Good news for Thrift Savings Plan (TSP) participants – the Thrift Savings Plan will begin to offering a Roth 401(k) option in 2012. In June 2009, President Obama signed the the Thrift Savings Plan Enhancement Act 2009, Public Law 111-31 which gives the Thrift Savings Plan the authority to offer a Roth 401k option. It will take the agency some time to set up the infrastructure and bookkeeping capability, so the launch is not expected until 2012.

Update: the TSP Roth 401k option has been delayed and is now expected to be offered in the first calendar quarter of 2012 (the original date was 2011).

If you think that a Roth 401K TSP sounds like some sort of hybrid retirement plan then your guess would be absolutely right! The Thrift Savings Plan Roth 401K is actually a merger of two of the popular retirement plans currently available; the Roth 401K, and the Thrift Savings Plan.

The Roth 401K is typically used by individuals in the private sector and the Thrift Savings Plan is reserved for government employees, including those working for the government under civilian programs and the DoD, and for those in the armed forces. The Roth 401k Thrift Savings Plan puts the best part of both plans in one new retirement option.

What is the Roth 401k feature for the Thrift Savings Plan?

A Roth 401(k) feature for the Thrift Savings Plan combines the benefits of a Roth savings plan with the TSP retirement savings plan. Instead of making contributions before paying taxes like you currently do with the TSP (and paying taxes when you withdraw the money), you will pay taxes now and make tax free withdrawals in retirement. This means your Roth savings will grow without the drag of taxes because your contributions have already been taxed. You will not pay any federal income taxes on your withdrawals so long as you meet Roth withdrawal eligibility guidelines – typically age 59½ and have been making Roth contributions for a minimum of 5 years.

TSP Roth 401k eligibility

Another benefit adopted from the Roth 401K plan is an absence of income limitations for plan participation. Anyone can contribute towards this retirement plan regardless of how much money they make. This differs from Roth IRA contribution limits which are tied to income. The TSP Roth 401k contribution limits will be the same as all TSP contribution limits, regardless of whether you invest in the Roth option or the traditional option. Contribution limits can be found here.

Benefits Associated with the Roth 401K

Here are some benefits you should expect to see with the Roth 401k plan:

• Contributions are made after taxes have been withdrawn.
• There are no taxes on withdrawals from a Roth 401K so long as you meet withdrawal eligibility requirements.
• There are no income restrictions on regarding who can contribute to a Roth 401K, so you can contribute regardless of income level.

Deployed contributions to Roth 401k for TSP could be huge

I’m a big fan of investing in the TSP while deployed because of the tax benefits – you don’t pay income tax on the money you contribute and the portion you contribute while deployed can be withdrawn tax free, giving traditional TSP contributions similar rules to Roth 401k contributions. The difference is the tax free portion of your withdrawals will be prorated across all regular TSP withdrawals, and there are minimum distribution requirements. A Roth 401k feature will eliminate the necessity to track which portions of contributions and withdrawals are tax free, and there are no minimum distribution age requirements. This makes the Roth 401k TSP feature much more flexible. You don’t get taxed on income and you can make tax free withdrawals in retirement. It doesn’t get any better than that!

Should you invest in the Thrift Savings Plan 401k option when it is available?

This could be a great opportunity to save some money with great tax benefits,though it may not be the ideal situation for everyone. You should look at your investment goals, tax obligations and other factors before making the decision to switch from the traditional TSP plan to the Roth 401k, or consider contributing to a hybrid approach and making a portion of your contributions to each plan so you can diversify your tax liability in retirement. Generally, if you are in a low tax bracket, or you have tax free deployment income, then you might want to consider the Roth 401k TSP feature. If you are in a higher tax bracket and don’t have tax free income, then the tax situation should be similar to deciding whether or not you should invest in a 401(k) or IRA. The previous link should be helpful in making the decision. You might also consider doing a Roth in-plan Rollover, which will allow you to transfer some or all of your current TSP assets from a Traditional TSP investment to a Roth for tax purposes. There may be tax consequences of this, so be sure to look into it before you make the move when it becomes available to you.

Military and government officials have been discussing adding a Roth Option for the TSP to try and bring the Thrift Savings Plan more in line with its civilian counterpart – the 401(k) plan. The benefit of offering a Roth TSP option is that Roth contributions are made with post tax salary, and withdrawals are tax free in retirement. This allows money invested in a Roth account to grow without the drag of taxes until the account holder reaches retirement age – potentially several decades.

Roth TSP plan may be several years off

The House recently approved a measure that will make the Roth TSP a reality for military and government Thrift Savings Plan holders, but it appears as though it may still take a couple years to toll the Roth TSP plan out to participating members, even if a bill is signed into law. The reason for the delay is that it will take TSP officials, military pay officials, and other federal agencies time to make the necessary changes in the payroll and accounting systems.

Additionally, a change such as adding a Roth option is a substantial enough change that the TSP Board will want to ensure that people are informed about the Roth option and will need to offer enough information to TSP participants to make sure they can make an informed decision regarding whether or not the Roth option would be better for them, or whether they should stick with the traditional offering.

Which is better – Roth or Traditional? The Roth and Traditional TSP plans would function in a similar manner as Roth and Traditional IRAs. I recommend reading on the pros and cons of investing in the IRAs to get a better idea of how it would differ with the TSP. Both options are good, but one may be better for you than the other, depending on your current and potential future income, and your current and potential future tax levels. You should make your decision based on those and other factors.

The House recently approved a measure that will add a Roth option to the Thrift Savings Plan. This feature will be similar to Roth 401k plans and Roth IRAs – contributions are made after taxes are withheld from your paycheck, and withdrawals are made tax free in retirement.

The benefits of a Roth option for the TSP

Many military members start off their career in lower tax brackets because they often receive a large portion of their income as non-taxable military benefits. This allows military members to put away a lot of money that was taxed at a comparatively low rate – potentially lower than they would be subject to in retirement years. This can be a great way to save for retirement and practice tax planning at the same time.

Roth vs. Traditional. Here is a comparison between Roth and Traditional IRAs, which covers some of the pros and cons of investing with pre-tax and post-tax money, and how the distributions work.

Other proposals for the Thrift Savings Plan

Survivor benefits. Another change on the line is a survivor benefit change that would allow spouses of deceased TSP holders maintain the TSP accounts after their spouse passes away. Currently, surviving spouses or heirs must transfer the assets from the TSP account within 60 days of the member’s death. The funds must be transferred to an IRA, or be subject to early withdrawal penalties.

Mutual fund option. Another proposal would allow TSP participants to invest money held in their TSP account in private-sector mutual funds. This option will negate one of the best benefits of the Thrift Savings Plan, which is the extremely low cost ratios of the funds. It is very possible this section of the proposal will not pass.

The Thrift Savings Plan is improving

It’s good to see that government officials are working to improve one of the best financial benefits available to military members.

When I separated from the USAF in 2006, I was faced with a decision regarding my Thrift Savings Plan (TSP). Since I would no longer be a member of the armed forces, I could no longer contribute to the TSP. So what should I do? In the end I decided to leave the money in there, but I’ll walk you through your options so you can make an informed decision if ever the need arises.

Options for your TSP when you leave the service

The TSP plan is similar to a civilian 401(k) plan. Members contribute pre-tax money into their Thrift Savings Plan account and only pay taxes when they withdraw the money. When your employment ends with the military or civil service and you can no longer contribute to your TSP account, you are faced with several decisions regarding your TSP account. Your options are similar to those with a civilian 401(k) plan.

There are 5 options for your TSP account.

1. Leave the assets in your TSP account.
2. Roll your TSP account assets into an IRA
3. Roll your TSP account into your new employer’s 401(k) plan.
4. Withdraw your TSP account assets in a lump sum.
5. Transfer your TSP account assets to a qualified annuity.

Let’s take a closer look at your options:

1. Leave TSP account assets in your account.

The easiest thing to do is leave your assets in your TSP account. However, you need to keep in mind that you will not be able to make additional deposits to your account once you are no longer part of the uniformed services or civil service.

Advantages: The TSP is a great place to invest for retirement. The TSP is easy to use, and while it doesn’t have many investment choices, the fees are among the lowest you can possibly find – even lower than most popular index funds. You always maintain the option of moving your funds from the TSP at a later date. There are also special tax considerations if you invested in your TSP while deployed to a war zone. Read more about advantages of investing in the TSP.

Disadvantages: The TSP has limited investment options. There are only 5 main funds to choose from and a few target funds. You will also not be able to make new contributions or take loans from your old TSP account. Having one more account to keep track of can also be a headache for some people. Not only does it involve more work when balancing your assets, but you also must maintain more paperwork. Read more about disadvantages of investing in the TSP.

Verdict: The fees charged to manage the Thrift Savings Plan are probably the lowest you will ever find. Consider leaving your funds in the TSP unless you don’t want to deal with extra paper work or you want more investment options. Otherwise, consider rolling your TSP account assets into your new 401(k) plan if you have one, or one of the other following options.

2. Roll your TSP assets into an IRA

Rolling your Thrift Savings Plan assets into a Traditional IRA will help you avoid the 10% early withdrawal penalty. You will also control your IRA and have unlimited investment options. If you enjoy hands on investments, then rolling your TSP into an IRA may be for you.

Advantages: The biggest advantages of rolling over your TSP into an IRA are avoiding the 10% early withdrawal penalty, maintaining certain tax advantages, and controlling your investment options which will no longer limited to the investment options in the Thrift Savings Plan or your new employer’s 401(k) plan. Total control allows you to limit your expenses and maintain full control of your investment. Also note that rolling your TSP assets into an IRA does not mean it is final – you may be able to roll it into your new 401(k) plan later.

Disadvantages: You will not be able to take loans from your TSP, which you would have been able to do if you rolled it into your new employer’s 401(k) plan. It is also easier to make withdrawals from 401(k) plans under certain circumstances.

Verdict: Consider this option if you want total control over your investments, you want more investment options, your new employer’s 401(k) plan does not offer strong investment options, or you want to consolidate your investment holdings into fewer accounts.

Looking for a Rollover IRA? Check out this tool from Mint.com, which will help you find the right Rollover IRA for your needs.

3. Roll your TSP assets into new employer’s 401(k) plan

This is a good option if your new employer’s 401(k) plan has strong investment options and low expense ratios. Another thing to consider is reducing the number of investment accounts you have to keep track of, maintain, and balance.

Advantages: Your retirement assets maintain their tax advantages and there are no penalties or fees to transfer or your money. You can borrow against your 401(k) if you want, and you will minimize the number of retirement accounts you have.

Disadvantages: You are limited to your new plan’s investment options. This is important if your new 401(k) plan has limited investment options or higher than average expense ratios, which cause lower returns. Some employers have a minimum waiting period before you can sign up for their 401(k) plan, so you may have to wait before you can rollover your TSP assets.

Verdict: Consider this option if your new plan has strong investment options and/or you want to reduce the number of retirement accounts you need to maintain.

4. Withdraw your TSP assets in a lump sum

Withdrawing your Thrift Savings Plan assets in a lump sum is not usually recommended because you will be assessed with taxes (usually 20%) and early withdrawal penalties (10%). Together, these can eat up nearly a third of your total TSP assets.

Possible Advantages: Your assets (minus income taxes and early withdrawal penalties) will be available for immediate use. This can help during periods of unemployment after separating form the military or civil service.

Disadvantages: The huge tax payment and the 10% early withdrawal penalty (if you are under age 59½) reduces the amount you receive by almost a third. In addition you also all lose tax deferral benefits, potential future earnings, and lock in any market losses. Most importantly, you reduce the amount of money you have for your retirement.

You can change your mind within 60 days. The law requires your old fund manager to deduct 20% of your withdrawal for taxes at the time of withdrawal. If you change your mind, there is a 60-day rollover rule which allows you to roll the money into an IRA within 60 days. However, you will be required to come up with the 20% difference to reinvest the entire amount and avoid paying income taxes. You will get the 20% back when you file taxes the following year as long as you complete the rollover within 60 days.

Verdict: Consider this option only if you need the funds immediately and you cannot meet those expenses through other means. But I strongly advise you to speak with a financial planner to look at other options before doing this.

5. Transfer the assets to a qualified annuity

The final option is to transfer your TSP assets into a qualified deferred annuity. This is an an option few people are aware of, and one not many people use. In many cases it is not the best option. As with rolling over TSP assets into an IRA or 401(k), the assets will remain tax deferred and you will not pay early withdrawal penalties.

Possible Advantages: An annuity is similar to a “personal” pension and creates an income stream for life. Retirement plans such as the TSP, IRAs, and 401(k)s are limited to the amount of money you are able to invest and you can outlive them. Your heirs may be able to inherit a portion of your annuity if you pass away during the accumulation phase.

Possible Disadvantages: Rolling your TSP into an annuity is final. Once it has been done, it cannot be reversed. Many annuities come with much higher fees than 401(k) plans and IRAs, and many states charge high tax premiums on annuity plans. In addition, you may pass away before your annuity pays out the amount of money you would have had in your 401(k) or IRA, leaving nothing for your heirs.

Verdict: Annuities are not necessarily bad, but there are often complicated and have many associated variables. If you think an annuity may be for you, consider talking to a certified financial planner or other tax or retirement professional for more details. One more note concerning annuities: beware of salesmen. Many annuities are given the hard sell because they are often extremely profitable for the investment management company.

Best options for your Thrift Savings Plan account

In most cases, the best option will be to transfer your TSP assets to your new 401(k) plan, an IRA, or leave your assets in the TSP account. Your should base your decision on your situation.

What did I do with my TSP account?

I chose to leave my TSP alone because the portion of money you invest in your TSP account while in a tax free combat zone will remain tax free, even when you withdraw it during retirement. I deployed 5 times while I was in the service, so I was able to invest a decent amount of tax free money in my TSP.

Do you have a 401(k) plan you need to transfer? Then check out this article: Should you consolidate 401(k) accounts? This article looks at the same situation rolling over a TSP account.

If you’ve read my article about the advantages of investing in the TSP, then you know that I believe the TSP is a great way for many military members and government employees to invest for retirement. However, there are also several drawbacks to investing in the TSP.

Disadvantages to Investing in the TSP

I will throw a caveat out there before I list some perceived disadvantages with the Thrift Savings Plan – the TSP is still a great investment vehicle for the majority of federal employees and military members who are eligible to participate in the TSP, especially with the new Roth TSP option, which recently became available to TSP participants.

Limited investment choices. There are only 5 investment choices (not counting Life Cycle Funds), which is a benefit and a drawback. The simplicity that makes investing in the TSP can also be a detriment to those who have a better understanding of investing or would like to further diversify beyond a few index funds. With the TSP you can not invest in REITs, or individual sectors such as technology, precious metals, healthcare, emerging markets, etc.

Limited tracking in money software. The second drawback is the inability to link to home finance programs such as Quicken, or MS Money. You can manually input your data into these programs, but there is no automatic download feature. So you must manually change it every time you invest, rebalance your portfolio, etc. That can be a pain, but it’s necessary if you want to have a clear picture of your net worth, asset allocation, performance, etc. (The TSP states the reason they do not offer this feature is to maintain low costs.)

No matching funds for military. Unless you are civil service, you do not get matching funds. In that case, it is usually better to max out your Roth IRA before contributing to the TSP. (This has changed to a limited degree since the initial publication of this article; military branches have the option of offering matching funds to service members, but only do so on a limited basis – usually only as a retention bonus. All matching funds come out of personnel budgets, which limits the service branches ability to do this on a full scale basis).

Difficult to track gains. The TSP site does not track cost basis. This is important to know for tracking purposes and monitoring your investments. You can do this manually, but if you did not do this from the time you began investing in the TSP, you will never get a truly accurate picture. A work around for this would be to use your current value as a cost basis, then track from now on. This will not give you a true cost basis from inception, but it will allow you to track annual growth. (But the TSP has well known index funds so they should be easy to track manually).

Inability to contribute after government service ends. Finally, once your service with the government is through, you can no longer contribute to the plan. However, this is just like any other 401k plan. You do have the option to leave your funds within the TSP, you can roll them into a different 401k plan, or roll them into a traditional IRA. Here are some more options.

The TSP is still a great investment option!

This article is not meant to dissuade you from contributing to the TSP, or look for other alternatives. This is simply meant to point out a few areas that more advanced investors may feel are limitations.

All in all, I still think the TSP is a good way to go for government employees looking for an easy to use and inexpensive retirement system. The pros far outweigh any cons, and regularly contributing to your TSP can be a great way to prepare for your retirement.

The Thrift Savings Plan (TSP) is a US Government sponsored retirement plan that is very similar to a traditional 401k. It is primarily open to US Military members and eligible civil-service employees. Why does it rock?

It is simple to do. Electronic sign-up takes less than 5 minutes and will start within a month. Once you set it up, you don’t have to do anything – it’s automatic!

It’s easy to invest with the TSP. 5 simple index funds and 5 LifeCycle Funds (targeted retirement date funds) make it easy for anyone to invest, even if you don’t know much about investing. The index funds are broken into 2 groups – stocks and bonds. A third group is a life-cycle fund, which is comprised of both stocks and bonds.

• Stocks. The stocks include indexes for Large Cap (S&P 500), Small Cap (Dow Jones Wilshire 4500), and International Stocks (Morgan Stanley International EAFE Stock Index).
• Bonds. The bonds include Govt. (Treasury Bonds) and Fixed Security Bonds (Lehman Bros. US Aggregate Index).
• Mixture. The LifeCycle Funds automatically allocate a portion of your portfolio to target risk and returns based on your proposed retirement date. These funds cover all the fundamental segments of the marketplace.

Very low overhead. The highest you can currently expect to pay in fees is .05%, including the LifeCycle Funds. This is extremely low as far as fees go!

Tax free withdrawals are possible. (Yes, it’s true!) TSP contributions are made with pre-tax dollars and reduce your current taxable income. You pay taxes only when you make withdrawals in retirement. If you contributed to your TSP while in a Tax Free Zone, you were not subject to any federal taxes on those earnings. Therefore, when you withdraw those monies they are tax exempt! You don’t get to pick and choose when to make tax free withdrawals, they will be allocated in proportion to your total amount. To see if you have any tax exempt money in your TSP, look at the bottom of you balance sheet: you will see “Tax Exempt Balance – $xxxx.xx.”

Invest bonuses. You can easily add a percentage (or all) of your special duty, Hostile Fire Pay, Hazardous Duty Pay, and other bonuses. If you have some extra income, why not direct a portion to your retirement funds?

Matching contributions for civil-service employees (up to 5%) . Sorry, still no current match for military. The Army has debated doing it in limited cases as a retention tool. Will the military get matching contributions? Not likely, as the funds would come from personnel funds, which are limited. If you are in the military and would like to see that change, you should write to your Congressman.

Overall, I believe this is a very simple and cost efficient method for investing. This is a great system for many civil-service and military members to supplement their retirement income.

The Thrift Savings Plan (TSP) has a feature that allows its members to withdraw money during a financial emergency. While this can be helpful in a tight situation, it is not a decision to take lightly. When money is taken out early, it cannot be replaced into the TSP and you will lose out on any potential growth from those funds.

The TSP is designed similar to a 401(k) plan, it is a long-term retirement savings plan with tax deferral advantages. It is not designed to be a temporary savings account, or to be tapped into before you are normally eligible, which is age 59 1/2. To deter people from taking early withdrawals, taxes and penalties are assessed in addition to the inability to replace withdrawn funds. Strict restrictions are also in place to determine who is eligible for an early withdrawals.

What are the rules for a financial hardship withdrawal?

TSP members must still be employed by the Federal Government to be eligible for financial hardship withdrawals. The amount of the financial hardship withdrawal is limited to your financial need, but you cannot withdraw less than $1,000. You may be able to withdraw both your contributions and earnings for a financial hardship, but as previously mentioned, you cannot replace any of these funds once they are withdrawn.

To be eligible for a hardship withdrawal, your financial need must result from any of these 4 conditions:

1. Negative Monthly Cash Flow: To determine negative cash flow, one can utilize the worksheet that is provided with the Financial Hardship Withdrawal Request (Form TSP-76). You do not have to return the worksheet with your request for a financial hardship withdrawal, however, you will be required to affirm under penalty of perjury that you have a genuine financial hardship and the reason for the hardship. It is a good idea to maintain a copy of this form for your records.
2. Medical Expenses (including household improvements needed for medical care)
3. Personal Casualty Losses
4. Legal Expenses for Separation or Divorce

What happens after the hardship withdrawal?

Besides the inability to ever repay the funds you withdrew from your TSP account, you cannot contribute to your TSP account for 6 months. If you participate in FERS, you will not receive any Agency Matching Contributions during the time you are not eligible to contribute to the TSP. You will, however, continue receiving the automatic (1%) contribution from your agency.

At the conclusion of the 6-month waiting period, you will need to change your contribution election form if you wish to resume contributions. You will not be able to apply for another financial hardship withdrawal request until 6 months have passed.

What is the cost of a financial hardship withdrawal?

A lot. You future retirement income will be permanently diminished by the amount you withdraw, plus the earnings you may have realized on your investment. The other consideration is taxes and penalties.

• Taxes: Your withdrawal is subject to Federal income tax, and may also be subject to state income tax as well. The TSP will automatically withhold 10% of the funds you withdraw unless you instruct them to withhold a different amount.
• Penalties: If you are less than 59 1/2 when you make the withdrawal, you may be subject to a 10 percent early withdrawal penalty tax in addition to the income tax.
• 6 Month Pause on New Contributions: In addition, if you are a FERS employee, you will also not receive any matching contributions because you will not be making employee contributions. You will continue to receive the automatic 1%, but you will be leaving a lot of other funds on the table and will never be able to recover them.

Is it worth it?

In the most urgent cases, you can probably justify it. But because you will have to pay taxes, possibly a lot in penalties, and are limiting the potential for the growth of your retirement funds, this is may not be the best available option. I would strongly consider applying for a loan before paying so many taxes and fees. As with everything though, your situation is unique and you should consult with a professional financial advisor before deciding whether or not to pursue this avenue.

For more detailed information about TSP financial hardship withdrawals, please visit the official TSP page – TSP Features for Civilians.

For more detailed information about the tax rules affecting in-service withdrawals, read the tax notice “Important Tax Information About Payments From Your TSP Account.“

The TSP is a retirement savings program for civilians and members of the armed forces who are employed by the United States Federal Government. The TSP is very similar to a 401(k) plan in many ways. They are similar because they are both employee sponsored and they are both defined contribution plans and tax deferred retirement plans. They also share the same annual contribution limits.

• Defined Contribution Plan: The TSP is a defined contribution plan, which means each TSP participant has their own individual account. The amount in their account is what has been invested by that individual, along with any matching contributions made by their employer. Increases or decreases in the value of the holdings, along with expenses and fees also determine the value of the account. Many civilians employed by the government are eligible to receive matching funds up to 5% of their total pay. Most military members are not eligible to receive matching funds of any kind.
• Tax Deferred Retirement Plan: Tax deferred retirement plans invest money from your paycheck before any taxes have been taken out. This money is then allowed to grow in an investment plan without the drag of taxes affecting the value of the funds. Taxes are assessed on the funds when they are withdrawn as qualified distributions during retirement.
• Contribution Limits: The Thrift Savings Plan follows the same contribution guidelines as the 401(k). The contribution limit in 2007 is $15,500, and those who are age 50 or above can make “catch-up” contributions, up to an additional $5,000 per year.

After signing up for the Thrift Savings Plan, investments are automatically withdrawn from the employee’s monthly pay check and invested in the fund of their choice. The default fund if the G Fund. More explanations about the individual funds are below.
Thrift Savings Plan Investment Options: The Thrift Savings Plan has 5 main fund options one can invest in. They are all based on index funds. There is also a 6th fund, the “L Fund,” or Lifecycle Fund, which is a fund comprised of the 5 main funds and allocated for a target retirement date.

Here is a listing of the funds available through the TSP (definitions taken from the fund prospectus, for more information, go to the TSP home page and click on Fund Sheets.):

• G Fund: The G Fund is invested in short-term U.S. Treasury securities specially issued to the TSP. Payment of principal and interest is guaranteed by the U.S. Government. Thus, there is no credit risk. The G Fund offers the opportunity to earn rates of interest similar to those of long-term Government securities but without any risk of loss of principal and very little volatility of earnings.
• F Fund: The objective of the F Fund is to match the performance of the Lehman Brothers U.S. Aggregate (LBA) Index, a broad index representing the U.S. bond market. The F Fund offers the opportunity to earn rates of return that exceed those of money market funds over the long term (particularly during periods of declining interest rates), with relatively low risk.
• C Fund: The objective of the C Fund is to match the performance of the Standard and Poor’s 500 (S&P 500) Index, a broad market index made up of stocks of 500 large to medium-sized U.S. companies. The C Fund offers the opportunity to earn a potentially high investment return over the long term from a broadly diversified portfolio of stocks of large and medium-sized U.S. companies.
• S Fund: The objective of the S Fund is to match the performance of the Dow Jones Wilshire 4500 Completion (DJW 4500) Index, a broad market index made up of stocks of U.S. companies not included in the S&P 500 Index. The S Fund offers the opportunity to earn a potentially high investment return over the long term by investing in the stocks of small and medium-sized U.S. companies.
• I Fund: The objective of the I Fund is to match the performance of the Morgan Stanley Capital International EAFE (Europe, Australasia, Far East) Index. The I Fund offers the opportunity to earn a potentially high investment return over the long term by investing in the stocks of companies in developed countries outside the United States.
• L Fund: The Lifecycle Funds diversify participant accounts among the G, F, C, S, and I Funds, using professionally determined investment mixes (allocations) that are tailored to different time horizons. The L Funds are rebalanced to their target allocations each business day. The investment mix of each fund adjusts quarterly to more conservative investments as the fund’s time horizon shortens. There are 5 different Lifecycle Funds targeting retirement dates through 2040.

While there are not many options to choose from, these options cover most types of major indexes and have very low fees. In 2006, the administrative expenses for all of these funds was .03% per year ($0.30 per $1,000). That is very low!

Investing for your retirement is one of the most important actions you can do for your financial health. Even if you receive a military pension, it will not likely be enough for you to retire in style. That is why it is important to invest for your retirement now.

This should help federal government workers and military members who are eligible for the Thrift Savings Plan decide which investment vehicle is best for their situation – the TSP or an IRA?

Where Should You Invest – Thrift Savings Plan (TSP) or IRA?

Understanding IRA Investment Options

First, we should define the investment plans; then we’ll get into the question.

IRA: There are two main types of Individual Retirement Accounts: Traditional and Roth. (I have chosen not to focus on SEP IRAs, SIMPLE IRAs, or other forms of IRAs as they are not applicable to everyone).

• Traditional IRA: The main benefit of a traditional IRA is that the money can be fully or partially deductible, depending on your situation. The money is invested before taxes are withdrawn, which can lower your adjusted gross income, and therefore give you a tax break now. The invested money will be taxed when withdrawn at retirement age, and there are stiff penalties for early withdrawal.
• Roth IRA: Roth IRAs are non-deductible, which means you use post-tax money to fund your account. The distributions (including earnings and gains) withdrawn when you reach retirement age are tax exempt because the money was taxed before you invested it. Many people recommend using a Roth IRA because of the tax free withdrawals in retirement. As with the Traditional IRA, early withdrawals may incur stiff penalties.
• For both IRAs: These are individual investments, meaning there are no company matches. The IRA contribution limits for 2011 are $5000 for those under age 50, and $6,000 if you are over age 50. There may be income limits based on your income, filing, and marital status. Always do your research before investing!

Understanding Thrift Savings Plan Investment Options

Thrift Savings Plan: The Thrift Savings Plan works on the same premise as a 401k plan, and is similar to a Traditional IRA in that the money is contributed prior to taxes being withdrawn, and the money will be taxed when it is withdrawn at retirement age. The maximum annual TSP contribution limit is the same as a 401k and is set at $16,500 for 2011. Like the Traditional IRA, penalties may also be incurred for early withdrawal.

The TSP differs from IRAs though, because in some circumstances, the money may be eligible for a government match. This is much more common for federal government employees, and less common for military members.

Note: Military members have a special situation that does not often apply to federal workers. Military members can make tax free TSP contributions with money earned while deployed to tax free zones and the funds can be tax free in retirement age. The earnings from the tax exempt funds will be taxable, but the principle will not be taxable. Members also have the option of depositing any % of special or bonus pay, such as Hazardous Duty Pay, or Imminent Danger Pay. To determine if you have any tax exempt funds in your TSP account, look under the balance and there will be a line that states: “Your tax exempt balance.”

Which Investment Plan is Better?

Investing in an IRA: With IRAs, all responsibility lies completely with the individual. The individual must decide where to open an IRA, how much to invest, etc. There is a lot of flexibility as far as where to invest: funds, stocks, bonds, ETFs, etc. Investing can also be done via automatic deposit so it is easy to set up and manage. The downside is that all the responsibility lies with the individual to find investments that meet his/her needs which can be overwhelming for some people.

Where should you open an IRA? You can open an IRA at almost any financial institution. However, some may be better for your needs than others. Check out this IRA finder by Mint.com for different IRA options.

Investing with the TSP: The TSP has a limited assortment of funds to choose from: 5 main funds that track major market indexes and 5 Lifecycle Funds which automatically allocate funds in different proportions based on your retirement date. As far as options, there are not many. But it is easy to manage, and the fees are very low. The downside is a lack of flexibility for those who desire it. Read more about the benefits of investing in the TSP, and disadvantages of investing in the TSP.

Where Should You Invest?

Federal Employees (non-military): I would recommend first investing in the TSP to take advantage of the matching dollars from the government. This is free money! After you have put in enough money to get the match, I would recommend investing in a Roth IRA, because you will be able to withdraw this money tax free in retirement. You are also diversifying your future tax liabilities by having a taxable and non-taxable retirement fund.

Military Members: Because there is not generally a match for the TSP, I would recommend first maxing out your Roth IRA. This gives you a tax free retirement income. If you have maxed out your IRA and still have investment funds for your retirement, then I would recommend investing in the TSP. There are times when I would consider investing in the TSP first. These would be if you are one of the few people that are eligible for a TSP match (The Army has used this as a retention tool, but only in limited cases), and when you are deployed to a tax free zone. Deployment money is non-taxable to begin with, and when you contribute it to your TSP, that amount will never be taxed! (the gains are taxed, however.)