3 Things You May Not Understand About the TSP
Misperceptions about the investment program persist.
In last week’s column, we got into some Thrift Savings Plan issues that were fairly complicated, such as whether or not to take a lump-sum payment and use it to eliminate debt. This week, the TSP is the focus again, but I’ll keep things a little more simple.
Here are the top three things that employees sometimes misunderstand when it comes to their TSP accounts.
How Does Matching Work?
One of the key features of the Federal Employees Retirement System is that employees receive agency automatic and matching funds in their TSP accounts.
Here’s how it works: Your agency automatically contributes 1 percent of your basic pay (including locality pay) to your TSP account. It also starts matching your own contributions as soon as you start making them. So if you contribute 1 percent of your basic biweekly salary, you will receive 1 percent in matching contributions, along with the automatic 1 percent agency contribution.
If you contribute up to 3 percent of your basic pay, the matching is dollar for dollar. If you contribute 4 or 5 percent of your basic pay, the matching on the additional contributions is fifty cents per dollar of your contribution. After you contribute 5 percent of your biweekly salary, there is no matching agency money. That’s why some people say you should contribute at least 5 percent of your pay so you don’t “leave money on the table.”
It’s important to note that the matching is on a biweekly, not annual, basis. Just this week, I met an employee who was going to have $18,000 (the elective deferral limit for 2017) already invested in his TSP account out of his salary by the end of August. So he won’t receive matching contributions from his agency until the 2018 pay year begins.
If your TSP allotments stop for any reason during the year (for example, if you voluntarily suspend your contributions, elect too large a biweekly allotment so you eventually exceed the annual limit, or take a financial hardship withdrawal and thus aren’t permitted to contribute for a period of time), you will no longer receive agency matching funds.
It’s important to evaluate your contribution strategy at the beginning of each year to be sure you receive the full agency match throughout the year. To learn more, read the TSP pamphlet, Annual Limit on Elective Deferrals.
What Is a Full Withdrawal?
The concepts of full withdrawal and required minimum distributions from the TSP can be confusing. Some people think a full withdrawal requires a lump-sum distribution of their entire account balance. I’ve also heard people say that at age 70 ½, you have to take all of your TSP funds out of your account. Both statements are false. You’re never required to withdraw your entire account balance in a lump-sum payment unless you have a balance of less than $200.
According to the TSP booklet, Withdrawing Your TSP Account After Leaving Federal Service, a full withdrawal is simply a designation of how much of your total account balance you wish to withdraw as a single payment, series of monthly payments or a life annuity. You may designate 100 percent to one of the options, or divide it between the choices.
Suppose, for example, you designate 50 percent of your account to be withdrawn via a cash payment. The TSP will pay this to you or allow you to transfer some or all of it to another retirement account, such as an individual retirement arrangement. For the other 50 percent, you could choose a series of monthly payments or purchase a life annuity. The monthly payments can be a specific dollar amount, or you can let the TSP compute payments for you based on life expectancy charts.
You can postpone deciding what to do with your money after you separate from federal service, but you must make a choice after you are separated and older than 70½ to avoid a penalty. This election must follow the rules for required minimum distributions established by the IRS. The same three withdrawal options are available at the time you face this deadline, so you won’t have to deplete your entire account balance in one lump-sum payment.
It’s important not to deplete your TSP account too quickly. You need a strategy to make the money last as long as you live. Remember that the C, S, I and F funds may experience negative returns from time to time. Your account will continue to accrue earnings after you’re retired, and you can continue to change the way your money is invested by making interfund transfers.
Be aware of the impact of inflation as you make your post-retirement withdrawal choices. According to the TSP, an inflation rate of 2 percent per year would reduce a $150,000 account balance to the purchasing power of only $82,811 after 30 years. Continued earnings are important to maintain your buying power. Volatility in returns can create anxiety. But keeping all of your money in the ultra-safe G Fund may not be the answer, because it may not allow for enough growth to keep ahead of inflation. This is why financial professionals emphasize maintaining a healthy balance between all of your investment options. The TSP’s life cycle funds can do this for you, adjusting investment choices to get more conservative over time.
A good rule of thumb is to never withdraw more than 3 percent to 4 percent of your account balance in a single year and to maintain some of your account balance in the stock funds and the fixed income (F) fund to balance risk and return.
Can You Really Catch Up With Catch-Up Contributions?
If you are 50 or older (or will turn 50 during the calendar year), you can make additional contributions to your TSP account over and above the annual elective deferral limit ($18,000 for 2017). These are known as “catch-up” contributions. In 2017, you can make an additional $6,000 in contributions. There is no agency match for such contributions. The funds will be invested according to your most recent account allocation in the same manner as your regular TSP contributions.
Catch-up contributions will not necessarily make up for not contributing for the first 20 years of your career, however. It’s important to understand the value of investing over long periods of time. There is a powerful illustration of this on the TSP website showing that an investment of $4,000 per year (of employee and agency contributions) at a 6 percent average annual rate of return will have a balance of $54,699 in 10 years, $154,220 after 20 years, $335,288 in 30 years and $664,722 after 40 years. You can try this for yourself by using the TSP’s online savings calculator.
The TSP is a critical element of the retirement planning toolkit for FERS employees. But to make the most of it, you need to know how it works.
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