The Thrift Savings Plan (TSP) is a retirement savings plan for federal government employees and uniformed services members. Established by Congress in 1986, the TSP offers the same types of savings and tax benefits that many private corporations offer their employees under 401(k) plans.
With 6.5 million participants and around $800 billion in assets under management, the TSP is by far the largest retirement plan in the country, which has its advantages and disadvantages. As discussed in our recent post, “The Evolution of the TSP,” there have been numerous improvements to the TSP over the past few decades in terms of investment options and mechanics for participants. However, managing a retirement plan for 6.5 million participants can be unwieldy. The TSP has struggled with making improvements in a timely fashion, ensuring flexible access to funds in retirement, and most recently, creating a user-friendly interface with which participants can make changes or requests regarding their accounts.
Below we discuss some of the main pros and cons of the TSP, highlighting in particular certain positive and negative qualities of the plan that have been relevant over the past year.
Pros of the TSP:
Inexpensive Funds. The administrative and investment fees of the TSP funds are very low, averaging less than 0.07% annually. This is significantly lower than many of the mutual funds offered in other workplace retirement plans.
Broad Diversification. While the TSP offers only 3 core stock funds (i.e. the C, S, and I funds), these funds own shares of thousands of stocks in the U.S. and around the world. This allows investors to enjoy broad diversification without unnecessary exposure to the volatility of any individual company’s stock.
G Fund Access. The G fund is billed as a government bond fund, but it is actually a unique creation with all of the advantages of a typical government bond fund and without the main disadvantage (loss of principal). The G fund is invested in short-term U.S. Treasury bonds that are specially issued to the TSP, and the federal government guarantees that the price of the bonds will never decline. So, G fund investors not only enjoy investment returns commensurate with short-term Treasury bonds, they also can rest assured that there is no downward volatility associated with their investment. In a year like 2022, in which interest rate hikes caused the principal for every other bond fund on the market to decline, G fund investors had reason to be particularly pleased with this special deal.
“Extra” Features. While the TSP began in the 1980s with very little flexibility in terms of investment and withdrawal options, it has evolved over time and now includes many extra features often included in large employer retirement plans. For example, the TSP offers: target date retirement funds (the L funds) with investment allocations that grow more conservative as investors approach retirement age; a Roth TSP option for investors who want to save after-tax dollars; TSP loans with a low interest rate and a variety of repayment options; and starting last year, a mutual fund window in which investors can open a separate account within the plan and invest a portion of their TSP in a wide variety of other mutual funds outside of its core fund offerings. (For more details on the changes in the TSP over time, see our related blog post, “The Evolution of the TSP”.)
Cons of the TSP:
Limitations of Investment Strategy with Core Funds. With the core stock funds in the TSP, investors miss exposure to certain segments of the equity market, and they cannot target particular segments of the market that have higher long-term expected returns (e.g. small company and value stocks) unless they use the new mutual fund window. There are no core funds offering investment in real estate, international small company stocks, or emerging market stocks. Also, even though the title of the S fund is “Small Cap Stock Index Fund,” it actually is comprised of all U.S. stocks that are not in the S&P 500. In addition to small-cap stocks, it includes many large- and mid-cap stocks.
Restrictions on Mutual Fund Window Use. While the current rules may evolve to be more flexible, there are many restrictions on using the new mutual fund window, which limit its utility. Investments in the mutual fund window may not amount to more than 25% of an investor’s total TSP balance. To start using the mutual fund window, investors must have at least $40,000 in their TSP accounts. Investors also pay higher fees for using this service: a $55 annual administrative fee, $95 annual maintenance fee, and a $28.75 per-trade fee, in addition to the expense ratios of the selected mutual funds. The need to open a separate account for the mutual fund window also complicates the management of those investments. Investors cannot direct future contributions to be automatically invested in funds inside the window; they must manually move assets over after saving to the regular TSP core funds. They have to set up a separate set of credentials and navigate a separate website to manage their mutual fund window investments as well.
Tax Hit When Spousal Beneficiaries Pass Away. If a TSP participant passes away and a surviving spouse inherits the TSP, he or she can leave the account within the TSP and only take taxable distributions once he or she hits the age for RMDs (required minimum distributions), similar to the rules for inheriting a 401(k) or IRA. However, when that spouse dies, his or her beneficiaries have to take a full distribution of the inherited TSP assets right away. They cannot transfer the inherited assets to a Beneficiary IRA and spread the taxable distributions over 10 years.
Inflexible Allocation Issues. As mentioned above, the TSP now allows after-tax dollars to be saved to a Roth TSP account. However, investors cannot allocatetheir traditional TSP and Roth balances differently. Any changes to their investment allocation will be applied exactly the same to all TSP assets—both the Roth and traditional TSP. This is a drawback since many investors would otherwise want to make the Roth TSP allocation more aggressive, knowing that they are likely to use the traditional TSP assets first. This inflexibility on asset allocation applies to TSP withdrawals as well. When money is withdrawn from the TSP, it comes out proportionally from all of the funds in which your TSP is invested. For example, if you have 50% of your TSP balance invested in the G fund and 50% in the C fund, any withdrawal amount will be taken from those two funds in the same ratio. Again, this is a drawback because you cannot target your withdrawals from particular funds in light of recent market performance (e.g. you cannot choose to draw only from the G fund if the stock funds have recently declined). This would require an additional step to rebalance the account after the TSP has processed your withdrawal.
Difficult User Interface and Transitions. For years, making changes and requests from the TSP required time-consuming paperwork that would be rejected outright if any details were missing or incorrect. Last year, the TSP rolled out a new website and increased online processing, which seemed like a promising development. The transition and the new website were largely underwhelming though. TSP participants have reported that the new website is difficult to navigate, requires new credentials, lacks access to past statements, and features transfer forms with confusing wording that has led to numerous errors, sometimes with negative tax consequences. In the process of transferring data to the new site, the TSP dropped beneficiary designations for thousands of participants without their consent (the paperwork still exists somewhere in theory but the TSP did not have confidence in the beneficiary designation data). Many TSP participants had their investment allocations randomly changed as well.
Overall, having access to the TSP and investing a portion of your retirement assets in the TSP is still advantageous, given the positive features of the plan mentioned above. However, having all (or the vast majority) of retirement assets tied up in the TSP can have drawbacks, given the limitations on investment allocation and the difficulty of interacting with the TSP when changes or withdrawals need to be made. Furthermore, like most other employer plans, the TSP does not allow certain actions that are possible with IRAs, such as Roth conversions or Qualified Charitable Distributions, which might be desirable in retirement.
If you have a TSP and would like to discuss how best to take advantage of its benefits and avoid its limitations, please do not hesitate to call or email any time.
