What is a Thrift Savings Plan (TSP)?

A Thrift Savings Plan is like a jar of loose change...

Every time you find some loose change, you add it to the jar. After years of adding money here and there, you open the jar and find you likely have a lot of money saved up. Similarly, in a Thrift Savings Plan, federal employees can add a percentage of their salaries to their TSP, and when they retire, they can start withdrawing their funds. However, unlike a jar of change, your employer may contribute to your TSP, it’s usually invested for growth potential, and you need to pay taxes when you finally open the jar and withdraw your cash.

A Thrift Savings Plan (TSP) is a retirement plan for federal employees, civil servants, and members of the uniformed services. It provides account holders tax-deferred investment and savings options. It is part of the Federal Employees Retirement System (FERS), along with the Basic Benefit Plan (a monthly payment based on how long you served) and Social Security.

In a Thrift Savings Plan, employees specify a percentage of their income that they’d like to contribute to their TSP, and their employers will deduct that amount from their paychecks to put in their TSP. Sometimes, the employer will also make matching contributions, i.e., if the employee contributes $500, the employer will also contribute $500.

These contributions are then put into different investment funds, and account holders can choose the funds in which they’d like to invest. For example, you could choose to invest in the G fund, which is a government securities investment fund, or the S fund, which is a fixed income investment fund. Alternatively, you can invest in the L fund, which is a professionally managed fund with a mix of TSP investment funds.

One of the main benefits of a TSP is that the contributions (also referred to as the elective deferrals) are usually tax-deductible. That means that employees don’t need to pay income tax on the money they contribute to their TSP until they withdraw their funds upon retirement. Similarly, employees who have a TSP don’t need to pay capital gains tax on any growth within their account — Taxes are only paid on TSP withdrawals. That said, it’s also possible to have a Roth TSP, in which case contributions are made post-tax, and qualified withdrawals are not taxed.

TSPs also have strict regulations regarding how much can be withdrawn from the account and when. Generally, if you make a withdrawal from a TSP before you’ve reached the age of 59½, you have to pay a 10% tax penalty on any funds that aren’t transferred to another account or rolled over — That’s in addition to any income tax you’d normally pay on the withdrawal. (However, there are some exceptions where you may avoid the penalty. You may wish to consult the relevant government tax notices or engage an accountant or other financial professional.)

Overall, a TSP can be thought of as the federal-employee equivalent of a 401(k), a popular retirement savings plan for private-sector employees. In fact, they are similar enough that 401(k) plans and individual retirement accounts (IRAs) can be converted into TSPs if a private-sector employee moves into the public sector or vice versa.

A TSP is a defined-contribution plan, which is a type of retirement savings plan. In a defined-contribution plan, employees contribute a defined amount of their pre-tax income to their retirement savings account. This amount is only taxed upon withdrawal, which usually occurs upon retirement.

Other examples of defined contribution plans include 401(k)s, which are popular among private-sector employees, and 403(b)s, which are common among teachers, professors, nurses, and other employees of certain tax-exempt organizations.

A TSP is not a 401(k), but it does share many similarities with one. A 401(k) savings can even be rolled over into a TSP and vice versa when an employee switches between the public and private sectors.

TSPs and 401(k)s are both defined contribution plans, which are retirement savings plans. In both a TSP and a 401(k), an employee makes a defined (fixed) contribution to their savings account in the form of a deduction from their paycheck. Employees don’t need to pay income taxes on this contribution until they make a withdrawal, at which point they’ll pay taxes on their contributions and earnings. The tax benefits are one of the main reasons these retirement plans are so popular. Contributions in both plans are invested into different funds. The account holder can choose how they’d like to invest their money.

Federal employees specify a percentage of their income that they’d like to contribute to their TSP. That amount, the elective deferral, is then deducted from their paychecks before taxes, and put into the TSP.

The elective deferral must stay within TSP contribution limits. In 2023, employees may defer up to $22,500 per year, up from $20,500 per year in 2022. Employees who are over the age of 50 and are actively contributing to a defined contribution retirement plan can make catch-up contributions, i.e., an elective deferral that exceeds the normal TSP contribution limit. In 2023, employees over 50 can contribute up to $7,500 per year (up from $6,500 per year in 2022) more than the regular limit. Employers cannot match catch-up contributions.

Account holders can choose how they’d like to invest their TSP contributions. There are several different investment options:

• G Fund: A fund that’s invested in government securities that are exclusively issued to the TSP.
• F Fund: A fund that focuses on fixed income assets such as government bonds, corporate bonds, and mortgage-backed bonds.
• C Fund: A fund that invests in medium and large-cap stocks from private corporations.
• S Fund: A fund that invests in small to medium-cap stocks from private corporations. There is no overlap between the stocks in the C Fund and S Fund.
• I Fund: A fund that invests in stocks from other countries.
• L Funds: The L funds, aka Lifecycle Funds, are a group of funds that are a mix of the other types of funds. They are professionally-designed and are constructed to provide TSP account holders with a diversified portfolio.

No matter what fund you invest in, any capital gains that occur within the account are not taxed until withdrawal — You will only pay taxes on TSP funds when you withdraw them. If you withdraw your funds after you’ve reached the age of 59 and a half, you will pay income tax on them. If you withdraw your funds before that age, you may need to pay a 10% tax penalty on top of the normal income tax.

Generally, funds cannot be withdrawn from a TSP without penalty before the account holder reaches the age of 59 and a half. If you withdraw any funds before then, you will likely need to pay a 10% tax penalty in addition to income tax. The only exception to this is if you end your service in the year you reach 55 (or later) or in the year you reach 50 (or later) if you’re a public safety employee.

You can withdraw from your TSP at any time. However, if you do so before you turn 59 and a half, you will typically be subject to a 10% tax penalty. There are specific exceptions to this rule for people who end their service at the age of 50 or 55.

A TSP is a popular retirement plan for federal employees, civil servants, and uniformed service members. Many financial advisors recommend using it, but it isn’t always right for everyone, such as employees who want complete control over their investments. A TSP can be a good retirement choice for eligible employees who want to contribute a fixed amount of their income to retirement, invest it, and defer income taxes on the contributions and capital gains.

The amount that you should contribute to a TSP will depend on your individual financial goals and needs. When determining how much to contribute, it is often best to speak with a financial advisor or another professional who can provide personalized advice on how to reach your goals. For example, the recommended contribution for someone in their 20s may be very different from a 55-year old who is considering making catch-up contributions and hoping to retire in 10 years.

The contents provided are for informational purposes only and is not a recommendation for any security or trading strategy. Any examples provided are for illustrative purposes only. Robinhood does not provide tax advice. For specific questions, you should consult a tax professional.