This is a good news/bad news piece.
The good news is, if you are a federal employee or retiree, including a member of the military, you're about to learn more about a great financial program.
The bad news is, if you do not work for the federal government, you can probably stop reading right here. (But please don't. We've come to like you.)
What Is a Thrift Savings Plan?
A thrift savings plan, or TSP, is a defined contribution retirement plan run by the federal government for federal employees, including members of the military and politicians. It's designed to give federal employees a retirement benefit similar to private sector 401k programs, and works in a very similar manner.
Who Qualifies for a Thrift Savings Plan?
Four main categories of worker can qualify for a thrift savings plan:
• Any federal employee covered by the Federal Employees Retirement System;
• Any federal employee covered by the Civil Service Retirement System;
• Any member of the uniformed services;
• Certain other civilian federal employees defined on a job-by-job basis, such as members of Congress and judges.
The Federal Employees Retirement System replaced the Civil Service Retirement System in 1984, although some older workers may still have coverage under the latter.
How Does a Thrift Savings Plan Work?
The thrift savings plan works very much like a 401(k). Under this program, the federal government has created a series of potential investments in which you can choose to place your retirement money. You invest over the course of your working life and, at retirement, collect a (hopefully) substantially larger outcome. Particular similarities also include:
Your contributions to a thrift savings plan are made with pre-tax dollars. The government will withhold this money before generating your paycheck and W-2, meaning that it will reduce your taxable income by the amount of your contribution.
Automatic Payroll Deduction
Whatever amount of your paycheck you choose to contribute, the government will withhold that amount and deposit it into your account automatically. In fact, unless you specifically opt out, most people who begin working for the government are automatically enrolled at a 3% contribution.
In most, if not all cases, the government offers matching contributions into a thrift savings plan. However, it's important to know that the details of this benefit differ based on your specific job and the retirement system that covers you.
The standard rate, however, is a full matching contribution up to 3 percent of your income, then 50 cents per dollar for any remaining contributions up to 5% of your income.
Thrift savings plans have contribution limits, like a 401(k). In 2019, those limits are $19,000 for workers under the age of 50; $25,000 for workers over the age of 50; $56,000 for active military members receiving tax-free income in a qualifying combat zone. (These are the same as the limits for a 401(k) plan.)
Selection of Funds
The government offers a selection of different funds into which you can invest your money. At time of writing, there were six different options for government employees to choose among. They include a target date fund, a government securities fund, and funds indexed to metrics such as small-cap stocks, global markets and the U.S. stock market.
Differences in Thrift Savings Plans vs. 401(k) Plans
There are a few particularly notable differences between a thrift savings plan and a private sector 401(k). The most important ones:
You can choose to make either traditional contributions or IRA contributions to your thrift savings plan. This is a very important feature and workers should consider it carefully.
Under traditional contributions, you will add to your retirement account with pre-tax dollars and then pay taxes on your withdrawals when you make them in retirement. Under the Roth option, you do not get to deduct the money that you invest in your retirement account. It is included in your annual taxable income.
However, you do not pay any taxes on the money you withdraw in retirement, neither on the original money you invested (since you already paid taxes on that) nor on the profits it gained. This is a huge tax advantage, given how much your retirement account will grow in value over time.
Workers can choose to make all of their contributions as either traditional or Roth, or they can choose to contribute in some combination of the two. You have to specifically elect to make Roth contributions, and most workers should seriously consider doing so.
For workers covered by a government pension, the thrift savings plan provides a supplemental retirement plan; that is to say, you can take both. However, depending on the rules of your pension, taking matching contributions to your thrift savings plan may change how much you can ultimately collect.
This is on a case-by-case basis, so be certain to look into your situation closely.
Most government employees will receive an automatic 1% contribution to their thrift savings plan.
Full Tax Exemption
Any contributions made to a thrift savings account with tax-exempt income, such as from military members serving in qualified combat zones, remain tax free when withdrawn. This includes all earnings on that money.
Vesting in Your Thrift Savings Plan
You must work for the government for a certain number of years before you are considered "vested" in your thrift savings plan. If you leave service before vesting you can keep your own contributions and all matching contributions but you will lose the 1% automatic contribution that the government makes to your plan along with its earnings.
The number of years you must work to be considered vested will vary. Most federal workers vest in their plan after three years of service. However, in some cases, it could be only two.
This program is known for its extremely low administrative fees. In part, the government keeps those fees so low by paying the bills with forfeited money from workers who left before they vested their thrift savings plans.
Withdrawing Money From a Thrift Savings Plan
In general, if you withdraw money from your thrift savings plan before retirement, you will trigger a tax penalty (see below). However, there are a few qualifying situations when you can take this money out safely. The most common include:
You can withdraw your funds earlier without triggering a tax event as long as you are rolling them over into another qualified retirement account such as a 401(k).
Per the Federal Retirement Thrift Investment Board: "In general, if you leave federal service during or after the year you reach age 55 (or the year you reach age 50 if you're a public safety employee), the 10% penalty tax does not apply to any withdrawal you make that year or later."
You may take a loan from your thrift savings account. If you do so, you will owe the account both the full amount of the loan and an interest rate currently set at the returns for the G Fund investment option. This is to make up for some of the gains that your account lost during the loan.
There are two types of thrift savings plan loans. You can take a general loan, which must be repaid within five years, or a loan for the purchase/construction of a primary residence, which must be repaid within 15 years.
You must apply to take this loan and may be rejected, and cannot take less than $1,000 or more than $50,000. If you don't repay the loan according to its terms, or if you leave government service before repaying the loan, it will be treated as an early withdrawal.
You may make a withdrawal from your thrift savings plan while still employed by the government if you are over 59 1/2. In this situation, you will pay ordinary income taxes on all traditional contribution funds, no taxes on Roth contribution funds and no early withdrawal fees. You may do this only once.
You may also make hardship withdrawals, if you are currently employed and suffer a qualifying hardship, such as divorce, medical expenses or a major personal loss. This will trigger all applicable income taxes.
Depending on the circumstances a hardship withdrawal may also trigger an early withdrawal penalty, although that is situation-specific. Finally, you can only withdraw your own contribution, not any matching or automatic contributions and cannot make a thrift savings plan contribution for six months afterward.
After you leave government service, you can make two types of withdrawals from your thrift savings plan.
The first is a one-time partial withdrawal of at least $1,000. You may only do this once. You will pay all eligible income taxes on this withdrawal, and if you are under 59 1/2 may pay early withdrawal fees as well.
The second is a full withdrawal. In this situation you can choose to receive the entire amount of your thrift savings plan as either one lump sum, a series of monthly payments over time or as an annuity that will pay a certain benefit for life. The amount of monthly payments you can structure or the size of the annuity will depend on the amount in your thrift savings plan at the time of withdrawal.
This is how you will withdraw your money to retire. You will pay all applicable income taxes (which are none in the case of Roth or active combat zone contributions). If you choose to take a full withdrawal before reaching age 59 1/2, you may also pay early withdrawal fees to the IRS.
Taxes and Thrift Savings Plans
If you do not meet any of the qualifying exceptions above, the following tax rules will typically apply to a thrift savings plan:
If you elected to make traditional contributions, you will owe ordinary income taxes on the earnings of all money that you withdraw starting at the qualified retirement age of 59 1/2. So, for example, if you invested $10 and it grew into $100, you would owe taxes on $90.
If you elected to make Roth contributions, you will owe ordinary income taxes on all of the money that you contribute at the time of contributions. You will then owe no taxes on this money or its earnings if you withdraw it at the qualified retirement age.
If you withdraw money before the qualified retirement age of 59 1/2, you will owe full income taxes on this money and an additional 10% penalty. This applies to Roth contributions as well as to traditional contributions, although in the case of a Roth account, you will not owe taxes on your original contributions (as you have already paid your income tax for that money).