Many people have heard of 401(k) plans but fewer people know about Thrift Savings Plans (TSP)
Both plans allow you to save for retirement. The money is usually invested in stock funds or bond funds to help you accumulate wealth for retirement. What’s the difference between both plans? The 401(k) plans are typically offered through private sector companies. TSPs are only available for federal employees and service members.
Similar to 401(k)s, TSPs allow you to save for retirement through payroll deductions. For 2022, you can contribute up to $20,500. If you are age 50 or older, then you could contribute an additional $6,500 for a total of $27,000. TSPs also allow the employer (agency) to contribute to the plan. However, not all agencies contribute. Contact your agency to find out if your employment agency contributes or not.
For example, if you are a part of the Federal Employees Retirement System (FERS) or the Blended Retirement System (BRS), your employer could contribute up to 5%. There are 2 types of employer contributes: Agency/Service Automatic contributions and Agency/Service Matching contributions.
- Agency/Service Automatic Contribution: Your agency or service will contribute 1% of your pay to your TSP. This is an automatic contribution from your agency regardless if you contribute. This money is from the employer and not from the employee. This money is vested after two years of employment.
- Agency/Service Matching Contribution: Your agency or service will match dollar-for-dollar on the first 3% that you contribute and 50 cents on the dollar for the next 2%. Unlike the automatic contribution, which has a 2 year vesting schedule, you are immediately vested with the matching contributions. If you stop contributing to your TSP, then the matching contributions will also immediately stop.
By combining the Automatic Contribution with the Matching Contribution, you could receive up to 5%. The average salary in the US in 2020 was about $51,000.* With a 5% company contribution, you would receive $2,550 annually. If you get a raise, then the company’s contribution amount would increase. If you aren’t participating in your TSP plan, then you should seriously reconsider. Think of this money as a gift. Would you turn someone down if they were to give you money? If you invest this money properly in the stock market (based on your financial goals, risk, etc.) over a 10 or 20-year period, then it could grow to a significant amount of money for retirement.
One Downside to the TSP would be Limited Investment Choices
There are 5 funds plus a number of Lifecycle funds. The Lifecycle funds automatically rebalance periodically and become more conservative over time. For an investor who wants more investment choices to diversify, the TSP is a disadvantage. If you are working with a financial advisor, you should ask your advisor for help to select the right investment mix in your TSP to complement your other investments.
TSPs Offer a Traditional and a Roth Option
The difference between the 2 options has to do with taxes. Traditional TSP contributions reduce your current taxable income. In other words, you are not taxed on the contribution amount while you are working. However when you withdraw money from the plan, you will pay ordinary income taxes on the contribution amount and on the earnings.
Roth TSP contributions do not reduce your current income. This means that the contributions are taxed when you make them. However when you withdraw money from the plan, the contributions come out tax free since you already paid taxes on them. Plus the earnings could also be withdrawn tax free as long as your first Roth contribution to the plan was made at least 5 years ago and you are age 59.5 or older.
Here are a couple questions to ask yourself about contributing to the traditional TSP or Roth TSP.
- Could my tax rate be higher or lower in retirement than what I’m paying now?
- Should I pay taxes now on my contributions or should I defer the taxes?
If you have questions about contributing to a traditional or Roth TSP, you should talk to your tax advisor and or your financial advisor. If your financial advisor can’t give you tax advice, then think about working with an advisor that can. Some financial planning firms have CPAs on staff to give you tax advice. Ask your financial advisor if his or her firm has a CPA on staff that you could talk to for free.
What Happens to the Money in Your TSP When Your Retire or Quit Your Job?
There are several choices when deciding what to do with your TSP. The two most common options are leaving the money in the TSP or rolling it over into an IRA. Below are some points to consider.
- TSP has a mandatory 20% federal income tax withholding on money withdrawn from the traditional TSP. If your tax bracket is less than 20%, then you could be withholding more money than you should. If you rollover the money into an IRA, then you could select a lower tax withholding percentage.
- If you are between age 55 and 59.5, you may be able to withdraw money from the TSP without an early withdrawal penalty. The early withdrawal penalty is 10% of the amount withdrawn. You would also pay ordinary income taxes on the distribution in addition to the penalty. If you roll over the money to an IRA, then you have to be age 59.5 or older to make a penalty free distribution.**
- At age 72 and older, the IRS requires that you take a required minimum distribution (RMD) from your TSP. The amount you must withdraw is based on your age and the total value of the traditional TSP and Roth TSP. To reduce the amount you must withdraw, you could roll over your traditional TSP money to an IRA and the Roth TSP to a Roth IRA. Then at age 72, you are only required to take a mandatory (RMD) distribution from the IRA and not Roth IRA. This would allow you to keep more money in the Roth IRA to let it grow tax free.
The decision to rollover your TSP to an IRA or Roth IRA should not be taken lightly. If your financial advisor is recommending this, then make sure you understand the fees and expenses involved. Ask your advisor what services would be provided if you were to rollover this money. Besides making the investment selections to manage the account, what other services could the advisor provide? Does the advisor’s firm provide tax preparation? Does the firm have CPAs so you could meet to do complex tax planning? Many firms claim they could help you with tax planning, but they can’t do tax preparation. Make sure you find a firm that provides the services you need at a reasonable cost.
**There are circumstances where you could make a penalty free distribution under the age of 59.5. Consult a tax advisor for more information.
Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.