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. This was originally written in 2017, but updated now for 2020.
The Thrift Savings Plan 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 a $19,500 per year employee contribution ($26,000 per year if 50 or over) plus any match she may qualify for.
Roth Option in the Thrift Savings Plan
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 most 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 will have in retirement filling the brackets, the better Roth retirement account contributions become.
Non-military members have received a TSP match for a long-time, but military members starting in 2018 also receive a match on up to 5% of base pay. That’s part of your salary, don’t leave it on the table. With the new “blended retirement system” (automatic for those entering the military after Jan 1, 2018, and optional for those already in the 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 Thrift Savings Plan had no match.
Why The Thrift Savings Plan 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 have gone up in recent years from 2.5 basis points to 4.1 basis points), 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 TSP may be the best 401(k) in the country. It has rock bottom expense ratios, broadly diversified index funds, and simple “Lifecycle” funds.
The TSP 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 (a recent change to add them was squashed due to concerns about the government endorsing the investment of money into Chinese companies)
- 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 Dec 2019, it was paying 1.875%. Not awesome, but better than the Vanguard Prime MMF paying 1.71% and the Vanguard Intermediate Treasury Fund paying 1.74%.
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
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.
Thrift Savings Plan Tax-exempt Contributions
Military members can contribute additional money (usually $57K – the $19.5K employee contribution minus any match received) 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 53% mid-caps according to the Morningstar Instant X-Ray Tool. Of course, that’s not all that different from the Vanguard small cap index fund which is now up to 59% 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 Emerging Market Stocks, Foreign Bonds, 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
For a long time, the biggest problems with the TSP, aside from the fact that you have to deal with government bureaucracy and military finance offices when using it, were all related to getting your money out of the account. For example, you could 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 would have had to take it all out. They would let you do as many rollovers into the TSP as you like, but it was a lot harder to get your money out.
Thankfully, this has dramatically improved since I wrote this post. There are both hardship-based and age-based in-service withdrawals, but more importantly, a lot more options for when you leave federal service.
# 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 used to have just 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 could 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.
But now you can also take out “single withdrawals” of $1,000 or more as often as you like. This is much more like a typical IRA or 401(k).
# 6 No Mega Backdoor Roth IRA Option
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.
In summary, the Thrift Savings Plan 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!