I’ve been asked to write a post about the Thrift Savings Plan (TSP), so this will be a bit of a back to basics post for those who are eligible for it. The TSP is basically the 401(k) for federal employees including military members. There is no profit-sharing component to it, so the employee is generally limited to an $18,000 per year employee contribution ($24,000 per year if 50 or over) plus any match she may qualify for.
Roth Option
When I was in the military, there was no Roth TSP option, but there now is. While most people should probably use a tax-deferred option instead of a Roth option during their peak earnings years, that is not the case for many TSP-eligible folks. Those in the military are probably in a ridiculously low tax bracket (thanks to low pay, probably no state taxes, and a large percentage of their income from non-taxable allowances and tax-exempt war zone pay) now, so they should generally use the Roth option. In addition, many military and federal workers will have a pension in retirement and the more taxable income you have in retirement, the better Roth retirement accounts become.
The Match
Federal workers (FERS) have had a match (1% of your pay plus 100% of the first 5% of your pay you put in up to a total of 5%) for a long time, but when I was in the military, there was no TSP match. However, the secretary of each of the various services can authorize a match at any time. Occasionally it will be offered for some critical specialties. The Army at one point had a test program going where they would match 100% of the first 3% of your pay that went into the TSP and 50% of the next 2%. With the new “blended retirement system” (automatic for those entering military after Jan 1, 2018 and optional for those already in military) military members will get the same match as federal workers along with significant changes to the pension system. Those changes are much better for those who don’t stay in 20 years since the pension previously had “cliff vesting” and the TSP had no match.
Why The TSP Rocks
The TSP may be the best 401(k) in the country. It has rock bottom expense ratios (people are literally complaining that the ERs increased to 3.8 basis points recently), broadly diversified index funds, and simple “Lifecycle” (like Vanguard Target Retirement) funds. In addition, it has the unique G Fund, which offers treasury bond yields with the safety of a treasury money market fund. I’ve written about that free lunch before. There are no additional fees.
The TSP is such a great 401(k), that savvy folks don’t roll their money out of it when they leave the military. Instead, they keep it open and roll money into it at every opportunity.
The Funds
There are five basic funds in the TSP:
- C (“Common Stock”) Fund: Basically a very low cost S&P 500 index fund
- S (“Small Stock”) Fund: An extended market index fund, mostly mid-caps despite the name
- I (International Stock) Fund: A developed market index fund- Europe and Pacific, but no emerging markets
- F (Fixed Income) Fund: A total bond market index Fund
- G (Government Securities) Fund: A unique fund similar to a stable value fund, but backed by the US government instead of an insurance company. As of May 2017, it was paying 2.25%.
In addition to these basic funds, there are also LifeCycle Funds, one for every ten years. The idea is that you pick your retirement date and put all your money in that fund. The asset allocations of these funds in May 2017 were:
- L (LifeCycle) Income: 11% C, 3% S, 6% I, 6% F, and 74% G
- L (LifeCycle) 2020: 22% C, 6% S, 12% I, 6% F, and 54% G
- L (LifeCycle) 2030: 34% C, 10% S, 19% I, 6% F, 31% G
- L (LifeCycle) 2040: 39% C, 12% S, 22% I, 6% F, 21% G
- L (LifeCycle) 2050: 44% C, 14% S, 25% I, 5% F, 12% G
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Like with any retirement date fund, you should pick your fund by the desired asset allocation, rather than the date. Bear in mind these asset allocations are significantly less aggressive than what Vanguard puts in their Target Retirement funds. That’s not necessarily good or bad, just different so be aware of that.
Tax-exempt Contributions
Military members can contribute an additional $36K in after-tax money into the TSP while they are deployed. This is not necessarily the best move given that earnings on that money remains tax-deferred. But if you can figure out a way to get that tax-exempt money into a Roth account, then it is a great idea. Unfortunately, in-plan conversions are not currently allowed.
The Downsides of the TSP
The TSP has been legitimately criticized as well (and for more than just raising ERs by 1 basis point.) Here are the problems I see with the TSP:
# 1 S&P 500 instead of Total Stock Market
Total stock market (TSM) funds are slightly better than S&P 500 funds. Not only are they more diversified, but nobody can front-run them. Together with the inclusion of theoretically higher returning small stocks, TSM should have slightly higher returns.
# 2 No True Small Stock Fund
An extended market fund is a poor substitution for a small stock fund. It’s 46% mid-caps. Of course, that’s not all that different from the Vanguard small cap index fund which is 42% mid-caps. If you want a small cap fund that is mostly small caps on a Morningstar X-ray you pretty much have to buy a microcap fund. But it demonstrates the importance of looking under the hood before you buy.
# 3 Simplicity vs Diversification
The TSP is traditionally very slow to add any additional asset classes. So one big criticism that many have of it is that you can’t buy REITs, TIPS, Small Value funds, Gold etc. Again, that’s not necessarily a bad thing since simplicity helps lots of people avoid dumb mistakes AND keeps costs low. But it forces asset class junkies like myself to build around what the TSP has using Roth IRAs or a taxable account.
# 4 Only One Partial Withdrawal
The big problems with the TSP, aside from the fact that you have to deal with government bureaucracy and military finance offices when using it, are all related to getting your money out of the account. For example, you can only do one partial withdrawal from the TSP IN YOUR ENTIRE LIFE! I’m not talking about while you’re employed (you can’t do one then). I’m talking about after you separate from service. I had to use mine to get my tax-exempt money out into a Roth IRA. But the next time I want to roll money out of the TSP, I’ve got to take it all out. They’ll let you do as many rollovers into the TSP as you like, but it’s a lot harder to get your money out.
# 5 Limited Distribution Options
Speaking of getting your money out, another big issue is when it comes time to spend your money in retirement. You have five options:
- Leave the money in the TSP and just take your RMDs.
- Take it all out- either pull it out and pay the taxes (and possibly penalties) on it and put it in a taxable account or roll the entire thing into an IRA or 401(k).
- Take out a specific dollar amount every month until the money is gone. This amount must be at least $25.
- Take out an amount each month calculated based on your life expectancy. This is not technically an annuity (i.e. no guarantee the payments won’t go down over time with poor investment performance) and the amount you get is recalculated each year.
- Annuitize the account. The annuity can be single, joint, with 100% or 50% to the survivor, and can be flat payments or indexed to inflation.
You can also do various combinations of the last four options. i.e. you could annuitize half of it and roll the other half into an IRA.
# 6 No Mega Backdoor Roth IRA Option
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There are no real in-service withdrawal or in-plan conversion options and the only time you can put in after-tax money is while deployed. Most 401(k)s don’t offer these, but some do!
Loans and Hardship Withdrawals
Like many 401(k)s, the TSP also offers loans and hardship withdrawals. Obviously, try not to. Neither are great options for extra cash. Loans must be repaid upon separation (or it triggers taxes and penalties) and hardship withdrawals may still cause penalties to be assessed (along with the expected taxes.) Either way, it’s certainly going to impede the long-term growth of the account.
Summary
In summary, the TSP is a great 401(k) and you should feel lucky to have access to it. It does, however, have a few quirks you should be aware of. Hopefully it will continue to improve as the years go by.
What do you think? Do you have access to the TSP? How do you use it and why? What do you like and dislike about it? Comment below!