Taking Advantage of the Thrift Savings Plan
If you’re a U.S. federal employee (including the DOD), you are probably eligible to participate in the Thrift Savings Plan (TSP). If you’re not sure, check your eligibility here or with your personnel office. Most people don’t take full advantage of this program and it’s a crying shame. I myself didn’t start until about 4 years into my career, but there was a reason I’ll get to later.
So what is TSP?
It stands for “Thrift Savings Program.” In short, it is a tax shelter for your retirement. You can think of it as similar to an IRA, but it is very similar to a 401k. Some government agencies (but not the DOD sadly, although, this is changing) will even match 1% of your contributions! There is even the option for a Roth TSP which acts just like a Roth IRA for tax purposes.
TSP has a (current) contribution limit of $18,000 per year and you won’t be able to get your money out (penalty free) until you are age 59 ½ .
The program has a number of different funds that you can allocate your money to and freely move between.
Cool, but what makes TSP better than an IRA?
The fact that it allows you to contribute more than 3x the amount of a Roth IRA into a Roth style shelter. For more info on why this is ideal, check out this post.
On top of the tax benefits, most of these funds have an expense ratio of .038%. That is less than 1/10th of the average Exchange Traded Fund (ETF) expense ratio (.44%) and about 1/20th the cost of the average index fund (.74%)! But why does this matter?
Look at how a higher expense ratio affects YOUR earnings over time:
It’s worth noting that a fund’s expense ratio isn’t the only factor in determining how much it costs to invest, but that’s not a discussion for this post. Suffice it to say, their total expenses are far less than most other funds.
How do I contribute to this badass tax haven?
If you’re in the DOD, the answer to that is pretty simple. Visit MyPay and select Thrift Savings Plan right from the homepage. It will give you the option to select a percentage of your base or whichever pay you want(you can’t count allowances like BAH) to contribute. If you’re trying to max it out, you may have to grab a calculator to get to $18,000 each year.
If you’re not in the DOD, ask your personnel, pay, or HR office for more information. The ideal situation here is that money is taken out of your pay check to contribute before it gets to you.
How do I know what fund is right for me?
By default, money you invest in TSP goes into the G fund (depending on which agency you’re in). As you can see above, the G fund doesn’t do that much for you. It hardly keeps up with inflation. I learned this lesson the hard way. I inadvertently let my money sit in the G fund for the first year and a half which was a complete waste of my time and investment.
Two people in the last year have talked to Dan and me saying that they were strong believers and investors in the G fund. I scoffed out loud at the thought of that. Seriously, why bother? Your money loses buying power over time with the rise of inflation. One of these two people argued that the market was bound to turn down in the next two years so her money would be safer in securities. Long term, after the upcoming crash, she plans to buy into the other funds.
I strongly recommend using the Lifecycle (L) fund associated with your target retirement date. If you want to be deeper into equities – select a Lifecycle fund that is past your intended retirement date. If you want one that is less risky and more into bonds and cash, select a Lifecycle fund that’s earlier than your planned retirement date. Your money will be managed and allocated appropriately as you move closer to the “retirement” date that the fund is set towards. It starts off with higher risk (more stocks, fewer bonds) and moves towards lower risk as you get older (fewer stocks, more bonds, and near-cash equivalents).
A financial specialist from a prominent bank gave a talk to DOD personnel around my area a few weeks ago and advocated instead to invest in the C fund since the S&P 500 generally has very consistent long-term returns which tend to be better than the L funds especially in the final 5-10 years before retirement where the power of compounding interest is truly amazing by compounding on what should be much larger amounts than what you had invested in your 20’s and 30’s.
So which of these is right? I strongly recommend against the G fund and always will unless you are actively in retirement and need peace of mind. If you really want to ensure you’re capturing longer stock returns and are willing to expose yourself to more risk, invest in an L fund with a further retirement date than you are planning on. That will keep your money in higher reward/risk markets longer.
But why did you wait so long to invest in TSP?
For the same reason that I used to avoid a traditional IRA. I wanted liquid money for my large investments like the down payment on my house. Now that I have done that I can start putting more money into tax shelters where I won’t be able to get to it for years, nor can the IRS. What I did as an alternative was invest in proprietary mutual funds through my broker which were very liquid and from which could be easily withdrawn.
So, long story short, if you are employed by the federal government, TSP is for you. Put as much money as you can in and if you take my advice you’ll put it all into a target L fund with regular contributions!