As a federal employee, you have lots of different decisions to make throughout your career and into retirement that will greatly impact both yourself and your family really for the rest of your life.
One of those decisions with particular significance is what you do with your Thrift Savings Plan.
Many federal employees have similar questions regarding the Thrift Savings Plan, both while they’re working and into retirement.
“What are the funds and how do they work?”
“What is the matching and how does it work?”
“Which fund is right for me based on my risk tolerance; while I'm working as a younger employee, throughout my career, and as I transition into retirement?”
“How much can I contribute?”
“Is there a limit to what I put in?”
“What choices do I have and how do those decisions impact myself and my family for the remainder of my life?”
1. WHAT IS THE THRIFT SAVINGS PLAN?
The Thrift Savings Plan, or “TSP,” was established by Congress in 1986. It's a defined contribution plan, and it's specific to federal employees. You can't get it anywhere else. It's a taxed-deferred retirement savings plan, and it's very similar to a 401k plan in a private industry or corporate world.
As far as an accumulation vehicle, the Thrift Savings Plan is one of the best places to accumulate wealth…if you'll take advantage of what's there. Since it’s fully determined by what you contribute, it is what you make of it.
What are some advantages of the Thrift Savings Plan?
- Agency Matching
- Tax-deferred growth
- Automatic payroll deduction
- Traditional TSP
- Roth TSP
When you look at the expenses or the fees, if you tried to go to a local financial planner to put together a plan, there’s no comparison. The expenses and the fees with TSP are minimal. If you're a FERS employee, the best thing you can do is take advantage of the TSP system– especially the matching. So let’s dive in with each of these elements in turn.
2. HOW DOES THE THRIFT SAVINGS PLAN MATCHING WORK?
This is your greatest advantage with the TSP. If you put in 0% of your paycheck as a FERS employee, the agency automatically puts in an additional 1% already. So you have a total of 1% of your income going into your TSP, no matter what.
Remember, the matching is per paycheck! A lot of federal employees will try to dump a lot of money into their TSP at the end of the year– or they’ll want to increase their contributions during two of the months when they get three bi-weekly paychecks. You can change your contribution every pay period, but your matching is only per pay period.
Your one, two, and 3% contributions are matched dollar for dollar (plus that extra automatic 1%).
One of the number-one pitfalls that federal employees make…is not taking advantage of the matching program.
For new employees now, they automatically default to 3% which includes the full 100% matching. So if you put in 3%, the agency is putting in 4%, so you have a total of 7% of your check going into your TSP: your future retirement.
On the fourth and fifth percent that you contribute, the agency will match 50¢ on the dollar. So the bottom line is, if you contribute 5%, then the agency matches 5%, and so you have 10% of your income going into your account at Thrift Savings Plan.
Please take advantage of this!
HOW MUCH CAN I CONTRIBUTE TO MY THRIFT SAVINGS PLAN?
This is actually determined by the IRS, and as of 2019 you can contribute up to $19,000.
If you're older than 50, there's a catch-up provision where you can give another $6,000: so if you’re older than fifty, you can contribute up to $25,000. (Remember, that's your contributions, not the matching.)
So what would be the benefit of actually switching from a percentage to a hard dollar figure? Which should you focus on?
A lot of federal employees that we meet and talk to have been on the job for 20 years. They calculated a dollar amount based on 5% of their income fifteen years ago, but they don't always remember to go back and change the amount as they get COLAs, step increases, raises, and promotions.
For employees who set their contribution as a percentage, that percentage stayed consistent and the amount of money grew automatically with their paycheck! They didn’t have to remember to update it…whereas the employees who simply set a hard dollar amount based on their 5% at the time may have missed out on more TSP savings by forgetting to update said amount as their income changed.
If you're just trying to get the matching, we always recommend choosing the 5%, because when you get a pay increase, that amount is going to update automatically to go along with your pay increase.
But you do have to be careful because if you put too much money into your TSP at the beginning of the year and you hit your contribution limit, you lose the ability to get matching later in the year.
So when people put in the maximum limit by October or November, they're not allowed to contribute any more money: therefore they're going to lose the matching for the remainder of the year.
3. WHAT’S THE DIFFERENCE BETWEEN THE TRADITIONAL AND ROTH THRIFT SAVINGS PLANS?
One of the things that TSP introduced in 2012 was a choice between the Traditional and the Roth TSP.
It’s important to know that the agency’s matching is always added to the Traditional side of your Thrift Savings Plan, regardless of whether you yourself are contributing to the Roth or the Traditional.
Is one better than the other? Let’s go over the differences between the two.
THE TRADITIONAL THRIFT SAVINGS PLAN
The TSP Traditional option is a pre-tax option, meaning it lowers your current taxable income. The contributions on the Traditional side also grow tax-deferred, which means you don’t have to pay taxes on the interest as your account grows.
Because the contributions on the Traditional side are made before taxes, and the interest is tax-deferred, ultimately all withdrawals are taxed.
Again, everything you take out of the traditional TSP is going to be taxed as income when you make those withdrawals.
THE ROTH THRIFT SAVINGS PLAN
The Roth option first became available in May of 2012. It’s not automatic: you must actively select this option upon selecting your contribution elections. All employees regardless of their modified adjusted gross income are eligible for the Roth TSP option.
Your Roth contributions are post-tax, which means you are paying taxes on the contributions as they are made.
So upon withdrawal, all contributions and interest earnings are tax free.
That's a tremendous benefit! One of the quirks to this, though, is that you have to be in the Roth plan for at least five years before making any withdrawals.
IS ONE TSP BETTER THAN THE OTHER?
A lot of employees ask us, “Should I do the Traditional or should I do the Roth?” Well, there's no easy answer. It really depends on the individual. Do you believe you will benefit more from tax savings today while working, or later in retirement?
You could put a partial amount into the Roth, and partial amount into the Traditional (remember, the matching from the agency is going into the Traditional regardless).
With the Traditional TSP, pre-tax contributions reduce your current tax liability, but the contributions and the growth are all taxable when you withdraw.
It all comes down to choosing between tax benefits now…versus tax benefits later.
To make that choice, you have to determine things like, “What is my income now? What is my tax bracket today? What may it be when I retire?”
The choice between the TSP Traditional and the TSP Roth is such an individualistic decision and there’s no single answer for everyone.
But in general, our best recommendation is…seriously consider both.
Because if you don't know which one to go with today, it's nice to have two buckets: a taxable bucket and a tax-free bucket when you get into retirement. That way you're covering both bases and keeping all your eggs out of one basket.
4. WHAT INVESTMENT OPTIONS ARE AVAILABLE THROUGH TSP FUNDS?
We always recommend a visit to www.tsp.gov. They have great information about each respective fund, with different charts and historical content that you can read to get in-depth information on TSP.
TSP offers several different investment choices for you. Here is a basic overview of the TSP funds.
THE G FUND
The G Fund is a U.S. Treasury Security guaranteed by the U.S. Government. It is a fixed fund, which means it will not lose money.
The rest of the funds are all variable funds. That means they can lose money based on the market. G is the only fund inside TSP that cannot post a negative return.
THE F FUND
The F Fund is basically designed to track the U.S. bond market. Considered low to moderate volatility, the F Fund still has risk mainly in the form of interest rate and bond price risk.
There's a lot of things that come into play on the bonds, but the F Fund is historically more stable than the C, S, and I funds.
THE C FUND
The C Fund is indexed to the S&P 500. The index contains the stocks of 500 of the largest companies in the United States.
THE S FUND
The S Fund is indexed to the DOW Jones U.S. Completion index, which is a broad market index that includes U.S. Companies not in the S&P 500.
THE I FUND
The I Fund is an international stock fund. In the I Fund, you're actually invested in the Morgan Stanley Capital Investment EHFE, which tracks companies in more than 20 developed countries across Europe, Australasia, and the Far East.
THE L FUNDS
Lastly, in 2005, the government created the LifecycleFunds, or L Funds.
The L Funds are kind of confusing because they're not their own fund: they're a blend of the five other funds: the G, the F, the C, the S and the I Fund.
You can choose the L Fund that makes sense for yourself– and what you’re choosing is essentially a diversified portfolio based on a specific time horizon. You can pick like the L 2020, L 2030, L 2040, and the L 2050. All you're doing there is picking the retirement “end date” or time horizon, and an algorithm is automatically reallocating your funds to become more and more conservative as that particular year approaches.
THE FEES FOR EACH FUND
If you’re trying to make investments in the outside world – in the private sector outside of a 401k, or an individual IRA – and you have to go through an investment advisor, the fees may be upward of 1 to 1.5%.
Investing some money with TSP funds instead of just hoarding it can be invaluable, because some TSP investment fees can get as low as .04% – that’s only 40¢ per $1,000 invested, which is basically nothing – and your next egg may grow far faster.
TSP is a tremendously cheap program that the federal employees have access to, and it's just something worth mentioning: very cheap funds that can pay dividends over time.
WHICH FUNDS ARE BETTER?
Let’s take a look at some of the recent returns for each of the funds, according to TSP.gov.
As stated: the G Fund will never lose money. Even if you go back all the way to the inception of the G Fund, it's not going to be red. That said, its average return over the past ten years is 2.30% – that’s a good safe return. It can change every year, but you're not going to lose money.
As for the rest of the funds, each has at least one year in the last decade when they've lost money. The F Fund lost 1.68% in 2013. Its average 10-year return is 3.73%, a little higher than the G. The C Fund has averaged 13.17% the last ten years. The S Fund, at a 13.67% 10-year average return actually slightly edged the C Fund– however, that doesn't mean it will be the best over the next ten years. The I Fund averaged 6.48% over the same ten-year period.
Typically, the more aggressive a fund is, the higher return opportunity you’ll have in the long term.
So the G Fund is your safe fund. The rest of the funds are going to lose money now and then. Why is this important?
Again, we're not telling you where to put your money; but if you look at examples from 2008, or 2001 and 2002, there are periods when the market drops. If you're about to retire during one of those periods, it can make a big impact on your retirement.
So if you're getting closer to retiring, L Funds (remember, those are a “combo” of all the other funds) can be very helpful because TSP automatically puts more and more of your money back into the G Fund; protecting the nest egg that you've built inside TSP as you get closer to retiring. In fact, if you pick the 2030, then by the year 2030 they will have put 74% of your money into the G Fund where it’s safe. At that point, only 26% of your money will be at risk at that point.
So if you're about to retire, you need to make sure you’re protecting your money.
The next question we often hear is, “How far out from retirement should you actually look at moving more money into the G Fund?”
Everybody is different, so it partially depends on your risk tolerance. It's good as you get closer and closer to retirement to take more and more of your retirement money and reposition it in a safer spot where you can start protecting it. While you’re working, that safe place can be the G Fund.
Now on the flip side, let's say you're young and you're just now getting hired by a federal employer. You can take the losses. If you have a 2008 crash and you're in your second or third year, it's okay because you have plenty of time.
Having your money in more aggressive funds when you're younger is traditionally the advice that's given: whereas once you get closer to retirement, you should start protecting what you've built.
5. WHAT PARTS OF MY THRIFT SAVINGS PLAN CAN I CONTROL?
There are three things that you can control inside TSP:
- Compound Interest
Here's an example: let’s say you’re earning $85,000, and you contribute 5% to TSP; receiving the 5% matching, with a 2% COLA; and let's say you average a 5% return from investment funds. If you did that for 10 years, you would have $118,000. If you do it for 20, it would be $338,000. If you do it for 30 years, the same thing, you would have $728,000. The only difference between those results is how long you contributed, and how long you let your money grow.
The lesson there is clear: start today and don't put it off.
The second thing you can control is compound interest. “What funds are my money in, inside TSP?” Again, we know that the market’s last ten years won’t be a clear prediction of the next ten years. But if you made the same income and contributions as above and then got a 3% return for 30 years, you'd have $531,000. But if you made the same contribution and you were in a more aggressive fund, and maybe you could average around 8% interest: then you would have $1.2 million. That's a big difference just based on what funds you choose!
Are you going to keep all your money in the G Fund? Or are you going to consider diversifying the little bit to try to get a higher average return? Remember, everybody’s situation is a little different.
The last thing you can control is contribution. Remember, 5% is the matching limit, but you can put in more. So if you took the same employee for 30 years with a 2% COLA, putting in 5% with a 5% return, they’d earn $728,000 (that number we saw earlier). But let's say you could contribute more, like 10% or 15%– over 30 years, that 15% contribution would result in $1.4 million dollars!
So to recap: if you start today, you can control time (to a degree); what funds you choose; and how much you actually put into TSP. Those are all up to you.
If you can act on just one of these three items, you can make the difference in your retirement because it's in your control.
We run into very few people that can actually do all three, and do all three well. Achieving success with all three is sometimes called a trifecta.
That means you gave yourself a lot of time to contribute; you tried to maximize your contributions; and you chose the right funds over your career.
For example, that $85,000 career with a 2% COLA for 30 years, contributing 15%, with no catch-up provision, receiving 5% matching, with an average of 8% return from investment funds over the 30 years can end up with $2.4 million! You can essentially become a multimillionaire just by planning in advance, having the right education, having the right guidance, and being smart.
We're running into more and more federal employees that are at least doing one or two of these things right. We're seeing more and more people that are setting themselves up for an easy retirement.
For the younger folks, as far as what's changing within the federal employee benefits and Thrift Savings Plan, this is even more important than ever. This is money that is yours.
We don't know what will happen with things like social security in the future, but this is your money, so take advantage of it!
If you can hit the trifecta, great! If you can at least do one out of three or two out of three, it still makes a big difference.
YOU DON’T HAVE TO JUGGLE YOUR THRIFT SAVINGS PLAN ALONE.
These are very large, lifelong decisions for a federal employee; and they're very scary. So it's important to sit down with a professional who can not only guide you through the options that you have, but actually give you an idea of how different decisions will impact you.
Our job is to be the expert that can sit down with you, as someone who understands the FERS, the CSRS, your social security, and more; then help you position your TSP to get the most that you can out of it.
Do you know if you're getting the maximum out of your TSP right now?
We can help you figure that out!
United Benefits has assisted thousands of federal employees on several impactful topics. We can help you, too. Ask us anything!
Click here to request a consultation and talk one-on-one with a representative about the options available to you.