Retirement Accounts • June 26th, 2020

How does a Thrift Savings Plan (TSP) work?

Stephanie Faris

Key Takeaways
  • Federal and military employees have access to a retirement account called a Thrift Savings Plan.
  • Contribute up to 3 percent each paycheck and your agency will match the amount, dollar for dollar.
  • Contribute an additional 2 percent and the federal government will match $0.50 on the dollar.

If you work in the private sector, chances are you’ve been offered a 401(k) plan as part of an employment perk. For government employees, though, 401(k)s aren’t as common. Federal government workers, including the military, have the option of their own plan, called a Thrift Savings Plan (TSP).

A TSP account operates similarly to a 401(k) in that money is put in before it’s taxed, with the understanding that you’ll pay taxes on the funds when you withdraw them. With more than 5.5 million members and total assets of $600 billion, TSPs make up a sizable chunk of retirement savings accounts in the U.S.

What is a TSP?

Established in 1986, the Thrift Savings Plan is a defined contribution plan. Defined contribution plans are usually set up so that employees can contribute to them before taxes have been taken out. When they retire, the funds they take from the plan are taxed as ordinary income. Retirement savings plans like 401(k)s and 403(b)s are also defined contribution plans.

A TSP isn’t a standalone product, though. If you’re a federal employee, you participate in the Federal Employees Retirement System (FERS), which includes your TSP, a basic benefit plan, and Social Security. All of this is set up as part of your onboarding, but you can make changes to your account through the department of your agency that handles employee benefits.

Thrift Savings Plan Eligibility

To have a TSP retirement package, you’ll need to be classified in one of four federal government worker categories:

  • Employee enrolled in the Federal Employees Retirement System (for employees who started work January 1, 1984 or later)
  • Employee enrolled in the Civil Service Retirement System (for employees who started work prior to January 1, 1984 and didn’t convert to FERS)
  • A member of the uniformed services (Active Duty or Ready Reserve)
  • A civilian in other categories of federal government service

As with many retirement plans, you can’t simply become a federal employee and retire with benefits the next year. In most cases, you’ll be “vested” after three years of service. “Vesting” refers to a minimum period required to qualify to take out your retirement. If you leave the federal government before three years are up, the 1 percent automatic contributions and any earnings on that money will be forfeited.

Roth TSP and after-tax contributions

At one time, if you participated in a federal TSP, you could only contribute funds before tax. But qualifying government and military employees now have the option of a Roth TSP, which lets you pay taxes now to enjoy tax-free distributions when you retire.

As with Roth IRAs and Roth 401(k)s, a Roth TSP lets you reduce your tax burden at retirement. However, it’s important to keep in mind that you’ll likely fall into a lower tax bracket after you retire, due to your decrease in income, so you’ll end up paying more taxes overall by going that route. Still, paying taxes now could be part of ensuring you’re taken care of when you do stop working and mitigates the risk of tax laws adversely changing in the future.

Tip: You may want to consider a Roth TSP if you want to remove that burden upon retirement and don’t mind potentially paying more taxes overall.

If you’re already participating in a federal Thrift Savings Plan, you can convert your contributions to a Roth at any time. Your change will only be effective starting with the date you convert it. In other words, you can’t convert money you’ve already contributed to a Roth TSP, only the money you’ll contribute in the future.

Contribution limits for TSPs

As with any retirement savings account, TSP retirement accounts have contribution limits. The Internal Revenue Code sets limits on retirement plan contributions, including TSPs. Your employer can contribute up to $19,500 per calendar year, while you can contribute up to $57,000. If you’re age 50 or older, you can contribute an additional $6,500 per calendar year as a catch up.

The federal TSP limits apply to uniformed servicemembers, as well. However, there is an exception for those in service in combat zones. The limit doesn’t apply to any tax-free contributions you make from combat pay.

How employee contribution matches work

To help fund your TSP savings account, FERS and BRS employees will see an automatic contribution every pay period. These Agency/Service Automatic Contributions are equal to 1 percent of your basic pay. This deposit is made regardless of whether you’re contributing to the fund yourself.

The best way to boost your plan, though, is to take advantage of TSP matching contributions. Your agency will match every contribution you make, up to a limit of 5 percent of your pay for the period. For the first 3 percent of your pay you contribute, your agency will be matched dollar for dollar. For the remaining 2 percent, your agency will match $.50 for every dollar you put in.

Experts typically recommend that you at least put enough money into any retirement plan to get the maximum match. Otherwise, it’s like you’re leaving money on the table for your future retired self. That means, at the very least, you should put 5 percent of each paycheck toward your TSP. You can contribute more, but once you’re investing more than 5 percent, it works the same as any investment, so it’s worth comparing your TSP to the return you’d get on another type of investment.

Final Thoughts

Although the 5 percent match makes a Thrift Savings Plan a great investment vehicle, it’s important to consider whether to invest above the point where your contribution is matched. As you’re setting up your TSP, meet with a Certified Financial Planner® to discuss your options and determine exactly how much you should put into the plan each pay period. If you’re a federal government employee or military member, get in touch with your agency’s retirement plan contact to make sure you’re taking full advantage of the benefits you enjoy as a government employee.

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Author

Stephanie Faris

Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a writer for a credit card processing service and has written about finance for numerous marketing firms and entrepreneurs. Her work has appeared on Money Under 30, The Motley Fool, MoneyGeek, E-commerce Insiders, and GoBankingRates.