How does the Thrift Savings Plan (TSP) fit into a financial plan, and how should you consider making changes to your account?
It’s easy to think about the TSP as a stand-alone retirement account, but it needs to work well with all the pieces in your financial situation.
We are going to review 4 key decision points around the TSP in this article:
- How much to contribute
- What type of contributions to make [Pre-tax vs. Roth]
- Investment options
- How to consider making changes
My goal is to give you the perspective of a financial planner and how key benefits and planning items play together within the context of a financial plan.
First, I want to start with a quick story.
Not too long ago, a man named Jack came into the office. Jack is 50. He sat down and said, “I’ve got 8 to 10 years left before my planned Federal retirement date. What should I be doing with my TSP?”
He and his family have been doing some good things: maxing out retirement accounts, funding education accounts, paying down the mortgage, building home equity, and accumulating significant assets on their balance sheet. However, they were using mostly “default options.” Jack’s focus was on the TSP, and I began thinking about all the planning areas where there may be gaps.
In conversations like this, a good place to start is account contributions and cash flow. How much money is flowing into the financial plan? Where is it going?
How much should I contribute?
One of the big questions we get is, “How much should I contribute to my TSP?” The prevailing advice out there is usually to max out your TSP account.
And, why not? The tax advantages are compelling; both Roth and traditional contributions have long-term benefits attached.
But at the same time, we need to answer two questions:
- How much cash flow is available to contribute across all your accounts?
- Are you on track?
With the first question, we know there are times when money flows a little easier into investments and times when it’s more difficult to come up with contributions.
Both situations are fine. It’s all about making good choices and doing the best we can at the moment. Things always change.
From my conversation with Jack, I found that his family’s situation allowed for cash flow to max out his TSP and do some other things as well.
But let’s assume you had $30,000 to invest for the year. With that amount, you could max out your TSP (if you’re over age 50) or you could invest some money in the TSP and some money toward other accounts.
One thing that’s helpful is to consider how much money you have allocated across different account types. If 100% of your investments are in the TSP, maybe this year you put 75% of your contributions toward the TSP and the rest to start building out other account types.
The second part is determining if you are on track for the future.
Answering this question requires understanding how much income you want available in the future, and evaluating where you currently stand in the journey to get there.
Review your current assets and account values, and project them based on different growth rates and contribution amounts over time. It can be interesting to work through those different scenarios. Will your projected assets be able to produce enough income?
Of course, the best situation is maxing out those employer accounts for the tax benefits, contributing to investment accounts, and paying down the mortgage if there are enough funds available.
- Max out TSP
- Contribute to an investment account
- Pay down mortgage
- Invest in other assets
Contribution Types
One of the biggest questions we get is, “Should I contribute to the Roth or traditional TSP?”
It’s important to remember that Roth and traditional accounts come out to be exactly the same in the end if your tax rates remain the same and you earn the same underlying return on your investments. It’s when tax rates move in your situation (you earn more or less) or Congress changes them that one option comes out ahead of the other.
Let’s consider a few things.
First is your tax allocation summary, or how much you have in various types of accounts – traditional, Roth, and taxable investments.
This is important in determining where to direct funds to create balance. We don’t want to be too overweight in any category – 100% in traditional money, or 100% in Roth money – the goal is to diversify your tax situation and hopefully create efficiency in the amount of tax you must pay in the future.
The second item is your marginal tax rate. This is the tax rate on every additional dollar you earn.
If you’re in the 12% or lower tax bracket, consider Roth for all your contributions. If you’re in the 22% or 24% tax bracket, consider split contributions or some kind of balance between Roth and traditional.
And if you’re in the 32% tax bracket or above, pretax may be the better option as the value of the deduction is increased. Hopefully, that helps you think through the contribution type question conversation. As always, it’s wise to consult your tax professional and financial planner on these types of decisions.
Investment Options
The TSP has a limited offering of investment options that include five individual funds, ten lifecycle funds, and a mutual fund window.
We’re going to stick to the individual funds in this article. Taking time to understand and put together the right mix of core funds is something worth doing for every federal employee. Lifecycle funds don’t account for your unique situation and the mutual fund window is not quite there yet.
Within the five individual funds, there are three equity options (C, S, and I Funds) and two fixed-income options (the G and F Funds). You can find detailed information for each investment option at TSP.gov.
A few quick thoughts:
- The C Fund tracks the S&P 500. It’s composed of large and mega-cap US companies.
- The S Fund tracks the Dow Jones US Completion Total Stock Market Index. This is essentially a collection of US stocks not included in the S&P 500 index. Although it’s called the Small Cap Index Fund, it’s not really a small cap story.
- The I Fund is an international index that tracks the MSCI EAFE Index. This fund is slated to change to a new index with a very long name later this year.
- The G Fund is composed of short-term US Treasury securities. The investment’s objective is to ensure capital preservation and generate returns above those of short-term treasuries. This fund will pay interest like a money market account.
- The F Fund tracks the Bloomberg US Aggregate Bond Index. The F Fund is often considered conservative, however, it has risk factors that you may not realize – interest rate and default risk are two of them.
When you’re thinking about crafting your asset allocation mix, one piece of advice we hear often is your life stage, or your age, should determine your investment mix – i.e. if you’re older you should be conservative. This isn’t necessarily true.
Everyone’s situation is unique, and your investment mix should reflect that. For instance, you could be a retired growth investor – if you don’t need income, you have a long-term time horizon, and your goals are for growth. These types of factors should determine your asset allocation plan, not your age.
General Guidelines
Key things to consider:
Risk tolerance. This can be tricky because sometimes we might feel conservative, but need to take more risk for our goals, or vice versa.
Time horizon is very important.
- Do you have ten years or more until you need to access your funds?
- Do you have 5 to 10 years until you need to access funds?
- Or five years or less?
You can use these three timelines and when you may need income to help with your asset allocation plan.
Goals. What are your goals and are there any changes to them on the horizon?
When you have a longer time horizon and a greater risk tolerance, then it may make sense to put a greater weight of your investments into stock allocations.
This post is intended as general information and not a specific recommendation of any kind, but many growth investors may consider overweighting the C Fund and mixing in some assets in the S and I Funds. That may make sense for some people. If you’re considering using fixed income and you’re a growth investor, that will limit volatility and risk, but it’s also going to limit the amount of return that you can potentially make on the account.
Ultimately, it depends on how you feel about risk and return. We know stocks carry more risk, but also greater return potential.
If you’re in one of those other two buckets with less than a 10-year investable time horizon and you’re not a growth investor, such as an investor with a 5-to-10-year time horizon, then you may need to consider more balance in your portfolio, i.e. a mix with less risk and volatility potential. This depends on your circumstances, but it may make sense to consider using greater weights of fixed income with equity allocations.
If you are a conservative investor with an even shorter timeline of five years or less until you plan to use the money, then you may need to slide further up the conservative scale in the mix.
I hope this thinking is helpful as you attempt to craft the right asset allocation plan for you. This is all very personal, so be sure to consult with an investment professional.
When to Make Changes
The last part of this conversation is when to make changes.
A rules-based approach may benefit you. There are two big things to remember in that context:
- You cannot time markets
- We must eliminate emotion
First, we know you cannot time the markets. Even the experts are not any good at it. It’s incredibly difficult, if not impossible, to time the markets. Don’t mess with your investment mix based on what you think might happen.
Second, don’t let emotion play into your decision-making with your investments. Fear of missing out, fear in general, or any other powerful emotion shouldn’t play a role in when, or how, we make changes.
We talked about time horizon, risk tolerance, and the need for income. When those types of items begin to change, or we anticipate them changing, that indicates an opportunity to review.
A rebalancing schedule can also be helpful. Pick 2 dates throughout the year to look at your accounts and consider rebalancing to your target. June and December can be good times for this.
These are a few of the basics to consider when making adjustments.
I hope you find this information useful. I would encourage you to take the time to consider how the TSP fits into your financial situation.
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Don’t be afraid to ask questions. I’m here to help.
