The Thrift Savings Plan (TSP), used by federal civilian and military personnel, is one of the best retirement systems in the world.
Since it consists of simple index funds, it’s a straightforward investment account that is accessible and understandable for all employees. It has among the lowest fees you’ll find anywhere, and it’s very tax-efficient.
However, there are still a lot of pitfalls to be aware of, and certain ways to optimize your returns. And there is a labyrinth of rules for contributions, withdrawals, loans, and rollovers.
This guide covers:
- Thrift Savings Plan 101: Overview
- How Fast Can your TSP Account Grow?
- TSP Fund Descriptions: Details on the Five Core Funds
- Investment Strategy: How to Optimize Your TSP Returns
- Traditional vs Roth Thrift Savings Plans
- How to Easily Manage Your TSP
My writings about the Thrift Savings Plan have been featured on Federal News Radio, Fedsmith, FEDweek, and GovLoop. Helping federal civilian and military personnel navigate the TSP is a passion of mine.
If you need specific investment advice, seek out a certified financial planner, but for general info this article can give you a step-by-step overview of the TSP all in one place.
Thrift Savings Plan 101: Plan Overview
The TSP essentially serves as the government version of a 401(k) for civilian and military federal employees.
It’s a defined contribution plan, meaning that you can choose how much money to put into it, and the amount of money you’ll get out in the end is based on the market performance of your investments during your career.
When combined with a federal employee or military pension, social security, and perhaps additional investments outside of your TSP, it’s a cornerstone part of your retirement strategy and allows you to build serious wealth.
As of 2019 you can contribute up to $19,000 per year from your salary, and an additional $6,000 per year in “catch-up” contributions if you’re 50 or older.
For the Traditional TSP, these contributions are tax-deferred, meaning you don’t pay taxes on them yet, and your effective taxable income is reduced. Then, your untaxed money in your TSP can continue to grow without paying any capital gains taxes, dividend taxes, or interest taxes over several decades of investment.
When you eventually withdraw money from your TSP in retirement, you can take it out in one lump sum, or receive monthly payments, buy an annuity, or any combination thereof. These withdraws and payments, however, will be subject to tax at your ordinary tax rate at that time.
Civilian employees under the Federal Employee Retirement System (FERS) receive up to 5% matching (1% automatic + 4% agency matching), as shown in this chart:
You absolutely should contribute at least 5% of your salary to the TSP if you’re in the FERS plan. To not do so is to leave a tremendous amount of money on the table over the course of your career.
Civilian employees under the Civil Service Retirement Act (CSRS), and most members of the military, do not receive government matching, and instead receive better pensions. They can still contribute to the TSP, and will still have tax-deferred status on their contributions and investment growth during that time.
Rollovers and Transfers:
- If you join federal service, you can transfer or roll over money from your existing employer-based retirement plan, like a 401(k), into your TSP. You can also roll your Traditional IRA into your TSP.
- If you leave federal service, you can roll over your TSP funds into an IRA or your next employer’s 401(k), or you can leave your assets in the TSP.
How Fast Can the TSP Grow?
How fast your account balance grows depends on your TSP allocation, on asset valuations, and on economic growth.
Historically, U.S. stocks have grown at a rate of about 8-10% per year over the long-term, while foreign stocks have grown at about 4-6% per year, and bonds and treasuries only grow at about 2-4% per year or less in a low interest rate environment.
This great growth rate of U.S. stocks was during the multi-decade post-WWII era, where we were the world’s primary superpower and much of the rest of the world was playing catch-up from the desolation that followed WWII.
Therefore, it’s best to assume that the United States won’t continue to have quite the same level of growth as it did in that special situation, since we have more global competition now and we’re starting from a higher level of development than in the past.
A reasonable estimate is that a diversified portfolio of stocks and bonds can be expected to grow perhaps 6% per year. If you get 7% from stocks, and 3% from bonds, and weight your portfolio more strongly towards stocks, you might be able to achieve 6% growth per year.
Of course, investment growth, especially from equities, is volatile. It’s important to take a long-term view of potential average annual returns, rather than focusing on what stocks do in any given year.
Consider two scenarios:
In Scenario 1, a federal employee makes an average of $100,000 per year, and invests 10% of her salary ($10,000) into her TSP. She also receives 5% of her salary ($5,000) in matching contributions, meaning that in total, she puts in $15,000 per year.
In Scenario 2, a federal employee makes an average of $50,000 per year, and invests 10% of his salary ($5,000) into his TSP. He also gets 5% matching, so that’s another $2,500, meaning in total he puts in $7,500 per year.
At an average of 6% growth per year, their wealth would grow like this over the course of their careers:
Both of them can become millionaires.
Inflation will negate some of the purchasing power, but the FERS pension and social security will provide extra retirement income. Together with a mortgage-free house by the time they retire, both of these employees can have a very comfortable retirement with plenty of investment income.
You can potentially achieve even higher figures if you put in your maximum of $19,000 (or $25,000 when you’re over 50), and receive another $2,000-$8,000 worth of agency-matching.
TSP Fund Descriptions: The Five Core Funds
The Thrift Savings Plan has five core funds:
- The “G Fund” holds unique treasury securities.
- The “F Fund” follows a broad bond index.
- The “C Fund” follows the S&P 500.
- The “S Fund” follows small cap companies.
- The “I Fund” follows international stocks.
Currently, all of the funds except for the G Fund are managed by Blackrock, Inc. They’re the largest asset manager in the world.
These funds are all “index funds”, which means they follow a specific market index. There is no highly-paid person actively picking the stocks; they are automatically-selected based on their inclusion in the index.
The two ways to manage the way your money is distributed within the TSP are:
- Setting your contribution allocations: this affects how new paycheck contributions go into the funds
- Performing interfund transfers: this allows you to move money out of a fund and into another fund
For most people, it’s important for your TSP allocation to have some exposure to all five of the funds, because they each have different risks and historical growth rates, and it’s important to be diversified.
Here’s an overview of the pros and cons of each one:
THE G FUND:
The G Fund consists of unique treasuries.
They give returns roughly equal to 10-year treasuries, but have liquidity and protection against interest rate fluctuations even better than 3-month T-bills. This gives the G Fund the best overall risk/reward ratio of any Treasury investment, and it’s only available to TSP investors.
More specifically, the G Fund interest rate is based on the average of U.S Treasuries with a duration of 4 years or more, and the interest rate resets monthly.
G Fund Pros:
- Protected from loss of value by the full faith and credit of the US government
- Virtually nonexistent volatility
G Fund Cons:
- Rate of return is strongly based on prevailing interest rates set by the Federal Reserve, which are currently low
- Low growth: just barely keeps up with inflation
THE F FUND:
The F Fund follows the Bloomberg Barclays U.S. Aggregate Bond Index, which means it invests in a diverse collection of government bonds, corporate bonds, and mortgage-backed securities.
Historically, this bond fund has provided slightly better annual returns than the G Fund, but is also slightly more volatile.
More specifically, the F Fund tends to be a better investment than the G Fund when interest rates are flat or falling, while the G Fund is better when interest rates are rising. Right now, interest rates are rising, and so it is safer to have money in the G Fund.
The only weird aspect of the F Fund is that the index it follows is meant to be a stand-alone bond index, so a third of the fund consists of U.S. Treasuries, and the rest is corporate bonds and mortgage-backed securities. That means if you hold both the F Fund and the G Fund, there is unnecessary overlap in Treasuries. But in the grand scheme of things, that’s not a big deal.
F Fund Pros:
- Not very volatile; only lost money in three years since inception
- Historically better returns than the G Fund
F Fund Cons:
- Currently offers low returns due to low interest rates set by the Federal Reserve
- Can lose some value in the short term if interest rates rise sharply
THE C FUND:
The C Fund follows the S&P 500 index, which is a collection of approximately 500 of the largest and most profitable corporations in the United States.
It is weighted by market capitalization, meaning that larger companies have a larger presence in the fund.
Currently, the top ten holdings in the fund ranked by size are Apple, Google, Microsoft, Amazon, Johnson and Johnson, Exxon Mobile, Facebook, Berkshire Hathaway, J.P. Morgan Chase, and Bank of America. Those ten companies account for over 20% of the value of the C Fund; the other approximately 490 companies make up the remaining 80% or less.
C Fund Pros:
- Historically has given returns of about 9% per year, which is better than most other investments available
- Fairly resistant against inflation over the long-term
C Fund Cons:
- Volatile, prone to occasional bubbles and crashes
- Has experienced decade-long periods without positive returns
THE S FUND:
The S Fund follows the Dow Jones U.S. Completion Total Stock Market Index, which tracks over 3,000 small and medium-sized companies that are not included in the S&P 500.
S Fund Pros:
- Historically has given returns similar to the C Fund
- Gives investors broader diversification than just large companies
S Fund Cons:
- Volatile, prone to occasional bubbles and crashes
- Has experienced decade-long periods without positive returns
THE I FUND:
The I Fund follows the MSCI EAFE Index, which is a collection of over 900 large and medium-sized corporations outside of the United States.
Specifically, “EAFE” stands for Europe, Australasia, and Far East. It invests only in developed countries; almost all the assets are in Japan and western Europe, with a tiny bit in Australia and Hong Kong.
The I Fund is the only one that I think is suboptimal. It’s overly-concentrated in just a handful of countries, and completely lacks emerging market exposure. Most diversified portfolio strategies include a more global international fund than the I Fund offers.
I Fund Pros:
- Gives much-need international equity exposure for a diversified portfolio
- Certain markets, like the UK, are very attractively-priced at the moment
I Fund Cons:
- Highly concentrated in Japan, which has a shrinking population
- Has been the worst-performing TSP fund since inception
Detailed Analysis: The Problem with the I Fund
The I Fund leaves a lot to be desired. Rather than following the entire international stock market (as, say, the Vanguard Total International Stock fund does), it only follows developed countries, and is heavily concentrated in just five of them.
I put together an infographic to explain why TSP investors should think carefully before putting too much money in your I Fund:
This is actually a problem that all broad market cap-weighted international stock indices have; they’re heavily concentrated in Japan.
However, the MSCI EAFE (and by extension, the I-Fund that follows it), magnifies the problem because it:
- Excludes emerging markets entirely.
- Excludes Canada, since it only invests in Europe, Australia, and Asia.
By limiting the investment scope of the index, it even more heavily concentrates in Japan than most international indexes.
The UK, France, and Switzerland have hurt the I-Fund’s returns over the past two decades, while Germany has been strong. Fortunately, although those countries have low population growth, their companies are global and they have no absolute structural problems. They will likely do better over the next 20 years than they have over the last 20 years.
Japan, however, is another story.
As great as their country is, their population is shrinking, which has a devastating affect on national growth. They have high debt, and an aging population along with among the highest life expectancy in the world.
The fact that literally a quarter of the I-Fund is invested in Japan will very likely continue weigh it down for years to come.
Military personnel and federal civilian personnel would do well to carefully analyze the I-Fund before deciding to put too much money in it. It’s a good way to diversify away from the United States, but this particular index has some major disadvantages compared to other types of international investments.
Fortunately, starting some time in 2019, the TSP plans to fix this problem by changing the index that the I Fund follows, which will include Canada and emerging markets and make the fund more diversified overall.
TSP Investment Strategy: Optimization
Most people invest with the crowd, which loses them a lot of money.
They buy stocks when good news is everywhere and stocks have already gone up in price a lot. Then, when an inevitable recession comes and their stocks lose value, they become frightened and sell their stocks after they’ve already fallen in price. And then, when stocks eventually go back up, they missed out on the recovery because they weren’t invested in stocks. Once stocks have already gone back up, they decide to buy some, and start the cycle all over again.
That’s called, “buying high, selling low”, and it will kill your TSP growth if you do it.
Other people just give up and put all their money in the G Fund, which barely keeps up with inflation. But with that approach, although you minimize volatility, you might not grow your TSP balance enough to cover your retirement needs. Not having enough money in retirement is a risk that needs to be considered, so the G Fund is not truly a risk-free investment.
With those pitfalls in mind, there are two smart ways to invest in the TSP.
Smart Strategy #1: Buy and Hold a Diverse Portfolio
The simplest TSP investment strategy is to build a portfolio that includes all five core funds. You could individually select your own funds, but the easiest way to do it is to buy one of the lifecycle funds, also called “L Funds”.
Lifecycle funds hold shares of the other five core funds, and automatically re-balance themselves. So, if stocks go up, they’ll automatically sell some stocks and buy bonds. If stocks go down, they’ll sell some bonds and buy some stocks. It’s a natural, conservative “buy low, sell high” strategy.
In addition, lifecycle funds grow more conservative over time. They slowly shift from holding more stocks, to holding more G Fund Treasuries.
Here’s the current list of lifecycle funds:
You don’t necessarily have to buy the lifecycle fund that matches your expected retirement.
Some financial planners have argued that lifecycle funds are too conservative. If you reach 65 years old, then your average life expectancy is about 85, and you could live much longer than that.
Most people should plan for 20-30 years of potential expenses after retirement, if not more.
Every investor has unique needs, and lifecycle funds are a “one size fits all” approach which may not be ideal for everyone.
However, lifecycle funds change very, very slowly. You can direct all your TSP contributions to your lifecycle fund, let it conveniently re-balance itself over the long-term, and every 5-10 years or so check and see if you’re still in the right lifecycle fund for you. You can always do an interfund transfer and move your assets from one lifecycle fund to another one with a later expected retirement date, if you want more stock exposure.
Smart Strategy #2: Contrarian Investing
At least 95% of investors should stick to the first strategy, because it’s simple.
But if you insist on being a little bit more hands-on with your portfolio, then one thing you can do is look out for bubbles and adjust your TSP allocation accordingly.
There are ways to measure when a stock market is considerably overvalued.
One of them, for example, is the cyclically-adjusted price to earnings ratio, or “CAPE” for short. This metric was developed by Yale professor Robert Shiller, and 130 years of data shows that whenever the CAPE is very high, stock market returns over the next 10-20 years are poor.
Here’s the current chart:
When stocks become outrageously overvalued, then shifting your portfolio a bit more towards bonds can make sense.
I wouldn’t recommend doing an “all or nothing” approach, where you just go 100% into bonds. But perhaps shifting from a 2040 lifecycle fund to a 2030 lifecycle fund, to give yourself a bit more bond exposure and a bit less stock exposure, wouldn’t be a bad idea when the CAPE ratio is over 30.
Then, if markets crash and the CAPE ratio drops below 20 or so, the smart contrarian move is to shift more towards stocks, like perhaps moving your assets to the 2050 lifecycle fund.
This approach historically beats the market by a little bit, and also reduces volatility. But the past is no guarantee of the future. And relying on just one metric, like the CAPE ratio, can be misleading. It’s useful to consider several different ways to value the market before trying to alter your portfolio around it.
Here, for example, is the chart of the ratio of stock market capitalization to GDP:
Fortunately though, contrarian rebalancing has more to do with logic than intelligence; it’s psychologically hard to move away from stocks when they are highly priced, and to buy extra stocks at the darkest part of a recession when they’re cheap. But the underlying principles aren’t rocket science.
The downside to this approach is that, if you tweak your holdings too much and try to micromanage them, you’re more likely to make a mistake and misjudge market conditions.
According to the latest S&P SPIVA Report, over 90% of professional fund managers fail to beat the market. So, simply moving assets around is not a trivially easy way to outperform and you’re unlikely to be some TSP superstar in your spare time.
All-in-all, the key thing here is that less is more. Be judicial with any changes you make.
The less you touch a relatively diversified portfolio, the better it will generally do over the long-term.
Traditional vs Roth Thrift Savings Plans
The Traditional TSP lets you put in tax-deferred money, so that you can grow it in your account, and then eventually pay taxes on it when you withdraw the money.
The Roth TSP taxes your income up-front, but then your investments can grow tax-free and never require any more tax to be paid.
No matter which one you contribute to, if you have agency-matching, your agency will deposit their matching contributions into your Traditional TSP.
How to Decide:
- If you expect that your current tax rate is lower than your tax rate will be in retirement, then investing in the Roth TSP may be better.
- On the other hand, if you expect that your tax rate in the future will be lower, then investing in the Traditional TSP makes more sense.
If you make a high income in the federal service, then another benefit of the Traditional TSP is that you can easily pair it with a Roth IRA. Contributions to your Traditional TSP effectively lower your modified adjusted gross income (or “MAGI”), which may help you keep your MAGI below the Roth IRA income limit.
When in doubt, I think the best move is to split the difference. Invest in a Traditional TSP, and if you have extra money to invest more, you can put additional money in a Roth IRA. But if your situation is complex, checking with a certified financial planner may be beneficial.
How to Easily Manage Your TSP
Many federal employees have money in their TSP, their bank accounts, an IRA, maybe a taxable brokerage account, plus all their spouse’s accounts.
A great free tool to help manage all of that is Personal Capital.
With Personal Capital, you can link your banks, brokerages, 401(k), IRA, TSP, credit cards, and other accounts to it, and it will provide a complete picture of your financial situation:
- A graph of your net worth over time, to see where you stand.
- A detailed breakdown of where all your expenses go each month.
- A fee-scanner, to find hidden fees you might not be aware you’re paying.
- A retirement planner, that helps you figure out if you’re on track.
You can access the free tool here.
By investing each month like clockwork, getting the full FERS agency matching for those that qualify, and remaining diversified across the funds, you should do quite well over time as you build your wealth towards retirement.
While there are some strategies to optimize your TSP allocation, my default recommendation to most people is to put their money into one of the appropriate Lifecycle funds. The Lifecycle funds are diversified and automatically re-balance themselves, so they require the least hands-on management to get solid returns.