All About TSP and How It Will Make You Rich
The Thrift Savings Plan (TSP) is a retirement plan for Federal employees and members of the military and it is one of the most underutilized and misunderstood benefits available to service members today. A good way to think about it is that it is the military equivalent of a 401k. So basically, it is an investment account into which you can contribute a portion of your paycheck in an amount of your choosing to grow over time. It follows many of the same rules of 401ks set forth by the IRS and you can decide to contribute pre-tax (traditional) or post-tax (Roth) funds.
Why Participate Now?
Let’s face it: saving money isn’t sexy. It’s way more fun to spend money on nice cars, clothes, and watches. But while retirement may be decades away, the more you start saving now the better quality of life you will have later. The beauty of the TSP and its civilian counterpart is that once you set it up, the savings are automatic and nothing you have to consciously commit to doing. And the benefits are huge. We’ll get to the numbers in a minute.
- Contribution limit for 2015 is $18,000 unless you are in a combat zone tax exclusion zone or are over 50 and eligible for catch-up contributions.
- You can contribute from 1 to 100 percent of your base pay.
- You can also contribute from 1 to 100 percent of any bonuses, incentive pay, or special pay as long as you are contributing something from your basic pay. You can’t contribute from any BAH or subsistence pay.
- Even if you haven’t received your bonus or special pay yet, you can set it up to deduct when you do.
- Employer match exists for civilian employees, but for uniformed service members matching is at the discretion of each branch – and none of them currently match.
Benefits of TSP Contributions
The main benefit of the TSP versus other investment options is that it boasts some of the lowest cost funds available today. While many civilian investment options average expense ratios of 1% or higher, TSP fund expense ratios range from .026% to .039% enabling you to save a ton on fees over 10, 20, and 30 years of investing.
Difference between traditional and Roth
There are differences between the types of contributions you can make and you need to decide which one fits with your savings goals. You can contribute funds to traditional, Roth, or a combination of both up to the annual maximum contribution limit of $18,000 for 2015.
Traditional contributions are tax-deferred, meaning you are deferring paying tax until you withdraw them from the funds at retirement. When you contribute to a traditional TSP, you lower your overall income by the amount you contribute – resulting in a lower tax liability. If you are just above the threshold of a certain tax bracket, increasing your traditional contribution can bring you down to a lower bracket and save you even more on taxes.
For example, let’s say you are a single E-6 with more than 8 years of service. With a yearly base pay of $39,132, you would only need to contribute a minimum $2,232 to lower your tax bracket from 25% to 15%. In addition to paying less in taxes, the 15% bracket allows you to realize long-term capital gains (over 1 year) without having to pay taxes on them.
Roth contributions are made with after tax funds and do no adjust your income. Since you already paid tax on the funds you contribute, they grow tax-free and you will never have to pay tax on them again. This is useful if you are currently in a lower tax bracket and you think you will be in a higher one when you retire. Post-tax investments are an important part of a retirement strategy and unlike the Roth IRA; the Roth TSP has no income limit.
How will contributing make me rich?
The best thing you can do is contribute as much as you possibly can to your TSP. You can never buy back time, so if you are not currently contributing – get yourself set up immediately.
If you start investing the yearly maximum of $18,000 ($1500 a month) right now and assume an 8% yearly return, in 20 years you will have contributed $360,000 and earned $529,420.83 in interest for a total balance of $889,420.83:
If you pair that with your IRA investing, you can comfortably retire as a millionaire.
Even if you can’t afford to contribute the max, do your best to put something away. If you were to contribute $10,000 per year (833.33 per month) with the same scenario as above – your $200,000 of contributions will have earned $294,121.51 in interest for a total balance of $494,120.71. That’s a pretty chunk of change.
So get set up now. Find a contribution amount that is both aggressive and realistic for your current situation and ramp it up to the max as soon as you can. Your future self will thank you.
Note: I am not an accountant, TSP representative, IRS agent, tax professional, or certified financial planner. This should not be considered professional advice. You have resources and professional investing, tax, and other financial advice available to you at your Financial Services office; you are encouraged to take advantage it.