The Federal Employees’ Retirement Systems (FERS) Act of 1986 created the Thrift Savings Plan (TSP) which began life on January 1st, 1987.
Created to provide federal employees and uniformed service members something closely modelled to 401(k) plans available to private sector employees, the TSP has grown into the single largest defined contribution plan in the world with over 6.5 million participants and more than $827.2 billion in managed assets.
The TSP is only open to federal employees and uniformed service personnel who, depending on the date they began employment, are either automatically enrolled in the program or required to opt-in.
Employees who began or re-joined federal service after October 1st, 2020, were automatically enrolled in the TSP with 5% of basic salary deducted and added to their TSP account. Between August 1st, 2010, and September 30th, 2020, enrolment was automatic at 3% of base pay.
All employees hired before August 1st, 2010, must opt-in to the TSP.
Of course, employees are free to either lower their contributions or stop them completely, however, this means losing out on incredibly generous match from the government!
In this article, I’m going to explain the basics of the TSP and highlight both the positives and negatives of the plan and put to bed some of the popular misconceptions about the TSP to help inform any financial decisions you might face now or in the future.
TSP vs 401(k)
While the TSP and a 401(k) are similarly structured there are some important distinctions.
Just like a 401(k), the TSP has the same contribution limits – $22,500 for 2023, with employees aged over 50 allowed an additional $7,500 catch-up contribution.
Deployed personnel have a maximum annual addition limit of $66,000 to account for tax-exempt combat zone contributions and any special pay or bonuses.
Just like a 401(k) there are also penalties for early withdrawals (10%) before the age of 59 ½.
On paper, both identical. But it’s in the details that the differences begin to show.
Fees
TSP fees are incredibly low! Averaging 0.055% annually, that is a long way short of the average annual 401(k) fees of 0.5% (although it can be as high as 2%)
That means the average 401(k) costs you 10 times more than the TSP which makes a sizeable dent on your balance over time.
To put it into cold figures, on a $10,000 balance, yearly fees with the TSP are $5.50, whereas the average fees for a 401(k) are $50.
Over 25 years that’s $137.50 (TSP) compared to $1,250 (401k).
Employer Contributions
Even if an employee doesn’t contribute to the TSP, the government will contribute 1% of the employee’s annual salary to their TSP.
This works on a sliding scale up to 5% of annual salary, meaning that when an employee contributes 5% of their salary, the federal government contributes another 5% to make it 10% in total.
Employer contributions in the private sector are nowhere near as generous, with the average 401(k) employer match sitting around 3%.
Investment Options
One of the biggest differences between a 401(k) and the TSP are the number of investment options available. The TSP offers 15 funds that employees can invest in.
Ten of the funds are Lifecycle Funds (target-date funds) that become more conservative the closer the employee gets to retirement that are designed to allow an employee to invest their entire portfolio in a single fund to achieve the best expected return.
Five of the funds are Individual Funds that employees can spread their balance across.
The C Fund – tracking the S&P 500
The F Fund – covering the entire US bond market
The G Fund – short-term bonds with government guaranteed principal and interest
The I Fund – an international stock investment fund
The S Fund – Small cap and midcap US companies
Last year, the TSP began offering a mutual fund window, allowing employees to invest a portion of their balance in private-sector mutual funds.
This makes investment choices a lot simpler and easier to understand compared to a 401(k) which will have far more complex options and different investment avenues to understand and consider.
Roth Options
Since 2012, the TSP have offered Roth versions for all their 15 funds.
The difference between the traditional TSP and the Roth TSP is when you pay the tax.
In the traditional TSP, the money you put into the TSP is not taxed, reducing your taxable income but is taxed when you withdraw it.
The Roth TSP is the reverse, you pay the tax on your contributions at the time, but it is tax free when you withdraw if you are over 59 ½ and have had money in the account for over 5 years.
There are some important things to consider when choosing between a traditional TSP and a Roth TSP.
Where you are planning to retire is one – a high-tax state or a low-tax state.
Do you expect to be in a higher tax bracket at retirement?
For many younger employees, it makes sense to pay the tax now while they are still in a lower tax bracket.
Bureaucracy
With any federal program, especially one as large as the TSP, the slow pace of bureaucracy and government departments are inevitable.
Improvements and modernisation move at a snail’s pace, with any change requiring a bill to be passed.
This means that the process for retirees accessing their money can be frustrating.
Each partial withdrawal needs a notorized signature from the account owner and if you are married, your spouse will need to sign too.
Long wait times in service centers also slow down getting money to beneficiaries.
The security processes for account authentication are antiquated and are in desperate need of an update – as with many federal systems, better technology exists but will be expensive to implement.
Without a doubt, the Thrift Savings Plan is an incredible choice even with the typical federal program issues.
The program may not have the flexibility of a 401(k) but that flexibility isn’t necessarily the best choice for most investors unless you really understand the markets.
The simplicity and clarity of the program, the very low fees and excellent matching contributions make the TSP an exceptional retirement fund vehicle, run by an independent Federal agency, required by law to act solely for the benefit of participants and beneficiaries.
Making the right decisions now on how best to approach your Thrift Savings Plan options, maximize your investment and reduce your tax burden is a vital step towards fulfilling your retirement plans.
At Beyond Financial Planning, LLC we will make sure that you have the guidance and advice so that every decision you make is designed to support you and your family’s future.
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