Six Thrift Savings Plan Mistakes to Avoid
January 27, 2023
Six Thrift Savings Plan Mistakes to Avoid
January 27, 2023
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If you work for the federal government or serve in the armed forces, you have access to a retirement and savings plan called a Thrift Savings Plan (TSP). According to TSP.gov, “Established by Congress in the Federal Employees’ Retirement System Act of 1986, the TSP offers the same types of savings and tax benefits that many private corporations offer their employees under 401(k) plans.” Although the TSP can be an excellent—and important—plan for saving for retirement for those who qualify for the program, mistakes can be costly if not utilized efficiently. This article will cover in more detail these common mistakes, so you can avoid making them.
Mistake #1: Not Putting Away 5% of Your Income
Not putting away the maximum contribution to receive a matching contribution from your employer is passing up money that could be put toward your retirement. The federal government matches up to 5% of your contribution dollar for dollar if you have a TSP. This means if you put 5% of your pay into your TSP plan, your federal employer will contribute the same amount, giving you a combined contribution of 10%. If you started your federal gig on or after October 1, 2020, your contributions were automatically enrolled at 5% of your base salary, but if you started prior to that, you may be contributing less, which means you’re leaving a percentage of money on the table—a substantial loss over time, especially when compounding interest is factored in. Check your automatic contributions with your HR department or in your HR/payroll system and adjust accordingly.
If you can contribute more than 5% of your paycheck, do so as it can help your TSP account grow faster. Per TSP.gov, if you are under age 50, you can contribute up to $22,500 in 2023. Employees 50 and older can make catch-up contributions up to an additional $7,500.
Mistake #2: Only Investing in the G Fund
The TSP has six funds one can elect to invest in. Out of these six funds, the Government Securities Investment (G) Fund, which is invested in government securities like notes and bonds, is designed to ensure preservation of capital. According to TSP.gov, the G Fund might be the right option for you “if you would like to have all or a portion of your TSP account completely protected from loss. If you choose to invest in the G Fund, you are placing a higher priority on the stability and preservation of your money than on the opportunity to potentially achieve greater long-term growth in your account through investment in the other TSP funds.” The G Fund is invested in short-term U.S. Treasuries specifically issued to the TSP, so the federal government guarantees your principal and interest payments. However, the G Fund isn’t immune to inflation. The G Fund may protect you from market volatility, but it may not protect you from inflation. Another option to consider is to split your investments between several funds with different goals to help counter the G Fund’s inflation risk and increase your overall diversification.
Mistake #3: Assuming Your Lifecycle Fund Is the Only Right Choice for You
Lifecycle Funds (L Funds) take a retirement target date approach with their investments. They consist of a combination of the five available TSP funds and automatically adjust your age and risk tolerance to determine your target date. If you are thirty years from retirement, your target date may be 2050 or 2055, which means your investments can handle market volatility due to the longer time horizon before you need the money. But if you are approaching retirement age and invested in a short-term L Fund with a target date of 2025, you have a much shorter time horizon before you will need the money. According to My Federal Retirement, the L Fund 2025 was down 6.72% in 2022. If the market continues to decline, your short-term lifecycle fund value can continue to decline.
The main issue with target-date investing is that a one-size-fits-all approach just doesn’t work for everyone. People have different financial goals, needs, and risk tolerance levels. According to Kiplinger, “Many federal employees have chosen a Lifecycle fund because it sounded like ‘autopilot.’ When you fly on an airplane, the middle of your flight is set to autopilot. But you still need a pilot for a safe landing. Autopilot without a pilot is dangerous, not safe.” You still need to be an active participant in your retirement planning—or appoint someone to do so if you don’t want to. This is where seeking advice from a financial professional can help to ensure you’re still on course with your retirement goals.
Mistake #4: Failing to Update Your Designation of Beneficiary Form
The TSP-3 is a designation of beneficiary form. According to Kiplinger, “If you pass away without a Designation of Beneficiary form on-file, your TSP will be distributed in the ‘statutory order of precedence,’ which starts with your spouse and goes through a variety of other potential beneficiaries.” This is especially important to update if you’ve gone through a divorce, new marriage, child or spouse’s death, or the arrival of grandchildren, as it can help ensure inheritance is distributed according to your wishes.
Mistake #5: Using Your TSP as a Loan Source
Using your retirement accounts as a source of a personal or emergency loan can be a potentially slippery slope. Many of us have the majority of our savings wrapped up in a 401(k), IRA, or TSP, and it might seem like a great option if you need an influx of cash for a large purchase or a rainy day. While there may be some situations where taking a loan from a retirement account is advisable, we generally don’t recommend it for several reasons:
- If you were to separate from federal government employment, either voluntarily or involuntarily, before you pay back the loan, you’re responsible for paying the remaining loan balance in full within 90 days or the IRS will consider the remaining balance a taxable distribution and require income taxes to be paid in full.
- If you’re younger than 59 ½ years old, you’ll also incur a 10% early withdrawal penalty on top of income taxes.
- The account balance will also be lower until you pay off the loan, thus denying yourself some of the positive effects of compounding interest
Mistake #6: Not Understanding Your Withdrawal Options If You Leave Federal Government Employment or Retire!
If you’re no longer working for the federal government, you have several options to take your money from the TSP account:
- Withdraw the money in full and pay both federal and state taxes on the lump sum
- Withdraw the money in equal monthly payments
- Have the TSP purchase a life annuity on your behalf
- Rollover the TSP into a traditional IRA and/or Roth IRA
- Rollover the TSP into a new employer’s 401(k) plan, if applicable
Out of these four options, option one can potentially be the costliest mistake. If you decide to withdraw your money, according to the TSP, you’ll be subject to applicable state and federal income taxes and a 10% early withdrawal penalty if you’re younger than 59 ½. If you’re considering option two or three, we highly recommend consulting with a financial professional to weigh your options and withdrawal strategies before making any decisions.
If you start working for a private employer with a good 401(k) plan, rolling over your TSP may be a good idea. However, another option is to roll over your TSP account to a traditional IRA and/or Roth IRA. According to Kiplinger, rolling your TSP into a traditional IRA and/or Roth IRA “may be a good choice for you if you’d like broader — and possibly better — options than just the five funds that are available to you in your TSP, and if advanced income planning, asset allocation, investment management, forward-looking tax planning, health care planning and legacy planning are important to you.”
With a traditional IRA, you don’t have to pay taxes until you start withdrawing money at retirement age, 59 ½. With a Roth IRA, you will pay taxes on the year that you performed the rollover, but after that, your money will grow tax-free, and your withdrawals during retirement will also be tax-free. Another advantage of traditional and Roth IRAs is you can invest in almost any asset class, such as stocks, exchange-traded funds, options, futures markets, bonds, etc. With the TSP, you’re limited to only six funds you can invest in.
A TSP allows you to save and invest money for retirement if you are a federal government employee or a uniformed service member. If you qualify for the TSP, it can be a great plan, but take care to avoid making common mistakes that can cost you—or your beneficiaries—money. A clear strategy for your TSP is an important part of your overall financial plan; don’t just settle for your default enrollments. A qualified financial professional with experience with TSPs can be an invaluable source of information and advice.
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Thrift Savings Plan. (n.d.). Contribution limits. https://www.tsp.gov/making-contributions/contribution-limits/
Thrift Savings Plan. (n.d.). Contribution Types. https://www.tsp.gov/making-contributions/contribution-types/
Thrift Savings Plan. (n.d.). Distributions. https://www.tsp.gov/publications/tspbk25.pdf
Thrift Savings Plan. (May 2022). Fund Information. https://www.tsp.gov/publications/tsplf14.pdf
Thrift Savings Plan. (n.d.). Lifecycle funds. https://www.tsp.gov/funds-lifecycle/
Tucker, Scott. (n.d.). What NOT to Do with Your TSP: 8 Thrift Savings Plan Mistakes to Avoid. Kiplinger. https://www.kiplinger.com/retirement/retirement-planning/602593/what-not-to-do-with-your-tsp-8-thrift-savings-plan-mistakes