Three reasons to keep your retirement savings in the Thrift Savings Plan

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Disclaimer:

This guest post is written by an advocate of tactical asset allocation using the Thrift Savings Plan.  It’s a form of active investment management, and I do not support that.  

However, despite our different perspectives, we managed to find a few things about the TSP that we agree on.  

I think this particular message is important, and I’d like to encourage more discussion from all sources– even controversial ones.  

The author and I have agreed to run this guest post with my disclaimers:

  • Unlike my usual policy of guest posts from business sites, the blog is not being paid to sponsor this post.
  • Excess return (“alpha”) from active management does exist– but it’s rarely achievable and never reliable.
  • Almost all proprietary trading systems lack sufficient performance history to discriminate luck from skill.
  • Military servicemembers have better places (like the TSP) to invest their money than in paid financial advisory services.  If you want advice, use a fee-only financial planner.

 

 

This guest post is brought to you by Norbert Hendrikse.  

(If you’re interested in contributing a guest post, please see our guest posting guidelines.)

 

 

When employees leave Federal service, they often wonder whether they should transfer their Thrift Savings Plan assets to a different investment manager or fund company such as Vanguard. Current government employees also wonder whether they should invest some of their savings in non-TSP accounts. Here are 3 reasons to keep your money in the TSP:

 

1. The TSP G Fund

The G Fund’s current rate of return is 2.125 percent. At first glance, this may seem low, but it’s about as good as it gets for a truly risk-free source of income. It’s significantly higher than the roughly 0.3% yield of short-term bond funds or CDs. More importantly, the G Fund protects your principal in a rising interest rate environment, and its interest rate is adjusted every month. When interest rates go up, the price of bond funds declines. Most investors have not experienced this personally, because we’ve enjoyed a 30+ year bull market in bonds. Interest rates were over 15 percent in the early 1980s and as they fell, bond prices rose, which has resulted in juicy fund returns. Until recently, that is. Interest rates were at multi-decade lows earlier this year, but have risen since then. Investors in “regular” bond funds have felt the pain — for example, the TSP F Fund has lost 3.6% since the beginning of May. (To put this in perspective, its current annual yield is only 2.4 percent, so the loss represents 1.5 years worth of interest payments).

If you look back further in history, you’ll learn that bonds can have severe declines during rising interest rate environments. And while no one can predict the future of interest rates, many experts nonetheless have suggested that the bull market in bonds is over for now. As Vanguard founder John Bogle himself put it not too long ago: “the outlook for bonds over the next decade is really terrible.”

But that’s exactly what makes the TSP G Fund so extraordinary: it’s guaranteed by the U.S. government to not lose any of your principal, regardless of what happens to interest rates and bond markets. In fact, the worse things get for regular bond funds, the better it gets for G Fund investors. Consider that the G Fund earned 9% per year in the late 1980s, with zero volatility, and would have earned double-digit returns if it had existed in 1982. I challenge you to find a higher risk-free rate of return anywhere else. The bottom line is that if you’re concerned about rising interest rates, the G Fund is a great place to park the low volatility part of your retirement savings.

 

2. Generous contributions to the Roth TSP

Roth IRA contributions for U.S. investors who are not in the Federal workforce are limited to $5,500 per calendar year, and are phased out for high income earners. By contrast, TSP Roth participants regardless of pay grade can contribute up to $17,500 per year to their account! These limits are raised further if you’re at least 50 years of age: in that case, you can contribute up to $23,000 per year — including the so-called “catch-up” contribution of $5,500. That’s a far better deal than the limits for private sector Roth contributions. It enables you to stash away an extra $12K-$17.5K (before taxes) every year, and any subsequent investment gains accumulate tax-free. As any regular reader of The Military Guide can tell you, allowing the magic of tax-free compounding to work on these extra savings can significantly accelerate your road to retirement.

[Editor’s note:  Yes, servicemembers can contribute as much as $51K to the TSP while on active duty in a combat zone.  See the related articles after the end of this post.]

 

3. Ultra-low costs

Even Vanguard funds can’t compete with the low expenses of TSP funds. For example, take the Vanguard Total Stock Market ETF (VTI) with an expense ratio of 0.05% per year, or Vanguard FTSE Developed Markets ETF (VEA) with fees of 0.10% per year. Compare this to the current TSP funds expense ratio of 0.027% per year. That’s 2-4 times cheaper than owning the Vanguard funds! Would you turn down an opportunity to save 50-75% on your grocery bill every week? I didn’t think so. And while these percentage differences may seem small, the impact over a lifetime of saving is enormous. For example, consider a typical 60-year investment horizon (30 years saving and 30 years spending money in retirement). Assuming a 0.10% expense ratio, $100,000 starting account value, 7% annual rate of return, $5,000 net in annual contributions, and a retirement withdrawal rate of 4% per year, you end up paying Vanguard $67,265 in fees over 60 years. Applying the same scenario but investing in the Thrift Savings Plan, due to the lower 0.027% expense ratio, you only pay $18,662 in expenses. You saved an extra $48,603 by keeping your money in the TSP. Mind you, that’s comparing the TSP to one of the lowest cost private sector alternatives (Vanguard). If you decide to invest in a typical actively managed fund that siphons off 1.4% of your money every year, you end up paying them $590,376 of your savings over this 60 year period. Needless to say, that’s a lot of groceries. We’re talking cars or houses now.

These are just three of the benefits of investing and keeping your money in the TSP. I haven’t even touched yet on others such as Uncle Sam’s generous matching contributions. Hopefully this provides some food for thought about what to do with your TSP savings.

 

About the Author: Norbert Hendrikse is a data-driven investor and founder of TSP Folio, where he occasionally writes about investing in the Thrift Savings Plan.

 

 

Reminder: This is a guest post. Please be polite, or the comments moderator will kick in.

 

Related articles:
When do you stop contributing to tax-deferred accounts?
Combat zone contributions to the Thrift Savings Plan
Ask your Dad if you should contribute to the Roth TSP.
The TSP matches contributions for military members?
Is the Roth Thrift Savings Plan right for you?
TSP tips and trivia
TSP annuity options
So where should I invest my money now?!?
TSP withdrawal options
Where to put your savings while you’re in the military
The Military Wallet: 2013 Thrift Savings Plan Contribution Limits

 

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WHAT I DO: I help you reach financial independence. For free. I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers, veterans, and families. All of my writing revenue is donated to military-friendly charities.

6 Comments
  1. Reply
    How Should I Invest During Retirement? February 20, 2014 at 5:01 AM

    […] on multiple streams of income Handling your cashflow after the military TSP withdrawal options Three reasons to keep your retirement savings in the Thrift Savings Plan Guest post Wednesday: The importance of your retirement account Exit […]

  2. Reply
    Brick By Brick Investing January 3, 2014 at 7:10 PM

    I really do like the the TSP for federal employees but I would like to see them match service members contributions as well.

    • Reply
      Doug @ The-Military-Guide January 4, 2014 at 3:47 AM

      I think the law is on the books, Brick, but DoD has not elected to match TSP contributions yet.

      FYI, a persistent military urban legend is that matching TSP contributions will be the precursor to killing off the military defined-benefits pension in favor of a defined-contribution (401(k)) system that starts withdrawals after age 59.5. So maybe we don’t want to tempt DoD into matching our TSP contributions anytime soon…

  3. […] funds have the world’s lowest expense ratios. (Even lower than Vanguard.) The final reason is the TSP’s “G” fund, which is a guaranteed return that can act like a high-quality … in your overall asset allocation plan. You may not want to use it, but it’s a great […]

  4. Reply
    Doug Nordman July 23, 2013 at 7:01 AM

    Thanks for the great questions, Tom! The answers are “sort of”.

    This post doesn’t cover all the details of every situation. Every time I write about the TSP (or IRAs) the caveats and exceptions and footnotes would triple the length of the text and make it read like the tax code.

    As you know, servicemembers make their contributions to the Roth TSP (or the conventional TSP) through payroll deduction– either from active-duty pay or from drill pay. The difference is that the Roth TSP contributions are after-tax dollars (servicemembers pay taxes separately on their contributions) while the conventional TSP contributions are pre-tax. And, of course, contributions from a combat zone are completely tax-free (but that’s a caveat for another post).

    The “over 50 catchup” provision allows an extra $5500 contributions, but admittedly that doesn’t apply to very many active-duty servicemembers. However I see a lot of Reserve/National Guard readers in their 50s, and the TSP is a much lower expense ratio than a civilian 401(k). Reserve/Guard servicemembers could do very well by contributing their drill pay & active-duty pay to the TSP. After their civilian employer’s 401(k) match (if any), that $5500 catch-up goes further in the TSP.

    Retired servicemembers can make contributions to the TSP if they’re back on duty and receiving earned income from a military salary (a very few elect to do this on occasion). Retired servicemembers can also roll over their conventional IRAs to the TSP. Now they can even roll over their Roth 401(k)s and other after-tax tax-deferred retirement accounts to the Roth TSP. See this chart:
    https://www.tsp.gov/whatsnew/roth/compareRoth.shtml
    A military pension is not earned income, so that couldn’t go into any retirement savings plan. A military retiree in federal civil service could certainly contribute their civil-service pay to their civil-service Roth TSP account. But I’m not sure that any military retirees could contribute directly to their military Roth TSP from civilian earned income. They’d have to use the rollover tactic.

    The Roth TSP withdrawal rules are similar to TSP withdrawals. Take a look at this link:
    http://the-military-guide.com/2012/03/19/is-the-roth-thrift-savings-plan-right-for-you/

    I’m not familiar with TSP or Roth TSP withdrawal provisions for kid’s college expenses, but I know that you could withdraw Roth IRA contributions at any time for any reason. Beyond the basic advice in this post, you’d want to chat with your financial adviser (or one of USAA’s CFPs). Aside from the tax code rules, I think any financial adviser would hesitate to recommend cannibalizing retirement assets to pay for a kid’s college degree.

    Let me know if these answers clear up your questions or just muddy the waters even further. I could turn this into several more posts on the topic…

  5. Reply
    5wahls July 22, 2013 at 7:17 AM

    Great article. So a retired Air Force member over 50 can contribute to a ROTH TSP up to $23k!? Wow. Are all accounts in the TSP ROTHs? Also, are the rules for the ROTH TSP the same as regular TSPs in terms of withdrawals? Specifically, can funds be withdrawn for kids’ college expenses with no early withdraw penalty? Thanks! Tom

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