP. In either case, when done correctly, the rollover will not be taxable.
  • Partial withdrawals – you may not have a need for a regular stream of income from your TSP, and in that case, a partial withdrawal might make the most sense. The problem with the TSP has been that, historically, you were only allowed to make one partial withdrawal. Once that withdrawal was complete, you had to choose from one of the other three options above. Fortunately, the situation is changing as of September 15th, 2019. From that point forward, retirees will be able to take a partial withdrawal every 30 days, and the amount of that withdrawal can be changed as needed.
  • Periodic Payments – there are two periodic payment options with the TSP. One option is to request a specific dollar amount be withdrawn on a monthly basis, and you can change the amount received during the annual change period. A second option is to request that the TSP make monthly payments to you based on IRS life expectancy tables . The amount will change annually, and the updated amount will be based on your age and the account balance. You can make a one-time only switch from TSP-calculated payments to the specified dollar amount approach.
  • A life annuity – the life annuity option shouldn’t be confused with your FERS annuity, and it also differs from the periodic payment option based on your life expectancy described above. The life annuity option involves transferring some or all of your TSP funds to an annuity provider, and that annuity provider will provide a guaranteed payment based on a series of options. The simplest option is to choose a single life annuity with no additional guarantees or features. In that case, the life annuity will pay a specified amount to you for the balance of your life – no matter how long you live.
    Options get increasingly complex from there, and the most common option is to continue to provide some level of payment to your spouse should you predecease him or her. Beyond that, there are also options to increase payments to keep pace with inflation up to a certain level, and options to provide a cash refund or continued payments for 10 years from the date you began receiving payments even if you pass away during that period. Each of these choices results in a payment that is lower than the payment under a simple single life option, but for many annuitants, the additional guarantees are worth that cost.

To complicate matters further, you can choose certain combinations of the options listed above. In choosing the best option, make sure you have a clear picture of your retirement income as well as your retirement needs.

Taxes on Withdrawals

The guiding principal when it comes to paying taxes on the TSP is that you’ve got to pay taxes at some point. If you avoid taxes now by contributing to the traditional account, you will pay taxes in the future whenever you withdraw those funds. The converse is true with the Roth option – you’ll pay tax now but owe nothing when you withdraw.

Withdrawals from the traditional account (or any traditional IRA or pre-tax retirement account) are taxed as income in retirement. Further, the IRS requires that you begin taking withdrawals from traditional IRAs at age 70.5, and minimum distribution rules also apply if you have a traditional 401k or TSP and are separated from service. You’ll need to take the withdrawals regardless of whether or not you need the funds, and if you haven’t taken previous withdrawals, your taxes will likely increase as a result.

The Thrift Savings Plan is a key part of your Federal Government retirement benefits. Make sure you understand your options and, more specifically, which options work best for you.