What is the Thrift Savings Plan?
The Thrift Savings Plan, or TSP for short, is the military and federal government employees qualified pension plan. In other words, it is their version of a 401(k) but there are some important nuances to the TSP you should be aware of as a service member, veteran or government employee.
How Much Can You Save Into the TSP?
The amount of money you can save into the TSP is the same as what you would be able to save into a typical qualified retirement plan at any other organization. This number fluctuates every year but in 2023 the maximum you can contribute is $22,500 for individuals under the age of 50 and up to $30,000 for individuals 50 and over because they have the ability to make catch-up contributions.
There is also a hard dollar cap on total contributions of every year. This cap is referred to as annual additions and for 2023 it is set at $66,000. You may hit this cap if your contributions, the government's matching contributions and the government's automatic contributions total $66,000 or more. This cap takes into account all sources of money (including combat zone tax exclusion, or CZTE, contributions) but does not include catch-up contributions.
This is important to keep track of because if you contribute too much it is possible to squeeze out the government's ability to match your contributions.
Roth and Traditional Contributions
Like many 401(k) plans, the TSP now offers service members and government employees the option to choose between Roth contributions and Traditional contributions. Traditional contributions are taxed in the current year, grow tax free and then are taxed as ordinary income during retirement. Roth contributions are taxed as normal income in the current year but grow tax free and are not taxed when distributions are made during retirement.
Deciding between Roth contributions and Traditional contributions is a complicated choice that involves many factors like your age, tax rate, accumulated assets, state of residence, and other goals. Please consult a professional financial advisor if you need help making this decision.
Combat Zone Tax Exclusion
Combat Zone Tax Exclusion, or CZTE for short, is a special provision of the tax code that allows military service members deployed to a combat zone or deployed in certain capacities to receive their pay tax-free. It is also during this window of CZTE pay that a service member is able to activate their annual additions contributions. This is how we go from being able to contribute $22,500 to being able to contribute a total of $66,000.
One important point to consider if you want to take advantage of the CZTE is that contributions made during deployment should be made as Roth/CZTE contributions to avoid missing out on your government match when you return home from deployment. If you leave your contributions set to traditional contributions while deployed to a CZTE area you may accidentally max out your contributions leaving the government no room to match your contributions.
The TSP provides a few individual fund options, several lifecycle funds otherwise known as target-date retirement funds and recently opened up a "mutual fund window" for investing in mutual funds.
G Fund - Is the only fund guaranteed by the U.S. government that you will receive your principal and interest back. It is similar to investing in U.S. Treasury securities in that way. However, one distinction is that the G-Fund receives special issuances of debt from the federal government that can not be found elsewhere. The advantage to that is that it is a short-term treasury security that yields a long-term yield. In other words, you get more money per dollar invested in the G-Fund than you would be able to get from a similar short-term treasury security you purchased outside of the TSP.
F Fund - This fund is designed to track a broad swath of U.S. debt securities (AKA bonds) that are investment grade. This fund can and often does include Corporate bonds, U.S. Treasuries, mortgage backed securities and asset backed securities. That diversity of assets provides good protection and favorable yields.
C Fund - Unlike the G Fund and F Fund, the C Fund focuses on equities instead of debt securities. The C Fund attempts to match the performance of the S&P 500 Index, the largest 500 publicly traded companies by revenue in the U.S. weighted by market value. The S&P 500 has a long history of strong of returns but also comes with a certain amount of volatility.
S Fund - This fund tracks a broad index of small to medium sized U.S. publicly traded U.S. companies. The underlying index seeks to track the performance of all equities with the exception of those companies included in the S&P 500 Index. This allows for further diversification in a person's portfolio within their equity allocation and compliments the C Fund well.
I Fund - This fund is the only fund in the TSP that provides investment exposure outside of the U.S. and for that reason acts as an excellent way to diversify a portfolio to help reduce risk that is specific to the U.S. economy. The I Fund focuses its holdings on 21 Developed countries. Those countries are most located in Europe with a few in the Pacific, including Japan, Australia, Singapore, New Zealand and Hong Kong. By focusing on developed countries this fund seeks to take advantage of those economies that are viewed as more reliable safe havens for foreign capital investments.
Lifecycle Funds - The TSP offers a variety of lifecycle funds which are similar to "target date" funds you might see elsewhere. The idea is to choose a lifecycle fund aligned with your desired retirement date and the fund will adjust your asset allocation on your behalf to reflect your reduced risk capacity as you approach retirement. This makes the lifecycle funds an attractive option for the beginner who wants a simplified choice and can set it and forget it. The draw backs of this investment option is that they do not take into account individual's risk tolerance or other outside factors that might justify a different asset allocation.
Mutual Fund Window - A relatively new addition to the TSP is the Mutual Fund Window. This option allows TSP participants to have access to greater range of investment options than what was historically available. While it is generally accepted that more options are a good thing there are potential draw backs to utilizing the mutual fund window. The mutual funds could potentially have higher fees, consist of a lower quality investments and you will pay additional fees to access the mutual funds in the first place. In it's current state (2023), the mutual fund window appears to be a higher cost option for TSP participants relative to the individual funds and lifecycle funds.
As with other retirement accounts your spouse will have certain rights when it comes to your TSP account. The TSP does take it a step further though by requiring your spouses consent to withdrawal funds or receive a loan from your TSP account.
Performance and Expense Ratios
The TSP has historically maintained a low cost position relative to other financial institutions. Prior to 2021 it was hard to beat the TSP's average total expense ratio of 4.3 basis points, or 0.043%. However, starting in 2021 the TSP began raising rates and as of 2023 their low cost position is no more. The combination of the TSP raising rates by more than 30% and many private financial services providers decreasing costs means that there are plenty of lower cost options available on the open market.
When it comes to performance the TSP has done an impeccable job of meeting or beating their benchmarks. They continue to deliver returns commensurate with the benchmarks they track.