The area of retirement planning has always posed a dilemma for workers, with policymakers struggling hard to persuade workers to save more for the golden years. For most Americans, 401(k) plans are one of the most commonly available plans; despite this they have mired in controversy for a number of years. A viable solution that has been hidden in plain sight for a number of years is the federal government’s retirement plan known as Thrift Savings Plan (TSP). This plan has the same function as a 401(k) plan, but it offers numerous advantages that 401(k) and other similar private plans lack.
401 (k) plans have been under constant assault by the critics, who claim that these plans charge high fee and lack the commitment that companies show by reducing employer contribution when times are tough.
TSP is the federal government’s retirement savings plan for federal personnel and members of uniformed service. According to current statistics, it is the largest 401(k)-like saving plan in terms of invested balance and number of participants. This article will take a look at some of the positive and negative aspects of TSP, how to start your TSP contributions along with a few strategies to incorporate the plan into your portfolio.
What is a Thrift Savings Plan?
TSP is a component of US federal employees’ retirement system, which comprises of the Federal Employees Retirement System known as pension, social security and TSP itself. Being a defined contribution plan, TSP is available to both military and civilian employees of US Federal government. It offers both Roth and Traditional accounts.
Starting Your TSP Contributions
You require at least 1% of your basic pay to participate in TSP, whether Roth or traditional TSP contributions. As Roth TSP is computed on the basis of your gross pay, but is deducted from your net pay, you will have to do the calculations to ensure you have the requisite net amount that is eligible for Roth contributions. Similarly, a traditional TSP also has various deductions, which are taken first; you will have to do the calculations to ensure you have the requisite pay that is eligible for a traditional TSP.
If you are planning on making a Roth election (or merging a Roth election to traditional election) you will have to utilize the Roth election worksheet. Use the worksheet in order to calculate Roth contribution from your basic pay, incentive pay and special pay and a different worksheet to calculate Roth contribution from your bonuses and one-off special pay.
Carefully consider the aggregate maximum percentages chart in case you plan to have both a Roth and a traditional election. Select the chart that matches your situation. It is vital to utilize these tools to avoid the possibility of running out of net pay to cover your contribution.
Why is the Thrift Savings Plan great?
TSP is an attractive option for investing your retirement funds due to a number of various reasons, which are listed below.
- TSP offers extremely low expense ratios on its mutual fund investments that are managed by BlackRock. The plan’s 5 target date funds as well as 6 core funds have an expense ratio of only 0.029% (currently), meaning it charges only $2.9 on every $10,000 invested.
- You will be delighted to know that apart from the above expense ratio, TSP has no other fee.
- TSP offers a good selection of funds. The plan’s 5 core funds thoroughly cover the major asset classes. These 5 funds along with their respective indices are:
- C Fund: Invests in large-cap US stocks – S&P 500, which accounts for 81% of the US stock market
- S Fund: Invests in mid-cap and small-cap US stocks – DJIA’s Total Stock Market Index, which makes up 19 % of the US stock market
- I Fund: Invests in international stocks like Australasia, MSCI Europe and Far East Index
- F Fund: Invests in US bonds – Barclays Aggregate Bond Index
- G Fund: Invests in special fixed income instruments which have no private equivalent
- TSP offers G Fund, which is the closest an investor can get to a free lunch. This fund comprises especially-issued United States treasury securities that guarantees an investor against the loss of principal
- TSP also offers lifecycle funds, its Lifecycle target date fund offers a suitable mix of 5 core funds that vary in terms of percentages as the target date approaches
- TSP is one of those plans that are almost good for life. Even after you part ways from your federal service you have the option to keep your account open and incorporate eligible retirement plans into TSP
- The Thrift Savings Plan is not very generous in terms of withdrawal options, which are very limited. The plan permits you only a single partial withdrawal before compelling you to withdraw the complete balance. This indicates that when you reach retirement age it is very likely that you will be making major IRA rollovers.
- Another issue is that you don’t have the option of converting your traditional balances to a Roth balance
- Although the ‘I fund’, which comprises of your portfolio, is good, it is not great. It is the weakest of the 5 core funds. The fund ignores Canadian markets, small-cap international stocks and emerging international market stocks. Privately managed international stock funds like the Vanguard’s Total International Stock Index usually offer greater diversification, but this comes at a slightly higher cost.
- Another downside is that 1% automatic matching has a vesting period of 3 years. Agency matching, on the other hand, up to 5% has no vesting requirements. An investor’s own contributions always vest immediately.
- Matching is on the basis of per-check. If you hit the $18,000 contribution limit by 2015 before the final paycheck, it means that you will end up missing a significant portion of your agency match.
- Another problem is that the Defense Department does not match service members’ contributions. Only civilians in the FERS retirement system are currently eligible for agency match
- The last issue is that there are no post tax contributions. Members of TSP have a limitation of $18,000 (2015) annual contributions.
How to Use Thrift Savings Plans?
In case TSP is your sole retirement fund, then it is worth knowing that Lifestyle fund offers what most target date funds offer: automatic rebalancing and allocation for no cost. With an expense ratio of 0.029%, the L2020-2050 funds and L Income fund are the most available and cheapest target date funds.
On the other hand, if you have multiple accounts, the TSP can help you in reducing your overall expense ratio by replacing your taxable or IRA account with a TSP option. The G, S and F funds are especially much cheaper compared to their large public counterparts.
If you are interested in matching, then better hit the $18,000 yearly contributions limit close to the end of the year for maximizing matching amount.
If you are planning to separate from government service, you can have a minimum of $500 each in both a traditional TSP account and a Roth TSP account. This will enable you to make transfers which will be eligible for conversion into TSP later. The minimum retention amount for a TSP account is currently $200.
Also know that the G fund is definitely the best fixed income fund that you can invest in. It reduces, to a great extent; both credit and market risk and guarantees your principal amount. However, it is vulnerable to the risk of inflation, but in terms of low risk, few funds come close to it. President Obama’s myRA objective was to expand access to securities that formed part of G fund.
Changing Your TSP Elections
A change in your lifestyle or financial needs can lead to a change in your goals. Whether you want to cut down your election contributions in order to manage the home budget or raise them to satisfy future objectives, it is mandatory that you submit contribution percentage of all the different categories of pay when modifying elections.
For instance, if you are happy with a majority of your current elections, but would like to raise the percentage of basic pay, it is mandatory that you repeat current elections for each category of pay along with increase in your basic pay percentage. Failure to do so will cause your election contributions to be recorded as 0%.
The TSP is, without doubt, one of the best advantages that a federal employee can enjoy. It offers low- cost access to a wide variety of securities, and gives a decent match and access to the coveted G fund for civilians. However, the TSP has its drawbacks, but these will be overcome hopefully in the future if the TSP board aligns the features of this plan with the offerings of the private industry with regards to in-plan conversions and flexible rollovers/withdrawals.