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.

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.

Andrew Mickey

USAF Veteran

Editor in chief, BreakAway Investor

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