At first glance, the Thrift Savings Plan (TSP) available to all military members and federal employees doesn't seem like a very FIRE-friendly investment vehicle. After all, it acts like a 401k retirement plan, meaning you put money into it while you're working and only pull it out once you've hit traditional retirement age. You'll pay penalties if you withdraw too early (50 being the absolute earliest -- for more on penalties, look here) so it doesn't seem to help our goal of retirement at 42, right?
Well, yes and no. As it turns out, there are a lot of great benefits to the TSP both during your career and after. This post is designed to walk you through all the FIRE-friendly aspects of TSP and explain why it is a core element of Mr. FIRE's and my strategy.
1. TSP is wildly popular and has automatic saving and extremely low fees.
Okay -- you need to invest your money somewhere and somehow. There are thousands of options -- USAA, Vanguard, Wealthfront, ScotTrade, etc -- and each charges you something to use them for investing. It turns out that the TSP may actually be the best option out there. It's the largest defined contribution plan in the world (with over $5 billion in assets) and the people who use it, love it: 89% of participants are satisfied or extremely satisfied with the Thrift Savings Plan.
Why is it so great?
First, the fund options are limited and simple to understand. In fact, there are only 6 options. Why is that important? Because investing doesn't have to be rocket science. Mr. FIRE's Vanguard 401k has hundreds of investment options, which quickly overwhelms our collective knowledge (and interest) in stock market investing. Take a look at the options below, or check them out in a handy-dandy matrix.
G Fund: Non-marketable U.S. Treasury securities. These assets are managed internally by the Federal Retirement Thrift Investment Board. Uncle Sam guarantees the G Fund, so it won’t lose money, but the potential for earning is low –basically, it’s trying to keep up with and beat inflation.
F Fund: Bonds. The investment objective is to match the performance of a Bond Index
C Fund: Common Stocks. The investment objective is to match the performance of the S&P 500 (large to medium-sized U.S. companies)
S Fund: Small Cap Stocks. The investment objective is to match the performance of the Dow Jones US Completion Total Stock Market (small-medium U.S. companies)
I Fund: International stocks. Investment objective to match the performance of the MSCI EAFE (Europe, Australasia, and Far East) Index.
L Fund: Lifecycle Funds. Professionally managed investment funds that are tailored to meet investment objectives for a specific time horizon or when you think you will retire and need your money. There are a total of five different Lifecycle Funds that target retirement dates through 2050.
Though Mr. FIRE and I have a little bit in every pot, I like the Lifecycle Funds the best. These funds are more risky (higher potential returns but also higher potential losses) early in the cycle, and get more and more conservative as you get closer to the target date. We've picked out a couple -- a FIRE-focused fund that matures when we hope to retire and a normal retirement fund that taps out when we hit the US-standard retirement age of 60.
Second, the fees are low... crazy low. John Grobe of Federal Career Experts has this to say about TSP's fees:
The TSP’s expenses aren’t just low, they are ridiculously low. I periodically give classes in federal retirement and benefits to financial planners who want to understand our benefits so that they can better serve federal clients. When I inform them of how low the TSP’s expenses are, I am often met with doubt or disbelief. For the year 2018, the expense ratio for the TSP was 4.1 basis points – that’s $0.41 in expenses for each $1,000 you have in your TSP account. Though this is up from the 2015 ratio of 2.9 basis points, you still will not find such low expenses in private sector employer provided retirement plans, IRAs or annuities. The lower your expenses, the more money that gets reinvested and compounded in your account.
Part of the way TSP keeps fees low is that it's not advertising for outside clients and it pays its managers reasonable compensation, not Wall Street salaries. And while the low rates may not seem like a big deal when you only have a little money invested, they will save you big when you have hundreds of thousands socked away.
Third, like most 401ks, your contributions are taken right out of your paycheck. So you never see the money and thus, can't spend it. Automatic saving is a huge component for FIRE afficionados because, well, we're human. And if you give me $10, chances are I'm going to spend it the next time I see a Starbucks. But if I never have the $10 in the first place, it's so much easier to keep driving!
So, since you have to invest somewhere, TSP is about as good a retirement system as you can find. And its advantages don't end there...
2. Your TSP contributions can be tax deferred, lowering your tax liability.
Since 2012, there are two types of tax vehicles inside TSP: Traditional and Roth. Depending on what kind of vehicle you choose with your TSP account, your annual contributions can be "pre-tax dollars" which lowers your overall tax liability, or they can grow tax free. Here's a quick rundown on the difference:
Traditional: With a traditional tax treatment option, your contributions are made with pre-tax dollars (taken out of your gross earnings), lowering your gross income for tax season. But, you have to pay taxes on your withdrawals in retirement based on your tax bracket at that time. Most people assume their tax bracket will be lower in retirement since they won't be taking income from a job.
Roth: Roth contributions are made after taxes have been taken out of your paycheck. That means you’ll pay taxes on the money before it goes into the TSP. But, when you make Roth contributions, that money grows tax-free and you won’t pay any taxes on the money you take out when you retire.
Now, people disagree on which is the best option here, and the reality is that it depends on your unique situation. The Roth option is valuable if your income is low (think: first 10 years of service or unmarried) and you don't need the upfront tax deduction, you're a long way from retirement and are worried taxes might go up (you will have already paid your taxes on this money), or you think you won't enjoy the emotional punch of paying taxes on your nest egg when it comes time to withdraw it. A Roth is especially useful if you're going to deploy, since all of your income will be tax free for a period of time, meaning the in advance tax rate you pay on your Roth contributions is....zero. Which is super nice.
The traditional option is helpful if you have a large income -- say, you're an O-4 or O-5, your spouse works, you are getting an annual bonus, or you routinely sell property for a profit. Being able to cut $19,000 (the 2019 TSP contribution limit) out of your gross income can often drop you a full tax bracket -- and that's no joke. Take a look at the tax brackets below.
Most military members will live in these four tax brackets because of the unique way our paychecks are constructed with taxable and non-taxable income. So how does the math work? As an O-1, you'll be making $3,188/month in base pay ($38,260 annual income), which will probably be the only taxable portion of your income since BAH and BAS are tax-free. That puts you in the 12% bracket. If you can scrimp and save to contribute the max amount of $19,000, your taxable income drops to $19,260. This means a scant $200 in other deductions (money to church, charitable donations, the AFAF) and you drop to the 10% bracket.
Now, that may not be worth it to you: the taxes on $38,260 will be $4,210 versus 10% of $19,050 is $1,905... a difference of about $2,300.** And that's why Roth can make sense when your paycheck is low. But let's do the math in the higher tax brackets.
An O-5 with 14 years in makes $8,230 a month, or about $98,769 per year in base pay. Assuming again that she has no other taxable income (spouse's pay, bonus, career incentive pays), then she would owe $13,607 in taxes. Over $4700 of that is from the 22% tax bracket, so dropping below that threshold will save her nearly five grand. And guess what: maxing out TSP to the tune of $19,000 gets her darn close, within $2,000 of magic limit.
**Note: these examples don't take into account any other deductions, including the standard deduction of $12,000 for individuals and $24,000 for married filing jointly. But, since taxes are cumulative (meaning you pay 10% on the first $19,050 of income and 12% on everything above that to $77,400, and 22% on everything above that....you get the picture) and your TSP contributions come out first (meaning they don't impact your other deductions) it's extra bonus.
And TSP's tax benefits don't end there. There's another little gem, capital gains tax, which turns to 0% (yes, that's right, zero) below about the same threshold: $78,750 for married filing jointly. Capital gains applies anytime you make money from selling an asset -- stocks, real estate, businesses. In our real world example, Mr. FIRE and I saved about $30,000 in taxes last year. We had sold one of our rental properties, but partly because of our TSP contributions, our income fell underneath the magic number.... so our tax rate was 0%. Not a bad benefit to saving toward retirement!
Since one of the three tenets of FIRE is maximizing your income, you can see how reducing the money you pay in taxes helps... all while accomplishing another tenet, saving/investing like crazy.
3. You can borrow from the TSP and pay interest on the loan... to yourself!
Unlike many other retirement investment vehicles, TSP allows you to borrow from your own retirement account at any time. Better yet, the interest you pay on the loan from future you to current you gets paid to....you!
How does it work? Well, TSP identifies two types of loans: general purpose and residential. General purpose loans can be used for anything (car, house, renovation, school, or just more trips to Starbucks...don't do that last one, it will kill your FIRE-ability!), requires no documentation, and has a repayment term of 1 to 5 years. The residential loan can only be used to buy or build a primary residence. Because of its specificity, you do have to provide documentation, but the loan term is longer: 1 to 15 years.
You can have one of each type of loan at a time and you can borrow between $1,000 and $50,000 from yourself depending on several factors (see the specific rules here). There is a one-time fee of $50 to take the loan and the interest rate is the same as the G-fund rate (right now, it's 2.5%). Those are incredibly low loan costs, and even lower when you remember that that interest is being paid right back into your account.
That means that besides the $50 fee, the only real cost to taking a loan from TSP (assuming you pay it back) is the lost future earnings. The longer you can keep your money invested, the more money you make -- remember the power of compound interest? But to buy a house or cover another major purchase, borrowing from TSP is an incredible bonus.
4. If you skip the TSP, you'll give up free money under the Blended Retirement System (BRS).
Under the new retirement system, BRS, failing to invest in TSP is passing up additional income. Uncle Sam is literally offering you free money, and all you have to do is save a little of your own hard-earned cash.
How does it work? Well, you can check out our whole post on BRS HERE. But the long and short of it is that Uncle Sam will match your TSP contributions up to 5% of your basic pay. So your 5% investment instantly becomes 10%, just by saving. Free money!
At lower ranks, this isn't going to add up to a ton of cash (though that doesn't mean you should pass it up....I mean, would you say no to a $50 gift card as a Christmas present? Hell no!). An O-1 contributing 5% of his pay would save $1,912; the government would match an additional $1,912, for a total of $3,825. That's almost $2,000 of free money!!!
But look what happens you get to our O-5 with 14 years in: 5% of her income is $4,938, so the government match is almost $5k of free money! I mean, seriously: are you going to say no to $5k of free cash? You could use this match as an excuse to save a little less in TSP (you save $14,000, you let Uncle Sam pay in $5,000) or even better as way to make your annual TSP contribution rise to $24,000! Amazing!
So, even if you don't max out the TSP contribution limit, the BRS government match is reason to make sure you at least contribute 5%. If you don't, you're going to miss out on free money toward your FIRE future.
5. You're still going to need money after you're 60 years old.
There's no question that TSP, like most traditional retirement vehicles, is designed to be used once you hit normal retirement age. But FIRE is all about having a layered strategy. YES, you'll need income or investments to carry you from the day you retire to the day you can access (penalty free) all the retirement vehicles you have invested in. So you can't make TSP your only answer.
But that doesn't mean it's not part of the equation. Mr. FIRE and I have a group of investments we intend to tap between age 42 and 65.... and then a separate group that will carry us from 65 until, well, death. In both phases we are planning on passive income from pension and rental properties. Balance is key -- but that balance definitely includes TSP!
To sum everything up, the Thrift Savings Plan is an excellent investment vehicle that is also FIRE-friendly, despite first appearances. It's also uniquely available to members of the military and federal employees, so there is no reason not to take advantage of everything TSP has to offer.
Happy savings!
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