Federal retirement expert, Chris Kowalik, helps federal employees better understand their Thrift Savings Plan (TSP) options while working, and begin to leverage the TSP to be a powerful part of their bigger retirement picture. Chris also throws in a few bonuses and challenges to help listeners make the most out of their TSP experience.
- There’s a lot to love about Thrift Savings Plan – the 5 reasons why so many employees contribute!
- Avoid what 95% of TSP participants most often do – it will take you 2 minutes.
- Learn how not to be one of the 25% of employees who are not getting all of their free money in TSP.
- Uncover a few ways employees decide which funds to invest in – and avoid taking a SWAG.
- The Lifecycle Funds – you might be doing it wrong.
- See how it may be possible to max the TSP and still miss out on some matching money.
- Explore the Roth TSP, how it’s different than the Traditional TSP, and what happens to your 5% match if you chose Roth.
- Understand why TSP loans should be taken as an absolute last resort.
Scott: Hello and welcome to this episode of Fed Impact, Candid Insights on Federal Retirement. I’m Scott Thompson with myfederalretirement.com and I’m here today with Chris Kowalik of ProFeds, home of the federal retirement impact workshop. Chris is chomping it a bit today to give us some keen insights on the very popular program, the Thrift Savings Plan. Hi, Chris.
Chris: Hi, Scott. Welcome everybody. Thank you so much for spending a few minutes of your day with us.
Scott: Chris, a lot of federal employees have concern about their TSP. they’re not sure what they should be doing in the TSP and they may really not know how it fits into the bigger picture of retirement. What do you have for our listeners today to bring them up to speed on this?
Scott: Great. So let’s jump in to the TSP then. Would you mind give us, giving us a little background on the TSP, like why it was created and how it’s supposed to fit into the bigger retirement picture for federal employees?
Chris: Absolutely. So today, I’m going to stay focused on what TSP looks like while an employee is still working so we’ll reserve the topic of withdrawing money out of TSP for another episode. So starting with the background of TSP. TSP was designed to be what we call a defined contribution plan. It was built in the mid-80s to accompany the brand new FERS retirement plan. It’s part of the three-legged stool for those who are familiar with the OPM analogy that for FERS employees they have the pension, they have the Thrift Savings Plan and they have the Social Security Program. Now of course, the CSRS employees are allowed to contribute to TSP as well.
Most employees realize that this is very similar to a private 401K styled program. The difference from the TSP out to the private sector is in the private sector, most of those people don’t have a pension to pair with their 401K. They simply have that 401K and what they decide to save for their future is what they have. So this is really a unique and pretty robust program. Now, like I mentioned both CSRS and FERS employees can contribute to TSP and TSP is really designed to provide an incentive for employees to save their own money. The purpose of that is to create a pool of money to draw from in retirement so this is going to be able to supplement the normal income that someone would receive from their normal CSRS or FERS pension.
Now, there is a lot to love about TSP. It’s easy. It’s cheap. There are safety components like the G Fund that we’ll talk about here in a few minutes and broad indexes. So when you contribute to the TSP, if you’re in one of the funds that are indexed against the stock market, you’re buying a wide variety of different types of funds. So that provides a lot of stability within the fund itself. Of course, from a wealth accumulation standpoint, for all of the reasons we just talked about that it’s easy, it’s inexpensive, there’s a lot of safety in it and there’s opportunity for growth, it’s a great wealth accumulation tool to build a lot of money over a person’s long career.
Now, the real key is getting started as early in your career as possible. It’s really to put time on your side. The more time you can put on your investing platform, the better opportunity you have to make a considerable amount of money. Now, employees want to make sure that they save enough money in TSP to have enough to live comfortably in retirement. We of course don’t want to run out in retirement.
Scott: Yeah, that’s always a concern. Now, the amount that an employee can contribute changes each year. Can you give us a little more detail on that and a few tips so employees can maximize their contributions in the TSP?
Chris: You bet. From a contribution standpoint, the IRS determines the maximum allowable contribution each year. It’s called the elective deferral limit. That’s the technical name for it. This year, for 2016, we’re looking at $18,000 per year for most employees. Now, for those employees that turn age 50 or older in a given year, they have the ability to contribute what we call catch up contributions, that’s in addition to the 18,000, they can put in an extra $6,000 per year so really a kind of last minute push to get retirement savings under their belt. Now when employees decide to put money into TSP, they can express the amount that they want in two different ways. They can either express it as a certain dollar amount or as a percentage of their salary. So I want to put $500 a pay period or 10% of my salary. Either one will get the money started in TSP.
Now, there’s one thing that I hear an awful lot of that’s really outdated information. But employees oftentimes think that there is a cap on the percentage of an employee’s salary that they can contribute to TSP and that percentage is 15%. That has not been the rule for some time in TSP, many many years but a lot of employees simply have it in their head that 15% is the maximum allowable amount and that is no longer the case. Now, when employees decide they’re going to put money into TSP or change the amount that they’re putting in, the form that they would use is either the TSP1. They can fill that out and submit it to TSP or what’s more likely is they’re going to log into their TSP account and be able to change their contribution right there online.
Now, here’s my first tip of the day. As the elective deferral amount changes from the IRS each year, it’s important to go back in and adjust the amount that you put in to TSP and especially for those catch up contributions because those need to be reelected each year. It’s not automatic. That’s my first tip of the day. The second tip is every time that you get a pay raise, a step increase, a true promotion up to a different grade, put more into TSP. so if your promotion gives you an extra $200 per pay period in your normal paycheck, take a hundred of that and put it towards TSP and use the other to increase your standard of living and really enjoy the fact that you got promoted. That is an easy way to increase the amount without really feeling it in your pocketbook.
Scott: Yeah, that’s a great tip, Chris. Something I know you want to share also with our listeners today is the value of the TSP match. I know this is a topic you’re pretty passionate about. So can you elaborate on that a bit with us?
Chris: Absolutely, Scott. This is free money and who’s not passionate about free money, right?
Chris: Now, it’s only available to FERS employees but it is a huge incentive to save for the future. This is far and away better than the vast majority of what the private sector 401K plans offer. Now, with the matching, like I mentioned, it’s only available to FERS employees and we typically refer to the match as a 5% match but really there are two different components that are working in there. There is a 1% automatic compound, or I’m sorry, an automatic contribution that the agency is contributing regardless of what the employee puts in. They could put in nothing and the agency still puts in 1% of that employee’s salary each and every pay period. The other 4% that the agency is willing to give an employee requires that the employee puts in 5% of their salary into TSP. so all in all, by the time an employee puts in 5% of their salary, the agency has put in 5% so that’s why we typically refer to that whole 5% as the match.
Now, in the private sector world, we call this a 100% return on your initial investment. You put in money, your agency puts in the exact amount of money, bam, that is beautiful. So very, very important. But here’s something that I hear a lot of employees have a little bit of a misconception about. They think that they amount that the agency puts in as the matching or that automatic contribution, they think that that counts against the elective deferral limit so remember that 18,000 or the 24,000 that the IRS allows an employee to put in.
Chris: That is only the employee’s portion of the contribution. That doesn’t count the agency’s side. So really, 18 and 24,000 are the target numbers that we really want to get to. So here’s my next tip. For employees under FERS who are contributing to TSP, they must contribute at least 5% of their salary every single pay period to get the full match. Now, oftentimes, we’ll see employees that want to leave a few pay periods at the end of the year so that their paychecks are a little fuller around Christmas time and so they front load TSP so they still put in all the amount that they wanted to, whether it was 18,000 or something less than that and then for their last say four pay periods, around the holidays, there’s no more contributions to TSP. Well, the challenge of course is that if there any pay periods in which the agency, the employee is not putting money into their own TSP account, the agency has nothing to match.
Chris: So they’re giving up that free money right there at the end. So we want to make sure at least 5% of their salary over all 26 pay periods goes into TSP.
Scott: Wow, that’s a really good tip, Chris. Now, for employees who are contributing to the TSP or maybe those that just want to get started, can you explain a bit about the various funds they can choose from?
Chris: Oh, you bet. Now, funds in TSP, there are five of them. Most employees are at least relatively familiar what these are but we’ll do a quick review. We’ve got the G Fund which is your government securities fund. So this is a very safe program. I tell employees in the workshop, you are safe from losing your principal. You are safe from losing your earnings and you are also safe from making any money in the G Fund. I mean, that’s not the place where you make a lot of money in TSP.
Chris: It is safe though. We have the F Fund which are your government and corporate bonds. So it’s a relatively safe fund but it does have the ability to lose money. Then we’ve got the C,S & I Funds. Now, these are the funds that are indexed against the stock market. So when we see the market going crazy, you bet the C, S & I Funds are doing the same thing. So the C Fund is your large US stocks. It’s indexed against the S&P 500. So that is the largest 500 publicly traded companies in the United States. The S Fund, a lot of people think, well, S must stand for small companies but that’s not exactly true. It’s a mixture of small and medium sized companies that are publicly traded. So when we look at the entire US stock market, if we subtract out the S&P 500, so the 500 largest companies in the stock market for the United States, the S Fund comprises everything else.
Chris: From small to medium and even those large companies that didn’t happen to make the top 500. Then we have the I Fund which is the international stocks. So large foreign companies, foreign stocks included in the I Fund.
Scott: Okay. Do you find that employees have a pretty good handle on how to choose which funds to invest in?
Chris: I ask this question an awful lot in our workshops. How do you decide where to put your money? I’m always surprised at the responses that folks give me. A lot of people come back and they say, “Well, I want the safety of the G Fund,” which is a very popular response. Some want to look at the timeline that they have before they retire. Like if they have another 10 or 15 years before they retire, they know they have a little bit more time to let the stock market work for them and to earn more money in TSP. others get a little bit more technical and they look at risk tolerance.
So I always tell folks there are two questions to ask yourself when you are thinking about how risky you might be when you’re investing. The first is how much you can emotionally handle to lose and then the second is how much you can financially afford to lose without jeopardizing the long term investment strategy that you have for your retirement money. Now, the funny part is in these workshops, when employees are being really upfront and honest, they’ll admit that a lot of them take a swag in TSP. that’s a scientific wild ass guess. Now, we don’t typically like to see swags being taken on the pool of money that is going to support somebody for perhaps a third of their life in retirement. So we want to make sure that there is some guidance.
Now, a question that so many people ask is how do I know what I’m supposed to do? Should it all be safe? It probably shouldn’t be all in the stock market if I’m about ready to retire so like what mixture? Well, the good news is that TSP gives a little bit of guidance on, a little bit of direction per se on where money should be in TSP based on how soon someone is likely to need the money in retirement. So these programs are called the Lifecycle Funds. Now, there are five different Lifecycle Funds. Each of those five include the five regular funds that we just reviewed, the G, F, C, S & I.
Now, the objective and the intent that the TSP had with the Lifecycle Funds is that an employee takes their entire TSP account balance and puts it into one Lifecycle Fund. That’s not the same as putting all of it in the C Fund or all of it in the I Fund. Because the Lifecycle Funds already contain the mixture of the five underlying funds, the G, F, C, S & I, the Lifecycle Funds simply set the right mixture of those five funds based on how soon someone is likely to need the money.
Chris: Now, the objective of the Lifecycle Funds is to strike an optimal balance between the expected risks and return of each of the underlying funds. So again, it’s setting that mixture, that balance. So what we caution employees against is having most of their money in the Lifecycle Funds and then deciding they want to have another 50,000 over in the G Fund or in the C Fund or the I Fund or wherever it might be and the reason is you’re throwing off the balance and so we want to make sure that if truly you’re going to leverage what the Lifecycle Funds have to offer, that you do what they expect you to do in that type of fund. Now, I like the Lifecycle Funds. They’re not perfect. They’re better than a swag. Of course they give some thoughtful direction as far as where money should be.
Chris: But I like to refer to these as the [inaudible 00:16:52] rotisserie chicken. Do you remember that commercial where it’s set it and forget it? You put the money there and leave it alone and the Lifecycle Funds automatically rebalance and reallocate every quarter. So as you move closer to that retirement timeline, you get a little bit more conservative each and every quarter. So it’s not something you have to actively go in and make adjustments to, you just put it there, leave it alone and it simply adjust for you.
Chris: So really a pretty neat thing. Now, one thing I always want to express to employees is TSP and investing, it’s a marathon. It’s not a sprint. So we want to make sure that any funds that employees select are based on their risk tolerance and looking at their overall larger financial picture.
Scott: Okay, right. Now, can you talk a little bit more about why the TSP is such an attractive program for federal employees?
Chris: Absolutely. Of all the topics in our retirement workshops, TSP is the one everyone wants to hear about. So the biggest reason TSP is so attractive is because of its tax advantages.
Chris: Right. We know that there are other parts that it’s cheap and easy and we’ve got the safety of the G Fund, all of that, but the real reason people love to put their money there is because they get a tax break. So let’s talk a little bit about the two different types of tax advantages within the Thrift Savings Plan. So the one most people already know and love is the traditional TSP. So that’s the TSP that’s been around since the mid-80s. You put the money in today. You don’t pay tax on it so it’s not considered income for you today but know that over time, as it grows and then you begin to take the money out, you owe tax not only on the money that you put into TSP but all of the earnings when it comes out. So there is a tax advantage but it happens right upfront and then you pay for it down the road.
Chris: Now with the Roth TSP, this works exactly the opposite. With the Roth, you put the money in today and you pay the tax on it right now so you do not get an immediate tax advantage then when you take the money out later, it all comes to you tax free. So the question is, would you rather pay tax on the seed or the harvest? For those that are further away from retirement, it’s even more of an attractive program to look at the Roth. Now, a couple of things that I see employees not really sure of on this. With the money that goes into TSP, as far as the matching money from the agency, for our FERS employees, that is always going to go onto the traditional side of TSP. the reason of course is the government is not willing to satisfy the tax burden on money that goes into the Roth side of the account.
Chris: So they’re going to have the employee pay the tax later when they go take the money out. Now, a lot of folks, I do a poll in our workshop, how many of you think that you’re going to be in a lower tax bracket when you retire? I’ll say most of the people in that room raised their hand and here’s the reality. You don’t end up in a lower tax bracket by accident.
Chris: You have to do it because you’re planning to be in a lower tax bracket because you’re creating these tax free accounts like the Roth TSP. So regardless of whether you do the traditional side or the Roth side, whatever decision that is, the real key is living on less than you make and the extra benefit is that you get a tax advantage to it. But if you’re able to organize your lifestyle today to live on less than you truly make and save for the future, that’s where the real benefit of TSP comes from. The tax advantage is just the icing on the cake.
Scott: Right, right. Now, sometimes, unfortunately, life gets in the way and employees might need to borrow money from their TSP accounts. You recommend taking loans out of the TSP as a very last resort. Why is that?
Chris: Gosh, I do. TSP really, the loan should really be a last resort and the reason … Well, let’s first talk about the loans itself and like why it looks attractive and then we’ll talk about the reason I want it to be a last resort.
Chris: So the reason that TSP loans are so attractive is because the interest rate is very low. So the interest rate is going to be at whatever the G Fund is returning at the time. So if we’re at a one or 2% G Fund return, that’s a one or a 2% loan rate which is incredible. That’s great.
Chris: Another thing that people try to fool themselves on is that how great it is that they’re paying themselves back with the loan repayment. While on the surface that sounds good and the interest is going into the account, the real killer of course is that the money is not actively working in the account to earn money and that’s of course the whole purpose of the TSP. now, the reason we want the TSP loan to be a absolute last resort is because you pay taxes twice. Here’s how it works. Let’s say we’re putting money into the traditional side of TSP like most employees are. You put the money in today. You get an immediate tax advantage. You do not pay tax on the money when it goes in.
Let’s say 10 years later you decide you need a TSP loan so you take a loan. $50,000 comes out of your account. You don’t pay tax at that point either. But when you go to make the repayment amount each and every pay period, that is paid with after tax money meaning it’s been taxed.
Chris: Okay, so the tax goes in once. We’ve now repaid the entire TSP loan balance and now we’re ready to retire and begin taking money out of TSP. Do you think the IRS says, “Well, you paid tax on some of that money so we won’t tax you again?”
Chris: Nope, they don’t do that. They simply say, “Well, this is all taxable income to you. The tax bill is due.” So if we don’t like paying taxes once, let’s not pay it twice.
Chris: That’s ultimately what we do with the TSP loan.
Chris: You got it. Now, here’s my tip to avoid taking TSP loans. Build up your emergency savings account. If that means perhaps cutting back a little bit on TSP contributions so that you can build that big buffer of a budget, that’s acceptable because we want to make sure that you have a side account, that emergency fund that when the hot water tank needs to be replaced, when your engine needs to be rebuilt in your car, whatever it is that’s not covered by insurance and all of that, we want to make sure that you have the ability to have the funds to finance that instead of running to TSP and taking out a loan.
Scott: Right. Yeah, that’s important. Now, I know there’s a lot of you passionate about when it comes to helping federal employees to take charge of their financial future and I think there’s a topic that you haven’t covered today that is really important to you. What is that?
Chris: Absolutely. Federal employees spend an entire career saving in the TSP. most of them have the desire to protect that money for their family in the event that something should happen to the employee or even as a retiree. The way we do that is to assign a beneficiary to an account. Now, most of the TSP account statements that we receive to help employees to figure out what they’re doing, 95% of these TSP account statements show no beneficiary is listed at all. Really. I mean, a shocking statistic.
Chris: I was just baffled when that happens.
Chris: A couple of things. Oftentimes, federal employees simply don’t update this document from the time that they were originally hired. The thought hasn’t even crossed their mind. So it’s not like they get an annual review from their HR department to get them to update it each year. It’s just something that slips their mind and they don’t ever think about it. So one unfortunate thing that happens is if we have somebody listed on a beneficiary designation perhaps many, many years ago that you have fallen out of love with like a former spouse and they’re still listed on there, upon your death, that person is getting your money and that’s gone all the way to the US Supreme Court and upheld.
Chris: So it is very, very important that we make sure to rename a beneficiary especially in those big changes that happen, getting married, divorce, any of those things. Now, a lot of times, employees ask, “Well, what if I don’t have anybody listed?” Like all those TSP account statements that we receive. Well, the challenge of course at that point is that your money ends up going to the probate court and that’s where the courts get to decide where your money goes. There’s a list in order and although the order looks okay, first it goes to your spouse then to your kids and to your parents and so on, that sounds okay right from the beginning. The challenge of course is creditors get first stab at your money in the probate court. So what you thought you were giving to your family might end up going somewhere else.
Now, we always want to make sure that those beneficiaries are up to date, the TSP 3 is the form that an employee would use to update that beneficiary. It’s super easy. It takes only a couple of minutes to fill up the form. Be sure to keep a copy for your family so that they know what to do if something should happen to you.
Chris: Now, here’s a bonus just to keep everything nice and simple for employees. We’ve got all the beneficiary forms listed, not just for TSP but all the other federal beneficiaries that need to be update on our website. It’s fedimpact.com/beneficiaries and like I said, all four forms are there. It will take you about 10 minutes to fill out all four of them and then you’ll be on your way.
Scott: Oh, that’s great. That will be really helpful. Thanks for that, Chris. Now, you mentioned at the beginning of our episode here that you had several tips to share with us. So what else have you got?
Chris: Absolutely. I want to call these challenges, not just tips but challenges to see if we can move the needle for our employees really to take action. So I’ll remind you of the previous challenge which was every time that you get any kind of pay raise, be sure to bump up your TSP contribution. Take that opportunity when you’re getting more money in your paycheck that you’re already used to not living on, that you stock that away for the future. So my next challenge for our listeners today is looking at your budget, what could you trim to allow yourself to increase your TSP contribution by 1%? That’s it, 1%. So let me give you an example. If we have an employee that makes $100,000 per year, 1% of course is $1,000. That equates to $39 a pay period. So every two weeks, what’s $39 of fluff that might be in your budget that you could trim that allows you to save more confidently for the future?
Chris: Now, my mega challenge for everyone is what would need to happen in your financial life to be able to max out TSP? So if you’re under 50, how can you get to $18,000 per year? If you’re at least 50, how can you get to 24,000 a year? Now, this might come in the form of getting high interest credit card debt paid off, reducing your frivolous spending, going out to eat less.
Chris: Whatever it might be. But if nothing else, it gives you a great target that you can chew for.
Scott: Okay. Those are great tips and challenges. Thank you very much. I know you have a lot more to share about the TSP and all of the other complex federal benefits. Can you give us an idea of what our listeners can look forward to in future episodes?
Chris: Oh, you bet. Now, my real mission is to give very candid insights and no BS advise on federal benefits. So in future episodes, we’ll dive deeper into TSP. Of course we have things like the relatively new Roth TSP that we hinted at today. We’ve got how the TSP works when you go to take the money out and then beyond TSP, we’ve got all of our other topics like the CSRS and FERS pensions and how we can make those retirement checks be as high as possible, the survivor benefit plan that lets you protect that pension, the life insurance under FEGLI, the health benefits long term care. Gosh, we have a wide variety of different topics that we’re going to be talking about. So much to share with our audience and I hope they’ll stay tuned for future insights.
Scott: Well, it sounds like we’ve got our work cut out for us, don’t we?
Chris: Oh, we sure do.
Scott: Well, Chris, thank you so much for bringing us up to speed on some of the basics of the TSP. You mentioned that you love getting feedback from federal employees and want to encourage our listeners to interact with you. What kind of feedback are you looking for and where should they visit to give that feedback?
Chris: You bet, Scott. We want to make sure of course that we’re providing relevant information that our listeners actually want to hear about. So if they have ideas on topics or just want to share their reaction to today’s content, they can visit our website, fedimpact.com/feedback and share their thoughts. So to all of our listeners, I can’t wait to hear what you have to say.
Scott: Great, great. Well, Chris. It’s been great to talk to you today. I’d like to invite all of our listeners to stay tuned for another upcoming episode of the Fed Impact Podcast with Chris Kowalik of ProFeds. We’ll provide more candid insights on your federal retirement.