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The Thrift Savings Plan, or TSP — the government’s version of a 401(k) for federal employees — has its supporters and detractors. But the plan’s array of features, including low fees and broad diversification, makes it a good savings vehicle for people who prefer a low-maintenance, do-it-yourself plan. It’s also a good plan for military service members, thanks to special tax-free advantages for military members serving in war zones.
Here’s a look at three features that make TSPs a good savings vehicle.
1. Low fees
When it comes to investment costs, nothing beats a TSP. The TSP C fund, an index fund that tracks the S&P 500, has an expense ratio of 0.029%, meaning that for every $1,000 invested, the investor pays a fee of 29 cents.
That’s as low as it gets. Just compare that to Vanguard index funds and exchange-traded funds, or ETFs. Vanguard Index 500 shares have an expense ratio of 0.17% ($1.70 for every $1,000 invested), and Vanguard’s Admiral shares have a fee of 0.05% (50 cents for every $1,000 invested).
These costs are regarded as generally the best in the industry, but they don’t come close to matching the low-fee TSP.
The TSP has five index funds, as well as target date funds that set asset allocation and automatically rebalance based upon the investor’s projected timeline. Some people don’t think TSP’s investment options are exciting, but access to an array of government bonds, the U.S. Aggregate Bond Index, S&P 500, MSCI EAFE Index, and the Dow Jones Completion Total Stock Market Index is plenty of diversification for passive investors.
3. Roth option
For civilians, Roth plans enable after-tax investments and tax-free withdrawals. In 2012, the government added a Roth feature to TSPs. Because U.S. military personnel deployed to a war zone can exclude gross income from their taxes, this means the best of both worlds in terms of savings: Service members can receive tax-free income and tax-free contributions and earnings from their Roth TSP once they’re eligible for withdrawals. In other words, their investment is completely tax-free.
The bottom line
When you combine these three features — low costs, passive fund diversification, and the Roth benefit for deployed members — you get the perfect vehicle to implement the wealth-building technique known as dollar-cost averaging. Dollar-cost averaging simply means regularly buying a fixed amount of a particular investment, no matter the share price. This takes advantage of the temporary dips in the market, where your contribution buys the investment at a discount, and has proven to be one of the most effective long-term investment strategies.
Some people may dismiss TSPs because they don’t offer current service members a matching contribution, the way some companies’ 401(k) plans do for employees. However, not all civilian employers match employee contributions, and there are virtually no defined benefit programs that match the military’s current retirement system. While there is talk of military retirement reform, combining TSP with the current military retirement system has proven itself over and again. Plus, the Roth IRA option is only one of the benefits of a TSP.
There are many advantages of being a federal employee, and TSPs are definitely one of them. Federal personnel should make sure to use the TSP as part of their long-term retirement strategy.
Forrest Baumhover is a fee-only financial planner at Westchase Financial Planning.