Optimizing Your TSP Investment
The Thrift Savings Plan has many advantages. The largest of which is the ability of participants to receive a match of up to 5% of their contributions.
Additionally, the value of the tax-advantaged nature of TSP contributions cannot be overstated.
- Traditional Contributions: The ability of a participant to contribute funds to the pre-tax portion of the TSP is an important advantage over other investments because the participant can receive a tax deduction for contributions up to the IRS limit, and these funds can then grow tax-deferred until the funds are withdrawn in retirement. Once the funds are taken out in retirement to be spent, the participants will then pay ordinary income tax on the full withdrawal because those funds have never been taxed.
- It is important to note that all employer matching contributions are considered "pre-tax."
- Roth Contributions: Until 2012, FERS participants did not have the ability to elect for their contributions to be considered post-tax or "Roth". The newly granted ability of participants to elect to make Roth Contributions is of great benefit. The main difference between traditional vs. Roth contributions is that Roth contributions are made after-tax, therefore causing the participant's taxable income to be higher in the year of the contribution then it would have been if the same amount was added pre-tax. Once the funds have been contributed, they are taxed similarly to traditional contributions in that they grow tax-deferred until retirement. The big difference is that once a participant is of retirement age and starts taking withdrawals, all funds in the Roth portion of the TSP come out tax-free.
So how much should you contribute to TSP Roth or Traditional each year? Well, it depends. When we work with our clients, we run a number of different projections to optimize the after-tax income each person will have in retirement with the goal of minimizing the amount of total taxes paid, and therefore maximizing retirement income.
Investment Options
Now that we have covered how the taxation of different contributions is treated, we can review the different investment options available to TSP participants. There are many advantages of the Thrift Savings Plan. Two that I will cover here are simplicity and cost. Studies have shown that if we are presented with too many investment options we often have a hard time deciding. The beauty of the TSP is that it's so simple. There are only five options and lifecycle funds. (Lifecycle funds are funds that have a date that is supposed to correspond to your retirement date.) Overall, the lifecycle funds work particularly well for those who do not want to think about their investments. The funds are still made up of the 5 funds, and over time they follow a glide path, where they move from being more aggressive when further out from retirement to more conservative as you get closer to retirement.
Another benefit of the TSP, and many qualified plans, is the low-cost structure. The TSP has some of the lowest expense ratios available in the investment world, which is a definite benefit of this plan.
There are also some challenges with the plan. These challenges mainly focus on the lack of investment choices and low level of flexibility. When you have a plan that is made up of 5 investment options, you really only have five sectors of the market to invest in. Although these five can serve participants well while accumulating assets, we often find that the clients we work with who have accumulated assets in this plan would like the option to diversify more and have more options in retirement. The other area of challenge with the TSP can be flexibility. Although the plan is continually improving, I am sure it is not a shock to you that a government-run program may lack the flexibility to be constantly in sync with your dynamic retirement lifestyle.
So how should you invest your TSP? It depends on a few factors.
1) How far away are you from retirement?
2) Whats are economic conditions like?
3) What is your risk temperament? How would you feel if your account dropped down by 50% in one year?
4) How involved do you want to be in managing your investments? Are you someone who wants to buy and hold, or will you be consistently making changes?
The truth is that an investment plan should be personalized to match you, and it should line up with your financial plan because every dollar has a purpose.
*The information provided on this page is for illustrative purposes only. Actual performance and results will vary. This information does not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed, and a financial advisor should be consulted”