You’ve probably heard of the Thrift Savings Plan (TSP) at some point during your military career. It is a retirement savings account offered to military members that allows you to take automatic deductions from your basic pay each month and put it away to grow for retirement. Where exactly do these funds go? How does your money grow? Here are 3 things that you need to know about your TSP account that you might not already know.
1. Roth vs Traditional
As of May 2012, you can contribute to your TSP account in two different ways. If you had been contributing to your retirement account prior to May 2012, you were making contributions into your Traditional TSP. This means that funds were coming out of your paycheck before they were taxed and you will instead be taxed when you withdraw the funds at retirement.
With the newer Roth TSP, you are able to contribute funds that you’ve already paid taxes on, they will grow tax-free and you will be able to withdraw the funds at retirement tax-free as well.
How do you know which type of TSP account to contribute to?
Typically you would make this decision based on your assumed tax bracket. Ask yourself, “Would it be more beneficial to pay taxes on this money today or in retirement?” If you are in a low tax-bracket today and think you might be in a higher tax bracket at retirement, then it might make more sense to contribute to the Roth TSP.
On the other hand, if you are in a high tax bracket today, it may make sense to delay paying taxes on the funds until you reach retirement (such is the case with the Traditional TSP).
What about tax-free pay?
There are situations in the military where your income may be tax-exempt, for example with combat pay. You may contribute this tax-exempt income into either the Traditional or the Roth TSP. If these funds are contributed to the Traditional TSP, you will only be expected to pay taxes on the earnings when you withdraw the funds. If you contribute tax-exempt funds into the Roth TSP, you will not have to pay taxes on this money ever.
2. Know Your Funds
Regardless if you invest into the Traditional or Roth TSP, there are 5 funds that you can put your money into. You can put all of your money into one of the funds, or you can divide your money up amongst any of the funds.
What are the 5 funds?
The G Fund is the Government Securities Investment Fund. It is invested in short-term U.S. Treasury securities and has the least amount of risk associated with it. There is no risk of loss of principal, meaning you can’t lose the money that you put into the fund, only potential earnings. The important thing to remember is that the level of risk is often directly related to the potential return on your investment. Because there is little risk, you might not gain much on your investment, but you also won’t lose much either.
The F Fund is the Fixed Income Index Investment fund. This fund aims to mimic the Barclays Capital U.S. Aggregate Bond Index and invests in various types of bonds. The F Fund is considered low to moderate risk.
The C Fund is the Common Stock Index Investment Fund and it follows the S&P 500 Stock Index. The S&P 500 is comprised of 500 large to medium-sized U.S. company stocks. The C Fund is considered moderate risk.
The S Fund is the Small Capitalization Stock Index Fund. It is similar to the C Fund, but instead follows the Dow Jones Stock Market Index which is comprised of small and medium-sized U.S. company stocks – none of which are included in the S&P 500 index. The S Fund is considered moderate to high risk.
The I Fund is the International Stock Index Investment Fund and follows the MSCI EAFE index which is comprised of large company stocks in Europe, Australia and the Far East. The I Fund is considered moderate to high risk.
What about the Lifecycle Funds?
The Lifecycle Funds (L Funds) are meant for individuals who are uncomfortable managing their own investments or simply do not have the time. They automatically allocate your TSP money into the 5 available TSP Funds based on your retirement year and work under the principle that the further away from retirement you are, the more risk you can handle. As you approach retirement age, the L Fund will redirect your investments towards more conservative options. The funds are reallocated every quarter.
3. Allocate Your Funds
If you contribute to your TSP (either type) and never log into your account at www.tsp.gov, your funds will automatically be directed into the G Fund. As I mentioned earlier, the G Fund is the most conservative option for your investments. Again, the higher the risk level on a fund, the higher the potential gain and potential loss. The more conservative the investment, the lower the potential gain and loss. It is important to understand your personal preferred risk level and to choose an asset allocation accordingly.
The L Fund makes general assumptions of your risk tolerance and chooses funds to suit that risk level. If you would like to choose your own asset allocation and are unsure what your risk tolerance is, you could use a calculator like the one found here at Yahoo! Finance: http://finance.yahoo.com/calculator/career-education/inv08/
The TSP can be a great resource for retirement planning, but you have to put your investments to work. It’s not only important to put money away for retirement, but it’s equally important, if not more, to know where that money is going. Take control of your investments. Attend a free TSP course at your local military installation. Read through the resources available to you at www. tsp.gov. It’s always better to start saving for retirement today than to wait until tomorrow.