By FPA member Phil Dyer, CFP®, RLP®, CPCC
Last Updated: November 1, 2011
The Thrift Savings Plan (TSP) is the federal government's version of a 401(k) plan. It allows military service members and federal government workers to contribute a portion of their income each month on a pre-tax basis into mutual fund type accounts. These contributions then grow tax-deferred, allowing for substantial accumulation of retirement savings over time. For those serving in the Armed Forces, the government does not provide matching funds to their TSP contributions (except for a very small set of critical specialties), which causes many service members to forego contributing to the TSP and direct money into commercial mutual fund companies in the form of Roth Individual Retirement Accounts (Roth IRAs) and other investments.
This may be a significant financial mistake. There are several key reasons why service members should consider making the TSP a cornerstone of their long-term financial savings. Consider the following five benefits of the TSP:
- Simplicity: The TSP is very easy to start, stop and change. The service member simply contacts his or her command's finance personnel and requests the TSP Election Form (TSP-U-1). Up to 100 percent of un-allotted basic pay and specialty/incentive pay may be contributed to the TSP annually.
- High Contribution Limits: A total of $16,500 can be contributed in 2011 (plus an additional $5,500 if the service member is 50 or older). The base contribution limit will increase to $17,000 in 2012 (the additional $5,500 limit for those 50 and older remains the same). Both of these numbers are indexed to inflation and will rise every year or other year. These contribution limits are three to four times higher than what can be contributed to an IRA or Roth IRA annually. In addition, contributions made to the TSP while receiving hazardous duty pay are segregated into a special "tax-free" channel. A special rule allows up to $49,000 (increasing to $50,000 in 2012) in contributions into that tax-free channel to be made in a calendar year while deployed in a combat or combat support zone and receiving hazardous duty pay (provided the service member's financial situation allows for that level of contribution). Funds in this tax-free channel may be rolled directly into a Roth IRA after separation from or retirement from the military with no penalty, allowing for rapid accumulation in a tax-free account.
- Loan Provisions: The TSP has very generous loan provisions, which allow service members to take loans from their account between $1,000 and $50,000 (depending on their account value). They can have up to two loans outstanding at any one time — a general purpose loan (usable to help purchase an auto or other necessity) and a loan to support the purchase of a principal residence. These loans have very low interest rates and the interest paid is credited to the account.
- Good Mix of Investment: The TSP has five basic investment choices (the service member can select their allocation from among these options however they see fit) and five "L" or "Lifecycle Fund" investment choices – which are put together in portfolios ranging from very conservative to very aggressive. The Lifecycle Funds act like a "fire and forget" missile, with the investment mix automatically changing every couple of years. The basic investment choices — with their 10-year average returns as of 12/31/2010 include:
- The "G" Fund — Government Securities Fund (+ 4.26 percent)
- The "F" Fund — Fixed Income Index Fund (+ 5.91 percent)
- The "C" Fund — Common Stock Index Fund (- 1.42 percent)
- The "S" Fund — Small Cap Stock Index Fund (+ 6.12 percent since 5/2001 inception)
- The "I" Fund — International Stock Index Fund (+ 3.45 percent since 5/2001 inception)
The current "L" funds include L Income, L 2020, L 2030, L 2040 and L 2050. The L Income Fund is very conservative, with 80 percent being allocated to fixed income (Funds G and F) and only 20 percent stocks (Funds C, S and I). The L 2050 is a mirror image, being 80 percent stocks (Funds C, S and I) and only 20 percent fixed income (Funds G and F). For those that don't want to spend a lot of time worrying about asset allocation, the L Funds can be a good choice.
- Very Low-Cost Investments: There is no commercial investment that will match the TSP Index Funds for low expenses. With average mutual fund fees around 1.25 to 1.5 percent per year, the TSP Index Funds expenses are a miniscule .028 percent! While that difference of 1.2 to 1.47 percent per year may not sound like much, investing $500 per month for 20 years in the TSP could net a service member an extra $36,600 over a mutual fund with annual expenses of 1.3 percent ($259,580 total vs. $222,980 total — assuming a seven percent average annual rate of return for both investments).
In summary, service members should strongly consider making the TSP a primary weapon in their retirement planning battle plan!
FPA member Phil Dyer, CFP®, RLP®, CPCC, is a 1985 graduate of the United States Military Academy at West Point and former Army Captain. He has been a fee-only financial planner since 1996 and is the founder and principal of Dyer Financial Advisory in Towson, Md. He specializes in advising federal workforce employees, including Active Duty military, retired military, current CSRS/FERS federal employees and CSRS/FERS federal retirees.