Thrift Savings Plan Investor's Handbook for Federal Employees

By FEDweek

The TSP has implemented long-awaited new withdrawal options and while the investment choices are still limited compared to an IRA, the program is still very good, and expenses are some of the lowest you can find (over time this adds up in a big way).

This new 6th Edition guide is designed to help you take full advantage of the TSP, understand the program's rules and important dates, and help set yourself up for a secure retirement.

• Language: English
• Publisher: BookBaby
• Release date: Jan 22, 2020
• ISBN: 9781098301125

Book preview

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CHAPTER 1

What the TSP’s Design Means for You

If you’re relatively new to the TSP, you need to make the effort to educate yourself about it. If you’ve participated in the TSP for years you probably are already familiar with the main plan features. Either way, you should consider the program overall in order to see how certain features work in conjunction with others, what options are allowed or not allowed, and why.

The foremost point to remember is that the TSP is a retirement savings vehicle; all its design features flow from that. It is not designed to give you ready access to your money as a bank account does. Nor is it designed to allow highly individualized investment choices, as an account at a stock brokerage does. It also cannot accept sporadic investments of chunks of money that you may have available to put to use.

Rather, the TSP is designed to encourage regular, ongoing investments in a few investment funds with significant tax advantages as an additional incentive to save.

Those characteristics of the TSP—its status as a payroll withholding plan and its tax treatment—in particular determine the limits of many of the program’s other features and in turn govern how you can and can’t use the TSP.

PAYROLL WITHHOLDING

The TSP is foremost a payroll withholding plan. Your investments are taken automatically out of your pay—for most employees, biweekly—once you decide how much you want withheld and into which funds you want that money directed. That’s a very convenient form of savings and also helps provide the discipline needed to save regularly for your future despite all the present uses to which you could put your money.

But you might not have considered the implication of that payroll withholding design: once you are retired or otherwise separated from the government, you are no longer on the payroll (despite the point of view of some retirees that an annuity is effectively deferred pay). That means that once you are no longer an active federal or postal employee, you may no longer put new investments into the TSP.

Note: This is not in the TSP’s discretion. It is a provision of law that similarly applies to other retirement savings programs such as 401(k)s.

After separation or retirement, your account will not grow at nearly the same rate it does when you are making regular investments in the TSP, even if you achieve the same earnings rates. Even if you would have the money available to make such new investments, they aren’t allowed. You can manage the money you have in the TSP by moving it among the investment funds and your money will continue to produce earnings (and potential losses, if you invest outside the government securities G fund). But you can’t add to it.

The only exception to this involves the TSP transfer policy. Under that policy, participants—whether active employees, or separated/retired individuals who still maintain TSP accounts—can move money into the TSP from similar tax-favored retirement savings plans from prior employers (or from individual retirement accounts holding money from such plans).

Apart from that provision, you can’t put sums of money into the TSP, as you might with other types of investments. This applies to both active and separated or retired participants.

So if you receive an inheritance, sell shares of stocks or have a lump sum come into hand—for example from a performance award or the lump-sum payment for unused annual leave at separation—you can’t put it in the TSP. If you want to shelter that money from taxes, you’ll have to do it elsewhere—for example, in an IRA or in the Voluntary Contributions program available to employees in the Civil Service Retirement System. Later sections will examine how you can balance the TSP and other investment vehicles for that purpose as well as others.

Another special consideration is that not all the compensation you receive from the government is eligible to be invested in the TSP. Basic pay for TSP purposes is the amount of pay based on the rate fixed by law or administrative action for the position held by an employee and is the same as basic pay for federal civilian retirement purposes.

The following elements of pay are basic pay for TSP investment purposes:

•locality-based comparability pay under 5 U.S.C. 5304;

•environmental and night differentials for wage employees under 5 U.S.C. 4343(c)(4) and 4343(f));

•premium pay for standby time under 5 U.S.C. 5545(c)(1);

•premium pay for law enforcement officers under 5 U.S.C. 5545(c)(2) (administratively uncontrollable overtime);

•availability pay for criminal investigators under 5 U.S.C. 5545a;

•physicians’ comparability allowance under 5 U.S.C. 5948;

•overtime compensation for customs officers under 5 U.S.C. 8331(3)(g); and

•additional compensation paid to employees serving in the republic of Panama (22 U.S.C. 3657).

The following are not basic pay for TSP investment purposes:

•other overtime pay;

•awards, bonuses, and allowances;

•foreign and domestic post differential for general schedule, and foreign post differential for wage employees;

•severance pay;

•retroactive pay granted to a retired or deceased employee pursuant to a wage survey;

•lump-sum payment for voluntary separation incentive payments (buyouts);

•workers’ compensation payments from the Office of Workers’ Compensation Programs;

•Sunday, holiday and military pay;

•supervisory differentials; or

•night differentials for GS and GM employees.

Note: The TSP disburses back to participants any excess deferrals they make into their accounts in a year and for which they request a refund. Excess deferrals are money that put into the TSP through regular deductions above the IRS dollar cap, and, if applicable, the limit on catch-up contributions allowed for those aged 50 or higher. Those receiving the refunds must report the excess amount on their taxes as income earned during that year.

You can change the amounts of payroll withholding (including stopping altogether) at any time by filing a new Form TSP-1, TSP Election Form.

You can invest either a percentage of your basic pay each pay period or a fixed dollar amount. If you make your investments as a percentage of your pay, the amount of your investments (and government contributions, if you’re under the Federal Employees Retirement System) will increase automatically as you receive pay raises. If you make your investments as a dollar amount, you will need to make another election to increase them, should you choose.

You also can at any time change your allocation of ongoing investments among the available funds in the same ways.

If you transfer to another agency, your new agency must continue your investments without interruption. Contact your new personnel office to make sure this is done.

INVESTMENT RATES AND AGENCY CONTRIBUTIONS

The TSP, like other tax-favored retirement savings plans, allows investment up to annual dollar figures set by the IRS.

The standard limit, called the elective deferral limit, is $19,000. Further, investors who are—or will be—age 50 or older during a calendar year may make catch-up contribution investments above that limit, of up to an additional $6,000. (Note: Those are 2019 figures; the amounts increase in some years, linked to an inflation measure.)

For those who invest in both traditional and Roth balances, the combination of the two types of investing counts toward each annual limit.

CSRS employees get no government contributions.

Investors who do not choose a fund allocation have their money automatically put in the government securities G fund. They must sign a statement acknowledging risk if they wish to invest in any other fund.

For FERS employees, agencies automatically contribute an amount equal to 1 percent of basic pay each pay period, starting immediately on hiring. They also match the first 3 percent of basic pay invested by the employee dollar-for-dollar and match the next 2 percent of basic pay invested at 50 cents on the dollar on the employee’s personal investments. There is no match for FERS investments above 5 percent of salary.

Note: The reason for the superior features for FERS employees is that the FERS system provides a lower basic civil service annuity than does CSRS. FERS employees must invest more in the TSP to make the overall FERS benefit—the civil service and Social Security portions combined—roughly comparable to that provided under CSRS.

Employer contributions for FERS employees are made on the traditional pre-tax basis and come out taxable on withdrawal along with their associated earnings, regardless of whether employee investments were made into a traditional balance, a Roth balance, or a combination of both.

Newly hired employees have 3 percent of salary invested by default—which in turn means that matching contributions also begin immediately by default, since newly hired employees are put under the FERS system. (Note: This is to increase to 5 percent for new hires starting in October 2020). The money is invested by default in the L fund most appropriate for their age, using an assumption that withdrawals will begin at age 62.

Note: For those hired from the start of this default policy in August 2010 through August 2015, the G fund was the default fund. Employees hired before August 2010 still must opt into making personal investments.

Participants subject to default investing are sent a letter that includes the date of birth used to determine the appropriate L fund (to be checked in case that is mistaken), along with acknowledgement of risk information.

Although default investing primarily affects newly hired employees, it also applies to those rehired after a break in service but who have no TSP account balance. (Those rehired after a break in service and who do have money in a TSP account will retain the last investment allocation on file with the TSP; if no allocation is on file, the G fund is their default fund.)

Those subject to default investing can choose a different rate, a different allocation or opt out entirely. They have 90 days from hiring to request a refund of any money that they did not wish to have withheld, and spousal consent or notice is not required. The distribution is not subject to an early withdrawal penalty, although matching contributions are forfeited.

While FERS investors always are vested in the 1 percent automatic contribution as well as in their own investments, they are not vested in matching contributions until after three years of employment. (Note: Vesting applies after only two years in certain congressional staff and non-career positions.) Vesting is not a consideration for CSRS employees since they get no agency contributions.

If you invest in the TSP and another tax-advantaged plan during a year—such as the 401(k) plan of a private sector employer before or after government employment—your combined investments into all such plans cannot exceed the IRS limit. Similarly if you invest in two TSP accounts (civilian and uniformed services) during the year, your combined investments into both plans cannot exceed the limit.

TAX TREATMENT

The TSP, as a retirement savings vehicle, enjoys favorable tax treatment that is designed to encourage investments in it and thus, individual savings for retirement. However, the implications of this favorable tax treatment are that the TSP is governed by many of the same laws applying to other tax-favored investment options, such as private sector 401(k) savings plans.

That means that access to the accounts during a working career is limited, and could carry serious tax penalties if handled improperly. Even after retirement, special care is needed in making withdrawals.

In traditional balances, investments are from pretax dollars. The up-front tax break for employees, particularly higher paid ones, can be substantial. Investment earnings are tax deferred until withdrawn. This provides a substantial benefit to investors, allowing the money to compound without reductions for taxes over the years. Generally, retirees are in lower tax brackets when they withdraw the money, adding yet another tax benefit.

In Roth balances (see below), investments are made with after-tax money and those amounts are tax-free on withdrawal, as are their associated earnings if certain conditions are met.

Note that the two are not separate accounts, but two different types of balances within the same account.

Once money is put in one of the types of balance it may not be moved to the other.

Decisions regarding whether to participate in one or the other type of balance or both, and how much to put in each if participating in each, are highly individual. They involve considerations both of current and expected future tax liability—which in turn are a function of current and expected future income, current and expected future tax rates, and a host of other factors affecting an individual’s taxes both today and in years ahead.

Investing on a Roth basis also involves a tradeoff of paying higher taxes currently on the expectation of paying lower taxes in the future, when compared with a traditional option, which in many cases raises questions of how much an individual could afford to invest.

ROTH BALANCES

The Roth TSP feature operates along the lines of Roth 401(k)-type features that have become increasingly popular in the private sector in recent years.

Unlike in a Roth IRA, there are no income limits on eligibility to participate in the TSP Roth feature. Thus, for higher-earning employees, the TSP Roth feature may be the only opportunity to make Roth-style investments. If you are eligible to invest in a Roth IRA, making Roth investments in the TSP will not affect that IRA.

An employee may participate in the traditional design, the Roth design or both and may designate how much of ongoing investments to invest in each. However, the combined total investment in both may not exceed the IRS-set maximum in a given year (see above).

Similarly, catch-up contributions—additional investments allowed for those age 50 or older in a year—can be made into either or both types of balance but the total of both, Roth and traditional, may not exceed the separate limit for catch-ups.

For investors who have both types of balances, the allocation of ongoing investments among the TSP’s investment funds applies to both, as does any interfund transfer of money already on account. The employing agency is responsible for properly accounting for the tax status of investments; there are procedures for correcting errors in how investments are designated.

Like traditional investments, Roth investments typically have to be made from ongoing pay. The exception is that the TSP accepts transfers of balances, either traditional or Roth, from other similar employment-based retirement savings accounts, such as the 401(k) plan from a worker’s previous employer (this option does not apply to holders of beneficiary accounts; however, their accounts can contain Roth investments made by their deceased spouse, and the associated earnings). These must be direct account-to-account transfers; the TSP will not accept a rollover of Roth money distributed from any plan after the participant has received the money. Nor will the TSP accept a transfer or rollover from a Roth IRA.

Agency contributions on behalf of employees covered by the Federal Employees Retirement System are based on the employee’s total percentage of salary investment, traditional and Roth investments combined, but agency contributions are made only under the traditional design.

For newly hired employees, who by definition are placed in the FERS system, the default personal investment of 3 percent of salary goes into a traditional balance by default, although they may designate that investment to a Roth balance. (Note: This is to increase to 5 percent for new hires starting in October 2020). They may also choose an investment level other than 3 percent, including making no investment. Those who don’t invest from their pay receive no matching contributions from the government but they do receive the automatic investment equaling 1 percent of salary that is paid regardless of whether a FERS employee invests personal money.

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