If you’re in the military, you’ve probably heard about the Thrift Savings Plan (TSP). Heck, you may even contribute to it. But what is it, how does it work, and why should you contribute?
TSP is the government’s user contribution retirement savings program, similar to a private employer’s 401(k) account. Military members and government civilians contribute money directly from their paychecks into their TSP retirement plans. TSP is a simple, convenient, and inexpensive way to build your retirement portfolio in a tax-advantaged retirement program. In addition, the 2012 introduction of the Roth TSP accounts provides more options for savers to reach their retirement goals. The money can be invested in different funds, and (hopefully) grows in value. Withdrawals, called distributions, are subject to a variety of limits and rules.
Why Should I Contribute To TSP?
Most people will stop working for an income eventually, either because they choose to retire or because they become unable to work. Contributing to a TSP account gives you retirement funds that are 100% in your control, whether you remain in the military or leave for the civilian world.
When you reach retirement, you can convert your account balance into an annuity for a lifetime income stream, cash in your account for a lump sum payment, or take a series of payments over a selected time period. You can even do a combination of them, perhaps taking a lump sum to pay off your mortgage and then converting the remaining balance into an annuity.
Most military service members will not qualify for retirement pay unless they remain in the service for at least 20 years. Your TSP account remains yours, whether you get out after one four-year enlistment or suddenly decide to resign at 19 ½ years.
How Do I Sign Up for TSP?
Enrollment in TSP is super-easy. You can enroll online via the MyPay system, or you can use Form TSP-U-1 and turn it in to your finance office. More directions can be found at the TSP website, www.tsp.gov. When you sign up, you have three choices to make:
- which kind of account you want to open (Traditional TSP or the Roth TSP)
- the amount that you want to contribute each month
- which fund(s) you want to purchase
Once you’ve figured out those issues, the actual signing up part is easy-peasy.
What Happens To The Money?
TSP has five different funds with a range of investment options, risk, and volatility. You may choose your allocation between these five funds based upon your own long-term goals, or pick one of ten Lifecycle funds that automatically rebalance your asset allocation over time based upon your identified retirement date. You purchase shares of these funds. The funds then invest that money according to the objectives of the fund. You can put your entire contribution into one fund, or split it up between multiple funds.
Roth or Traditional?
Once you’ve decided to open a Thrift Savings Plan (TSP) account, you have to choose between a traditional TSP account and a Roth TSP account. The primary difference between these two accounts is when you pay taxes. If you are familiar with traditional and Roth Individual Retirement Arrangements (IRAs), you already have a head start on understanding the differences between the traditional and Roth TSP accounts.
Traditional TSP Accounts
With a traditional account, money is contributed to your TSP account before you pay income taxes. This reduces your taxable income in the year that the money is contributed. Money grows in your account, and you will pay taxes on the contributions and your earnings when you take money out of the account.
Times this might be a better choice for you are:
- if you have some reason to anticipate that you will be in a lower tax bracket during retirement
- if you think that our country is going to decrease its income tax rates
- if you are on the border for certain income tax credits, such as educational credits
Roth TSP Accounts
With a Roth account, money is contributed to your TSP account after you pay income taxes. Distributions, including both the contributions and the earnings, are tax-free if five years have passed since 1 January of the year in which you made your first Roth TSP contributions, AND you are 59 1/2 years or older, disabled, or deceased. Tax-free income is almost always a good thing.
How To Choose?
Which account is right for you? That depends on a number of factors, including your tax bracket now, your anticipated tax bracket in retirement, and what you think is going to happen to our country’s tax structure in the future. Don’t forget that you can also choose to put a portion into each account, although the math gets a little trickier.
Most financial advisors feel that a Roth TSP is a better choice long-term in most situations. Yes, you will pay more income tax now, but all distributions are tax-free. I’ve not yet heard anyone say, “Gee, I wish I hadn’t paid those taxes before.” If you are currently paying no federal income tax due to a deployment or low income, choosing a Roth TSP account is brilliant. No taxes now, no taxes later.
What If I’m In A Tax-Exempt Combat Zone?
Money earned while in a Combat Zone Tax Exempt location receives special treatment when contributed to either a traditional or Roth IRA. Distributions of tax-exempt contributions are always exempt from federal taxation, but the distribution of earnings on these contributions may be taxable. The earnings from the tax-exempt contributions to a traditional TSP account will be taxed at distribution. The earnings from tax-exempt contributions to a Roth TSP account will remain tax-free at distribution, provided you’ve met the rules as listed above.
Understanding the differences between a traditional TSP account and a Roth TSP account allows you to make the best decision for your particular situation. If you absolutely can’t decide, I recommend choosing a Roth account and moving forward. You can always change the allocations of any future contributions if you change your mind. Don’t let this decision keep you from contributing to a TSP account.
Contribution Limits and How Much To Save
When it comes to the amount that you contribute to your Thrift Savings Plan account, there are two issues: the federal government’s TSP contribution limits, and how much you feel you can contribute. Both are important parts of the equation, and understanding them both will help you to make an overall plan for contributions during your time in the service.
TSP Contribution Limits
Federal law limits contributions to tax-deferred savings accounts like TSP. For 2021, the regular contribution limit is $19,500. This limit is for taxable income, including base pay, incentive pay, special pay, and bonus pay. This limit is called the elective deferral limit.
There are special rules for non-taxable income, such as income earned while in a tax-exempt combat zone. This limit is called the annual addition limit or I.R.C. Section 415(c) limit. For 2021, you can have a total contribution total of $58,000. There are some tricky bits of the tax code as it applies to contributions that exceed the elective deferral limit and enter into the annual addition limit area – be sure to get good advice when making these contributions, or read my friend Doug’s explanations here: Maximizing Your Thrift Savings Plan Contributions In A Combat Zone.
If you are aged 50 years or older, or will turn 50 during the 2021calendar year, you can also make additional “catch-up” contributions of $6,600. This additional $6,600 is on top of both the elective deferral limit and the annual additional limit. This is called the “catch-up contribution limit.”
How Much Should I Contribute?
The short answer is: as much as you can. However, different situations require different strategies. In figuring your total contributions, I want you to look way beyond your current situation and look into the future. How much money would you like to have saved by the time you separate from the service? I think this is one aspect of TSP planning that is very different from any other retirement planning. Unlike Individual Retirement Arrangement (IRA) planning, you can’t count on decades of contributions. You can only contribute to your TSP account while you are serving, or if you move to a government position. For most of us, that means 4 or 8 or 20 years of contributions, not 30 or 40. That makes a big difference.
Even if you think you know how long you will remain in the service, there is always the possibility that an injury, a drawdown, or some other surprise could cut your military service short. This is why I really encourage members to save as much as they can manage from the very beginning of your career.
Once you are looking at the big picture, you can make smart decisions about timing your contributions to take advantage of tax-free pay and other issues. No matter how you cut it, more is always better.
How Do I Start Saving?
One important thing to remember about TSP contributions is that you can change them regularly and easily via MyPay. That is why I encourage people to aim high when planning their TSP deductions – you can always lower them if you just can’t possibly manage with the amount you planned. You can make changes as frequently as you want, always considering the contribution limits listed above. Changes will happen either in the month you make the change or in the next months.
Contributions to Roth and Traditional TSP accounts are designated differently. Contributions are designed as a percentage of base pay, incentive pay, special pay, and bonus pay. Contributions to TSP accounts can be managed and changed via your MyPay account. Be sure to click all the way through the pages to ensure that your changes are recorded properly, and maybe check back in a few weeks to verify that the changes “stuck.”
Contributing is always good, contributing more is always better, and making thoughtful decisions that look at the big picture is the best. Consider carefully how many years you might have to contribute, the likelihood that your timeline will be cut short, and how you can maximize any potential tax-free contributions and increased contribution limits for tax-free amounts. Most of all, just save!
Thrift Savings Plan Funds: Which One Is Right For You?
There are a variety of factors to consider when selecting a fund for your TSP investments. You need to consider your tolerance for risk, and also look at your entire financial picture. Every investment carries a level of potential gains, and a level of potential losses. The balance between those two is defined as its level of risk. Investments with little potential for loss, but also smaller potential for gain, are considered very safe. Investments with huge potential for gains, but also huge potential for loss, are considered very risky. Most investments fall somewhere in the middle, with some potential for loss and some potential for gain. A decision about investment risk is very personal. You have to consider whether you would be more comfortable with smaller, guaranteed returns or the possibility of making great gains or taking great losses. Investing should not make you stay up at night, worrying about your choices. A good investment plan has a balance of risk and safety that allows you to meet your financial goals and be happy with the decisions that you’ve made.
One thing that I think is seriously under-considered is how a TSP investment falls into your greater retirement plan. As a retirement savings tool, it is important to consider your other retirement savings tools when choosing how to invest your TSP money. Perhaps you expect to receive a military retirement and Social Security. A military retirement is extremely safe, lifetime income that is adjusted for inflation. Therefore, you can assume more risk with your other retirement assets and still have balance in your overall retirement plan. On the other hand, if you are planning to leave the military after a few years and start your own business, you may want to invest your TSP contributions in more safe investments to offset the inherent risk of starting a business. For every situation, there is a balance of security and risk that makes sense and makes you feel comfortable.
The G Fund
The G fund is the Government Securities Investment Fund. It used to be the default fund, and if you did not select a different allocation for your contributions , your money ended up in G fund.
The G fund’s objective is to avoid risk and produce a rate of return that will outpace inflation. The G fund invests only in specific, short-term U.S. Treasury security that is only sold to the TSP. Earnings come from interest income on these securities. The G fund will never lose money but it is subject to inflation risk, which is the possibility that inflation could grow faster than the value of the G fund. This decreases the purchasing power of the money invested in the G fund.
Leaving your money in the G fund is the single biggest TSP mistake I hear people make. There are very unique situations where the G fund makes sense, but they are rare. If you’re in the G fund, make sure you understand exactly why you’re there. Or better yet, move to a different fund(s) that meet your goals.
The Index TSP Funds
There are four index funds: the F Fund, the C Fund, the S Fund, and the I Fund. An index fund is an investment designed to match the performance of an index of a specific financial market. A stock market index is a tool for measuring the value of a portion of the stock market. Examples of stock indexes are the Dow Jones Industrial Average, the NASDAQ Composite, and the S&P 500. Each one measures the value of a certain sector of publicly traded stocks. Index funds are passively managed and do not change their holdings frequently. Each of the four funds offered by TSP attempts to replicate the index of a different sector of the stock market.
The F fund is the Fixed Income Index Investment Fund. Its objective is to match the performance of the Barclay’s Capital U.S. Aggregate Bond index, which represents the overall U.S. bond market. It includes U.S. Government bonds, mortgage-backed bonds, corporate bonds, and foreign government bonds. Money is earned through the interest paid on these bonds. The F fund may have larger growth than the G fund, but it is subject to more kinds of risk. The F fund’s value moves with the bond market and, therefore, is subject to market risk. This means that the value of your investment may move up or down. In addition, there is risk of default, meaning that the issuing company or government could fail to repay the money used to purchase the bonds. The F fund is also subject to inflation risk, where the growth of the fund is smaller than the growth of inflation. Lastly, F fund investments are subject to prepayment risk, which is where the purchased bonds are paid back earlier than expected and the fund is forced to reinvest at lower rates. The F fund is right for you if you want to invest in bonds.
The C fund is the Common Stock Index Investment Fund. Its objective is to match the performance of the Standard and Poor’s 500 (S&P 500) index, which is made up of stocks of 500 medium-sized and large-sized U.S. companies. Money is earned through the growth in value of the stocks, and also through dividends issued by the stocks. The C fund has the potential for larger gains than the G or F fund, but it is subject to market risk. Market risk is the rising and falling of the value of individual stocks inside the fund. C fund investments are also subject to inflation risk. The C fund is right for you if you want to invest in large, U.S. companies. The S fundis the Small Cap Stock Index Investment Fund. Its objective is to match the performance of the Dow Jones U.S. Completion Total Stock Market index, which is made up of stocks of small-sized to medium-sized U.S. companies that are not included in the Standard and Poor’s 500. Money is earned through the growth in value of the stocks, and also through dividends issued by the stocks. The F fund has the potential for larger gains than the G or F funds, but also subject to market risk and inflation risk. The S fund is right for you if you want to invest in smaller, U.S. Companies.
The I fund is the International Stock Index Investment Fund. Its objective is to match the performance of Morgan Stanley Capital’s International EAFE (Europe, Australasia, and Far East) index, which is made up of stocks from around the world. Money is earned through the growth in value of the stocks, dividends issued by the stocks, and changes in currency valuation. The I fund has the potential for larger gains than the G or F funds, but is also subject to market risk, inflation risk, and currency risk. Currency risk is the potential for losses due to the rising and falling of the value of the US dollar versus the currency in which the stock is traded. The I fund is right for you if you want to invest in international companies.
The Lifecycle TSP Funds
Traditional investment wisdom suggests that you should invest in more aggressive stocks and bonds earlier in your investment life, and gradually move towards more safe investments as you get closer to retirement. In order to make the process simple for investors who don’t want to make a lot of decisions for themselves, the TSP created Lifecycle funds (L funds). These funds use pre-determined investment mixes designed to meet specific investment objectives based upon the target retirement date. L funds invest in the G, F, C, S, and I funds. The funds are automatically rebalanced as the L fund moves closer to its end date. The L funds are subject to all the same risks as the individual funds in which it is invested. L funds provide a simple, diversified portfolio that requires little effort on your part.
The choice of TSP fund is very individual and should include a comprehensive look at your entire retirement income portfolio. However, don’t let analysis paralysis mean that you don’t start contributing. If you have to, just pick one and get started. You can always change your mind later, and making adjustments is quick and easy online.
After putting money into your Thrift Savings Plan (TSP) account, you will someday want to take distributions from your account. There are three basic situations for taking money out of your account: regular retirement distributions, in-service distributions, and loans (not technically a distribution.)
How and When Do I Get My Money Out?
Withdrawals from a qualified retirement account are called distributions. There are federal laws that govern the distribution of money from qualified investment accounts.
The withdrawal options for TSP accounts include:
- Make a single payment, or “lump sum” withdrawal. You will liquidate your entire TSP account and receive the balance in one payment. Any taxes due on a traditional TSP account would be calculated on the entire sum.
- Set up a series of monthly withdrawals. You can have this figure calculated on your life expectancy, or you may designate a certain dollar amount to be distributed each month. Either way, payments will end when the account is empty. Any tax payments will be spread out over the distribution period.
- Purchase a TSP annuity. An annuity is a contract to provide lifetime income to one or two people in exchange for an initial payment. Under the annuity option, the TSP uses your account balance to purchase an annuity from a private company. This is a permanent decision and can not be changed. The taxability of annuity payments depends on the taxability of the account whose funds purchased the annuity.
- Have any combination of the above.
You must be taking the required minimum distributions by the time you reach age 72.
What If I Need My Money Before I Reach Retirement Age?
There are a variety of different ways to access money in your TSP account before retirement age.
Full disclosure: I am not a tax professional. This information is for your education, so you can have smart conversations with your tax professional or financial planner. Also, rules change all the time. Verify that this information is accurate at the time you take action.
If you are still serving in the military or working for the federal government, you can take out a loan against your TSP balance. TSP loans can be used for any purpose. There are special terms and conditions if the loan is made for the purchase of a home. The money borrowed is removed from your TSP account. Repayments, including interest, are returned to your account. Repayment must be made via payroll deductions. If you leave federal service, your TSP loan is due in full and must be repaid within 90 days. If it is not repaid, it will be converted to a taxable distribution.
In-service withdrawals are available to TSP participants who are currently employed, either in federal service or in the armed forces. TSP in-service withdrawals are only available for documented financial hardship, or TSP participants over aged 59 ½ may make one age-based in-service withdrawal during their life. In-service withdrawals remove the funds from your TSP account permanently and carry a variety of consequences, including tax issues and reduced ability to make subsequent contributions.
I really love the TSP for its convenience, low costs, and many options. My only regret about TSP is that my husband didn’t start contributing more money earlier in his career, and that we didn’t know we could contribute more with deployments. With a limited number of years to contribute, making a larger effort is important for building up a sizable account balance. However, even smaller savings can add up. Don’t procrastinate – start contributing to your TSP account today!