Planning for Retirement
Military members and government workers often start planning for their retirement in their early years of service. They develop long-term strategies for savings, invest in a retirement program, or seek help from advisors. Whichever method they adopt, the underlying motive is to be thoroughly prepared for their eventual retirement. But all to often, when these folks do retire it is a different story altogether. And while many people will approach them with “professional advice” during their working years, civil servants and military personnel should keep in mind that not everyone who offers help has their best interest at heart.
For years, financial policy makers and federal employers have encouraged employees to invest their money in defined contribution plans, such as the TSP funds. They claim that these retirement plans are the best— the most low risk and the most profitable. However, before before getting swept away in these claims, it’s important to develop some insight on the TSP.
Informed Decision Making
The TSP is an investment plan for US federal employees. This plan works on the “defined contribution” method, which means that the income individuals will receive at retirement will vary in accordance with the amount contributed during their days of employment. It will also be affected by the estate contributions and profit the invested income yields.
Being aware of the profitability and return criteria of the individual funds in the TSP is a good beginning to understand the bigger picture. This awareness is what determines your own investor behavior, and can help you make informed decisions. While it is usually not possible to know every minute detail of your retirement fund, having a basic knowledge is necessary for your own piece of mind. Doing your own due diligence is a smart play to avoid an irrational trust in ‘experts,’ and can help you evaluate if you should do exactly as and advisor says, or strike a different or more balanced approach.
Bottom line: before investing money in a retirement plan, ensure that you have a general concept of the workings to help avoid making poor choices.
Let’s use a hypothetical situation as an example: lets imagine a servicemen who has been contributing to the G fund of his TSP account for the past five years, and who has every expectation to continue to invest. He wants to earn high rewards for his investment, and may be worried about potential returns in the future. Let’s also assume our servicemen has little knowledge about his fund, or the alternatives. Because of this lack of knowledge, he isn’t going to know the ‘tricks’ that might help his investments. For example, if he had been more knowledgeable, and had known that the G Fund bears low yields, he might have distributed his contributions to other funds, such as the C and S Fund, which are typically more rewarding. He also might have known that the TSP C fund and S Fund are more risky, and he could weigh the benefits versus risks.
There is no secret to strategy for TSP success. Once investors are aware of the basic functioning of the plan, and have done their research, there is very little left to worry about. TSP is not technical; neither does it have hidden policies. But investors do need to develop an understanding of the business cycle in order to invest wisely. A retirement plan is nothing like the stock market. In fact, the plan doesn’t even require continuous calculations and comparisons. The TSP mostly revolves around the concept of ‘buying and holding,’ not hasty decision making in response to market volatility.
Both Sides of the TSP Advice Equation
Directly recommending a certain retirement program, or dissuading from another, is never professional, and users should make their own choices, based on their knowledge, research, spending patterns, and of course, their life situation. However, knowing the advantages and drawbacks of the TSP might help federal employees in deciding whether the program is suitable for them or not.
Benefits of the TSP
Matching funds contribution
The best part about availing yourself of the TSP is that investors are allocated an equal percentage of their contribution to the TSP account by the agency. This means that investors earn as much as they contribute, as the agency has to match that percentage. Therefore, a worker who contributes 10% of his salary to his TSP account will get a 10% contribution from the agency as well. Matching funds are very attractive feature of a TSP account.
Immediate tax leverage
A great advantage of the TSP is that it causes an immediate cut in the income tax. This is because the contributions that an individual makes towards the TSP account are transferred before the calculation of income tax. TSP account holders get to pay a lower annual amount in the form of taxes, as their net salary becomes lower. This may greatly benefit government employees who come under higher tax brackets, and can help alleviate some the direct tax burden.
Long Term tax shelter
If workers accumulate all their tax cuts, they will realize that they have saved a significant portion of their earnings due to the compensation in taxes brought by the TSP account contribution. An additional benefit is the possibility of landing in a lower tax bracket at retirement, other things being equal.
Option of withdrawal
The Thrift Savings Plan can easily be rolled over into another retirement plan of the investor’s choice. This option can come in handy when one decides to leave (or is made to leave), civil service. Even if an exit from civil service isn’t applicable, there are numerous options that workers have regarding the disposition of their funds over the long term. Examples include: leaving the funds in the TSP account; transferring to 401k or IRA; selling it outright.
Low expense ratio
A significant advantage of the TSP is that it offers an extremely low expense ratio to account holders in the US. This allows them to keep a higher portion of their funds during their working years. This can lead to long term compound growth of the individual’s portfolio, and could profit the investor with a significant gain.
Drawbacks of the TSP
Matching funds not offered to military personnel
A great downside of the TSP is that it does not offer the matching funds contribution to military members. There are technical reasons for this under special circumstances, but typically the offer is only limited to government employees who have not served the armed forces.
Limited availability of options
The TSP has improved significantly compared to what it once was, and it now comprises 5 Individual Funds and 5 Lifecycle Funds. However, the choices are still limited when compared with other retirement plans, and workers cannot request any tailor-made plans designed to meet specific requirements.
Because the employers contribute an equal amount to the TSP account as the worker, there is a limit on the amount that a worker can contribute annually. Unlike an annuity, the TSP has a specified amount or percentage of contributions which cannot be exceeded by the worker.
No option of individual stock purchase
Another drawback of the TSP is that it does not allow investors to choose, or to purchase, stock individually. This obviously isn’t a downside for investors who have no interest in stocks, but one should be aware of the limitations.
Decrease in net income
This is an obvious drawback; contributing to the TSP account may lead to a significant decrease in the employee’s income. Less take home pay means that individuals face a decrease in their purchasing power.
Look at your options and consider the best course of action when deciding on the TSP or an alternative investment. Carefully weigh the benefits and detriments and evaluate the options in a rational manner that gives you the best outcome for your personal situation. As with any investment, it’s always a good idea to seek the advice of an experienced professional to help guide you to the best solution.