While military members may not have access to an employer’s 401(k) plan, they do have an outstanding alternative – the Thrift Savings Plan. This tax-advantaged retirement account provides service members an incredible savings opportunity. As such, we’ll use this article to provide an overview of some great Thrift Savings Plan strategies.
Specifically, we’ll discuss the following:
- An Overview of the Thrift Savings Plan
- Different TSP Tax Strategies: Traditional vs. Roth
- The Ultimate TSP Tax Savings
- The Lifecycle Fund Strategy
- TSP Loan Options
- Rolling Your TSP into a SDIRA
- TSP Withdrawal Strategies
- Final Thoughts
An Overview of the Thrift Savings Plan
Before discussing particular strategies, we need to first provide an overview of this retirement option.
The Thrift Savings Program, or TSP, provides military members and eligible federal employees an employer-sponsored retirement savings account. As a result, the TSP is loosely equivalent to the 401(k) plans offered by many civilian employers. More precisely, the TSP acts as a tax-advantaged, defined-contribution retirement plan. Simply put, this means that the TSP: A) provides tax benefits for retirement savings; and B) has a guaranteed government contribution on top of member contributions – on up to the first 5% of the pay you contribute each period (conversely, a pension has a guaranteed benefit).
And, like 401(k) plans, the TSP allows account holders to set up an automatic contribution for each paycheck, meaning you don’t need to think about retirement contributions – they just happen. Service members choose a percentage or flat amount of their paycheck, and that amount will automatically transfer into your TSP each pay period. Additionally, you can select an option to contribute between 1 to 100% of any incentive, special, or bonus pay, even if you’re not currently receiving them (though BAH and subsistence allowance contributions are prohibited).
Different TSP Tax Strategies: Traditional vs. Roth
With respect to tax-advantaged treatment, the TSP offers two options: traditional or Roth. With a traditional TSP, individuals get a tax benefit now. Every dollar you contribute to a traditional TSP reduces your current taxable income. Conversely, Roth TSPs provide a tax benefit later. You don’t reduce your current taxable income with contributions. But, every dollar you withdraw after retirement age (59 ½) comes out tax-free. This includes both the original contributions and the earnings on those contributions.
The Roth vs. traditional TSP decision largely depends on your thoughts on future taxes. If you believe you’ll be in a lower tax bracket in retirement, taking the tax savings of a traditional TSP now may make more sense. Conversely, if you believe you’ll be in a higher tax bracket in retirement, paying taxes now and withdrawing them tax-free later likely makes more sense.
The Ultimate TSP Tax Savings
When deployed in a combat zone or other select duty stations, service members receive tax-exempt pay. This sets you up for the possibility of triple tax savings. In particular, for Roth account holders, TSP contributions with tax-exempt pay offer the following savings:
- No tax on TSP contributions
- No tax on TSP account earnings
- No tax on TSP withdrawals
Combine this with the fact that troops can contribute significantly higher annual amounts to their TSPs from a combat zone, and this strategy provides incredible tax saving potential.
The Lifecycle Fund Strategy
As military members, many of us don’t like to show vulnerability. That is, we don’t want to admit that we don’t understand something. But, from a personal finance perspective, it’s okay to admit that you’re not an expert! And, the TSP offers an outstanding retirement savings strategy for individuals without a solid grasp of investment fundamentals: lifecycle funds.
From a fund perspective, the TSP lets account holders choose between five different investment options. These five funds represent a variety of different categories of stocks and bonds. If you don’t know how you should balance your portfolio, that is, how you should allocate your money between these stock and bond funds, a lifecycle fund will do all the work for you. These funds target a particular retirement year (e.g. 2040, 2045, 2050, etc.) and automatically balance your portfolio with the optimal mix of stocks and bonds to meet that target retirement date.
Simply put, the TSP’s lifecycle funds let servicemembers “set it and forget it” when it comes to retirement savings.
TSP Loan Options
Many service members don’t realize this, but you can take a loan from your TSP account – a potentially solid strategy in the right situations. More precisely, the TSP allows account holders to take two different types of loans from their accounts – a residential loan and a general purpose loan. For both, you must repay the loan with interest. But, this interest is pegged to the current government fund (G Fund) rate – typically quite low. And, you repay this interest to yourself.
To qualify for a loan, you must still be an active service member. And, you can only have one of the two loan types outstanding at any given time. With that said, here’s a brief overview of each loan type:
TSP Residential Loan
- For purchase or construction of a primary residence
- Requires documentation
- 1- to 15-year repayment term
TSP General Purpose Loan
- May be used for any purpose
- No documentation required
- Has a 1- to 5-year repayment term
While these loans do provide a low-interest borrowing option, TSP account holders should also consider what they lose with these loans. When you take money out of your account, you stop earning interest and dividends on those funds, meaning your account balance will be smaller in retirement. Consequently, carefully weigh this reality against your borrowing needs before taking a TSP loan.
Rolling Your TSP into a SDIRA
For separated service members looking for more flexibility in choosing investments, rolling your TSP into a self-directed individual retirement account, or SDIRA, may make sense.
An SDIRA is a unique type of IRA. Unlike their IRA counterparts, SDIRAs allow account holders to invest in a far broader range of asset classes. This represents the primary practical difference between normal IRAs and SDIRAs.
Like normal IRAs, SDIRAs serve as a form of tax-advantaged retirement account. More precisely, investors can choose between a traditional or Roth version, both of which offer unique tax benefits. With a traditional SDIRA, investors contribute pre-tax funds, which reduces your current taxable income. However, when you withdraw funds from your SDIRA in retirement, you’ll need to pay income taxes. Alternatively, you can opt for a Roth SDIRA. With these, you contribute post-tax funds. This means you don’t receive a current tax benefit, but you have the advantage of withdrawing tax-free funds in retirement.
For current TSP holders, the primary advantage to rolling funds from a TSP into an SDIRA involves investment options. More precisely, you can invest in alternative asset classes not available in the TSP or standard IRAs. Some of these investment options include:
- Real estate
- Precious metals
- Closely-held companies
- Real estate tax liens
- Cryptocurrencies (e.g. Bitcoin, Ethereum, etc.)
- Private loans
However, before making this move, TSP account holders should consider the associated fees. Due to the added complexity of these investment options, SDIRA custodians typically charge far higher fees than the low ones offered in the TSP.
TSP Withdrawal Strategies
When service members separate from the military, they do not need to close their TSP accounts. Instead, the federal government allows you to keep your account open for as long as you’d like. For many service members, this option makes sense for two primary reasons:
- Low expense ratios: The available investment fund options in the TSP have extremely low expense ratios (amount you pay to hold the funds).
- No account charge: You also do not need to pay the government any sort of administrative charge to keep your account open.
If you choose to keep your TSP account open after separating from the military, you have three withdrawal options once you reach retirement age (59 ½ years old):
Installment Payments
You can choose to receive payments from your account monthly, quarterly (every three months), or annually. Your payments will continue, unless you stop them, until your total account balance equals zero. There are two ways of setting the payment amount: payments of a fixed dollar amount and payments based on life expectancy. With the latter option, the TSP will calculate your distributions based on IRS life-expectancy tables.
Single Withdrawals
You can withdraw any amount of $1,000 or more from your account in a single payment. There is no limit on the number of single withdrawals you can make, but the TSP will not process more than one in any 30-day period. You are allowed to take a single withdrawal of part of your account even if you’re currently receiving the above installment payments.
Annuity Purchases
You can use all or part of your TSP account to purchase a life annuity through the TSP’s outside vendor. Purchasing an annuity means that you pay now to receive monthly payments that last for the rest of your life (or, if you choose a joint life annuity, the life of your joint annuitant). For people worried about running out of money in retirement, annuities can be a great, low-stress option.
Final Thoughts
The Thrift Savings Plan offers service members an outstanding, low-fee retirement plan. But, as with most financial planning topics, retirement savings must be tailored to an individual’s unique situation and needs. By reviewing the above strategies, you’ll be better suited to make the best TSP decisions to support your retirement goals.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.
