Thrift Savings Plan: What the government isn’t telling you could ruin your retirement
It’s almost that time of year when you need to start considering taxes. And the government is going to make its final push to get you enrolled in the Thrift Savings Plan (TSP). But there’s one thing they’re not telling you: This is a bad deal for anyone under 50 years old and could cost you more than $290,000 in cash you’ll need in retirement.
I know someone at the family center is going to harp on the benefits of reducing your tax bill now while saving for retirement; but if you’re not saving more than $5,000 per year towards retirement, that TSP isn’t doing you any good.
Here’s why. The TSP is a tax-deferred account. That means the contributions you put into the account will be deducted from your pay before taxes are taken, similar to when you had to put money into your GI Bill. As a result, if you elect to put $100 in your TSP account each month, only about $80 will be deducted from your take-home pay.
That may sound like a pretty good deal, right? It’s not. The TSP is a tax-deferred account, which means quite a bit to your retirement. In fact, if you’re 35, have no retirement savings, and plan on investing $5,000 per year toward retirement over the next 30 years, reasonably, you could be sitting on a nice nest egg of about $1.14 million when you turn 65.
But remember, you followed the advice of the government and contributed to the tax-deferred account. Fast-forward 30 years: You’ve completed your military career and another career and it’s time to enjoy the fruits of your labor, all 1.14 million of them.
But you signed up for the TSP. Now you have a giant tax burden that you’ll need to pay off as you tap that $1.14 million you worked so hard to save. To access that full amount, you’ll need to pay the government about $290,000 in deferred taxes. And when you’re retired and have to live off a meager Social Security check (if it’s not bankrupt), you’ll definitely notice that $290,000 is missing.
That money will be the difference between having a beach-filled travel retirement rather than one spent waiting in line at discount warehouses and choosing between paying the gas bill and going bowling.
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Don’t worry, though. There is a way to avoid this huge tax burden and that’s to open a Roth Individual Retirement Account (IRA) account. A Roth IRA has special features that will prevent you from building up a $290,000 tax bill. Instead of being tax-deferred like the TSP, a Roth IRA is tax exempt.
When you go to cash in your $1.14 million nest egg that’s held within a Roth IRA, there will be absolutely no taxes to pay. The entire value of the investments in the account is yours to keep. The government gets no part of it.
The unique tax treatment offered by the Roth IRA will cost you a little bit more. If you’re going to put in the $5,000 max, it’ll cost you an extra $80 each month. That cost is going to go directly to paying taxes you were going to pay anyway. So when I use the term “cost,” I use it very liberally.
Almost every brokerage offers Roth IRAs. Each major online broker including TD Ameritrade and E-Trade and full-service brokerages like Merrill Lynch all offer pretty much the same deal. All it takes to start one is to fill out a small form and fund the account. Competition is so heavy in the brokerage industry, they’ll even have somebody walk you through the whole process and answer any questions you have. When it comes to starting a brokerage account, it’s certainly a buyer’s market right now.
One final benefit to opening a Roth IRA account is that the account minimums are so much smaller. A full-service brokerage like Merrill Lynch or Morgan Stanley will normally tell you to get lost if you can’t write a check for $10,000 your first time in their office just to open a regular account.
When you start a Roth IRA you can usually fund it with less than $100 if you use an online discount broker. They also have no annual fees to have the account open and much lower commissions to pay when making investments.
Now, they’ll even manage the money for you and offer the same investments the TSP does. The G, F, C, S and I funds are all offered by brokerages. They may have different names, but the funds have the exact same performance as the TSP funds.
Opening a Roth IRA will also give you one more advantage: It will allow you to pick and choose the stocks you want to so you’re not stuck with the different TSP options that all failed to earn just 10% on average per year over the past 10 years.
To prevent growing a huge tax liability, it’s imperative to max out your Roth IRA before contributing one dollar to your TSP account. This will help make your retirement a much more comfortable one and will ensure when you retire, you actually retire.
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Article Opinions
Kiana wrote:
Thank you for this, you answered exactly what I was just wondering! I wondered to myself, I have SGLI and TSP, what are they and what are their differences? I know now, but for the ROTH 401(k), how do I transfer my funds from TSP? BTY, I am active Navy, if that makes a difference in this topic. Thank you for your advice!
01/02/07 23:29:51
Roderick Rugg wrote:
The Government will not contribute matching funds to your IRA.
05/17/07 08:17:10
Phil wrote:
Duh! What Andy isn't telling you is that the money that goes into an Roth is post tax money...ie the gov took its taxes. True the Roth provides for tax free money withdrawn from a Roth, but you are forgetting the benefits of the TSP which is the lowering of your taxable income each year you invest by the amount you invest into TSPs thus reaping taxes saving there over 30 years. And like another person said the gov does not match any funds into an IRA...So don't listen to Andy...he is an Roth salesman and wants to obsfucate the situation. TSP is the only way to go! Stay away from Andy.
07/16/07 08:54:39
FatherFrank wrote:
I disagree with Phil. TSP is clearly NOT the only way. Look, what's the point of TSP and Roth? It's to save for retirement. Now, when do I want to pay taxes? When I am active duty, making good money? Or when I am retired on a limited income? Besides, Phil's argument neglects to mention the favorable tax treatment that military members receive in terms of tax-free allowances, which really takes the bute out of paying taxes today. In addition, by paying by taxes now, I have locked in a zero% tax rate for my golden years. Given our increasing debt and the federal entitlement program dilemma facing us soon, who knows what the govt will do with tax rates in 35 years? All that sais, it's hard to beat a Roth IRA for the younger crowd!
08/31/07 13:09:37
Rob wrote:
I agree, the TSP is far superior in many ways. One, the expense ratios are tiny, you can contribute up to $44,000 a year when in a qualified combat zone, two the L Funds are greatly diversified, and low maintenance. The TSP is the way to go. But in defense of the Roth IRA, everyone should have a Roth along with the TSP.
10/29/07 05:30:39
Jim W wrote:
First off...neither is a "bad" way to save for retirement. The argument is which is the better of the two options. I'm by no means a certified financial planner, but the subject does interest me and I've read alot regarding the subject. My advice would be to max out your Roth IRA contributions, and if you manage to save more than the limit put it in the TSP. There are lots of reasons for this. First off, for military, the TSP is basically a Traditional IRA with access to very low expense funds. For those in the beginning (relatively speaking) years in the workforce, the vast majority of financial planners recommend Roth IRA's over Traditional IRA's. Also, you are in a relatively low tax bracket as it is (your BAH, BAS, and TDY pay is not included in your gross income which puts you in a lower tax bracket), therefore the "now" tax benefits of the TSP are less than a civilian putting money into a Traditional IRA. Also, let's face it, taxes are likely to be higher in the future, so I'd rather not pay taxes then. Also, there are plenty of very low cost index funds out there that, although they don't beat TSP fund expenses, come decently close. So as long as you invest your Roth IRA with a low-cost fund provider, you're not doing too bad. In summary, both are "good" choices, but in my humble opinion the Roth IRA is a slightly "better" choice.
12/17/07 01:22:40
BlasterMaster wrote:
Andy, is twisting the truth a bit! Also,do you really think that the Roth will ALWAYS remain tax free? Congress will see a huge untapped cash reserve and guess what...the baby boomers will need funds to tax, yep nothing is for certain except death and taxes. TSP is a good deal and it's easy to make happen--everyone should do both (Roth & TSP), and oh by the way, TSP has other benifits besides retirement funds. For most of us, clicking take x% of my pay via DTIC is far easier than trusting some mutual fund company who have front end loads, fees and poor performance. It's the tax you know now versus whatever will happen to your Roth later.
05/23/08 09:03:08
BadBeagle wrote:
This article is crap. His 1.14 million nest egg assumes an unrealistic return of at least 11 %. Furthermore, most retirees find themselves in a lower tax bracket at retirement. Who the hell is going to withdraw their TSP in a lump sum and assume that huge tax burden in one swoop? Like a traditional IRA, most people will draw down their TSP for income and tax bite won't be that bad. ROTHS are great but not always better than TSP.
05/30/08 15:18:37
Nikki wrote:
I have been searching the Internet for good information on the TSP vs. Roth IRA question.
Unfortunately, most of what I have read is a boxing match of people throwing punches at each other.
As an E-5 (now E-6), I have invested 5% of my base pay in the TSP for about a year (about $150/month).
I do want to start a Roth IRA, but don't have a lot of money to contribute to it (maybe $50/month, unless I stop my TSP).
What are my options (without beating me up....)
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