The federal Thrift Savings Plan (TSP) provides access to a user-friendly retirement savings plan for members of the armed forces and other government workers. And the DoD gives you a head start by enrolling you in the plan and setting up an automatic 3% contribution from your earnings each pay period that goes into the default investment, a lifecycle fund.
But it’s up to you to explore all the investment options and contribution levels to take full advantage of the plan.
One of the great benefits of automatic enrollment is that it simplifies decision making. The initial rate at which you contribute and the way your money is invested are set. Choices like that, especially if you’re making them for the first time, can be intimidating. And if you’re afraid of making a mistake, you may decide it’s easier to do nothing about investing—which is the worst choice you can make.
But it’s also good to know that with the BRS, you’re not locked in to either the default contribution rate or investment choice. You have the right to contribute at a higher or lower rate. Of course, if you want your account value to grow larger, higher is the way to go. Similarly, if you would rather put your money into the individual funds offered in the TSP, you can make the switch whenever you’re ready.
If you stick with the default investment, your contributions plus the automatic 1% and the matching contributions from DoD you’ll qualify for after completing two years of service will go into a lifecycle (L) fund, called the L2050. It’s one of a series of L funds, now including L2020, L2030, and L2040 and eventually L2060.
If you prefer to use one or more of the five individual investment funds (G, F, C, S, and I), the contributions will be allocated to them on the percentage basis you have designated.
The G (for government) fund invests in a portfolio of US Treasury securities.
The other four funds (F for Fixed Income, C for common stock, S for small and mid-sized company stock, and I for international stock) are index mutual funds. An index fund is designed to mirror the performance of a specific stock or bond index by owning all, or a representative sample of, the securities in the index.
The L funds, which are funds of funds, include all five individual funds in a single package. But each L fund holds the five funds in different proportions, or weights. For example, the L2050 fund has 84% of its assets in stock funds, while the L2020 fund has just 41% in stock funds.
One change you might consider right away is having your contributions go into a tax-free Roth account rather than the default tax-deferred account. All you have to do is authorize the change on the TSP website using the automated ThriftLine or by talking to a TSP representative.
Unlike contributions you make to the default tax-deferred account, those you make to a Roth don’t reduce your current taxable income or the income tax you owe.
But the more important difference is what a Roth account will let you do in the future. You’ll be able to take totally tax-free withdrawals after you’re at least 59, provided your account has been open at least five years. Chances are your income and your tax rate will be higher then than it is now. So tax-free income could mean substantially lower taxes, and more money in your pocket, during retirement.
And while withdrawals are required from the default tax-deferred account every year after you reach 70, withdrawals are never required from a Roth account.
If you want to take advantage of both tax deferred and tax-free withdrawals, you can split your contributions between a traditional and a Roth account any way you choose—for example on a 50-50 or 25-75 basis, or using some other proportion. The only limitation is that the combined total you contribute to your accounts cannot exceed the annual cap, or dollar limit, that applies to TSP contributions. That cap is $18,500 in 2018 and is raised from time to time to reflect increases in inflation.
TSP offers significant flexibility. You can change the way your contributions are divided between traditional and Roth accounts at any time, stop contributing to either account, or convert your traditional account to a Roth account by paying the taxes that are due. The one thing you can’t do is convert a Roth to a traditional account.
Lifecycle funds, including the TSP’s L funds, are sometimes described as target date funds. That may provide a clearer sense of what they’re designed to do.
Each L fund is focused on a particular target date that’s part of its name and adjusts it portfolio. For example, the L2050 is appropriate for members who won’t turn 62 until 2045 or later. In contrast, the L2010 fund, which reached its target in 2010 and was converted to an income fund, has 74% of its assets in the G fund to preserve account value for servicemembers invested in this fund and already withdrawing retirement income.