Those who serve in the armed forces know all about sacrifice. But there’s no reason why a commitment to duty and service to others—rather than a civilian line of work—should make it more difficult for those in the military to save for a secure retirement.
Enter the Thrift Savings Plan, or TSP: developed to provide those in the military—along with others working in the federal government—with an effective tool to fund their retirement. Established by Congress as part of the Federal Employees’ Retirement System Act of 1986, TSPs are defined contribution plans, meaning the funds available to retirees in retirement depends on how much workers contribute during their careers.
How Does a TSP Work?
In many ways, a TSP functions in the same way as the more well-known 401(k) plans offered by private employers, as well as other retirement savings tools, like an individual retirement account (IRA). As with the aforementioned, money contributed to a TSP is tax-deferred, meaning that taxes are not levied until the owner of the account begins to withdraw money, usually at a certain age.
“Taxes stay sheltered until they are withdrawn from the retirement account, typically in retirement,” says Brian Windsor, a certified financial planner and vice president at Bogart Wealth, which has locations in Virginia and Texas. “This allows the money to compound more over time without any tax drag issues.”
In 2023, the pretax contribution limit for TSPs is $22,500. Those who are over 50 can invest an additional $7,500 in what are known as “catch-up” contributions, similar to a 401(k). Money contributed to a TSP each year also has the benefit of reducing an individual’s taxable income.
There are also Roth TSPs, whose contributions are taxable in the year they are made. But like Roth IRAs, withdrawals from Roth TSPs are not taxable. When deciding which to contribute to, consider your current tax bracket. If you’re in a low tax bracket now but anticipate being in a higher one in the future, a Roth TSP might make more sense for you.
Participating in either a traditional or Roth TSP is straightforward. Military members make automatic payroll contributions of a percentage of their salary. In fact, those who joined the military on or after October 1, 2020, are automatically enrolled with 5% of their salary going into a TSP account.
TSP participants can opt to change that contribution level, though Windsor says it is smart to take full advantage of matching contributions from their employer. For many service members, that match goes as high as 5% of their salary. Ask your HR department about your match eligibility.
How TSPs Differ From 401(k)s and IRAs
One significant difference between TSPs and 401(k)s and IRAs are the investment options available to participants. Both 401(k)s and IRAs offer extremely diverse investment possibilities, everything from low-cost index funds that mirror the performance of the S&P 500 and other market indices as well as more expensive managed funds that focus on small and middle-sized companies, tech firms or those involved in clean energy.
By contrast, TSPs offer a selection of five individual funds and 10 “lifecycle” funds, which are mixtures of the individual funds that are configured based on when a participant expects to start withdrawing their money (for example, in 2025, 2030, etc.). More recently, the TSP began offering what the plan administrators call a “mutual fund window,” which provides more investment options than just index funds.
“The TSP has been well known over the years for its inexpensive institutional index funds, meaning the underlying costs of the actual investment are some of the lowest in the industry. These cost savings can help you keep more of your earnings over the years,” Windsor says. “However, the TSP offers only a handful of index options. While it covers a very broad base and a lot of the financial markets, avid investors have generally had an appetite for more investment options.”
That is to say, it often makes sense for TSP owners to also have IRAs as part of their investment portfolio. “It is beneficial to have a mix of account types before and during retirement,” says Nicole Strbich, managing director of financial planning for Ohio-based Buckingham Advisors, an independent financial advisory firm.
“If you need to distribute funds for education expenses or for the purchase of your first home, TSPs do not have the same exceptions to the early distribution penalty that IRAs normally do. Additionally, IRAs have an almost unlimited choice of investment options that you may want to access outside of your TSP account.” Diversifying your portfolio is key, no matter what vehicle you choose.
TSP Withdrawal Options
Once in retirement, TSP owners have multiple options for withdrawing their funds. One is to have money distributed in set installments, either monthly, quarterly or annually. TSP holders can change how frequently these distributions occur and how much money is withdrawn in each installment.
Another distribution option is to have TSP administrators disburse money from the account based on life expectancy, which is calculated using Internal Revenue Service tables. In other words, the amount distributed is based on the following: the total funds in the account, the account holder’s age and the performance of the account.
TSP owners also have the option to use the funds in their account to buy a life annuity, which provides monthly income for the rest of their lives. This means giving up control of the investment decisions within the TSP, a decision that can’t be reversed once it is made.
For TSP owners who choose installment withdrawals, Windsor suggests sequencing the distributions to maximize potential tax benefits and growth. “I would typically advise a client to withdraw their pretax sources of monies first and allow their Roth sources to grow unencumbered,” Windsor says. “This maximizes the tax-free growth, tax-free withdrawal potential for the Roth funds.”
Adequately saving for retirement is a long journey. Having investment vehicles like a TSP that offer low administrative fees, death benefits for spouses, diverse investment options and employer matching contributions provides an important tool for generating the wealth needed for a secure retirement. Which is exactly what members of the armed services have earned.
A former editor at Los Angeles magazine, Chris Warren has had work appear in publications ranging from Institutional Investor and Forbes to National Geographic Traveler, Oxford American and Greentech Media.
Illustration by Jack Hudson
LEARN MORE: 10 Financial Benefits Veterans Need to Know
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