Question:
One of our readers wrote:
"The military’s retirement plan is called the Thrift Savings Plan (TSP). It is set up to where you can easily change what you want to save per paycheck and what type of account you want it to be (Traditional IRA or Roth IRA). My question is, would it be better to open a personal IRA and invest how I want, whether I stay in the military for 5 more years if 25 more years, or does the military give me some say in how I want my money invested? I have never heard of people being able to do anything more with their IRA, and on the website where I can access this account, the only options I have are what percent I want put in, and what kind of account I want."
Short Answer:
A TSP is basically just the military version of a 401k (not an IRA). So replace "401k" with "TSP" and follow the same cheat sheet. Instead of VOO in your TSP, you want to choose the C fund for our investment election (the default is a more expensive target date L fund).
Long Answer:
I'm not very familiar with TSPs, but you're asking a good question here. The root of the question is what choices you have in a TSP. One quick clarification, the TSP is more similar to a 401k or some other employer sponsored account. An individual retirment account (IRA) is something you can set up on your own without your employers help. So when you say "Traditional IRA or Roth IRA", just drop the "IRA" if you want to be accurate. Both IRA and 401k/403b/TSP accounts can be Roth or Traditional.
It looks like there's three major decision areas in a TSP: which type of account to contribute to (roth vs. traditional), which fund to contribute towards, and how much of your paycheck. It looks like you don't have any questions about roth vs. traditional (for those who do you can look at our retirement accounts page). So let's start with which fund to invest in.
A quick reminder because this is an area that trips up a lot of people: contributing money to an account (ira, 401k, taxable brokerage, TSP, etc) is not the same as investing it. After you move the money into the account, there is an additional step to actually purchase some kind of investment with that money. In some accounts (especially retirement accounts), there is usually a default investment that will be purchased for you, unless you specify otherwise. Often, this is a more expensive option. Unsurprisingly, when you let other people decide how to invest your money they will usually choose to pay themselves more fees, not less. To see how these fees take a huge chunk of your savings over time, check out the bottom of our index funds page.
So, in your TSP case, what is the default? Doing a quick google search for "default fund choice tsp" I found that you'll probably be defaulted to an age-appropriate L fund. Is that good? To check, we can look at the TSP comparison page. I'm guessing that you're young and your fund would likely be something maturing around 40 years from now, so we can look at the 2060 fund. If we look under "Fees & More Info" we see a total expense ratio of 0.067%. So every year, you'll pay 0.067% of your total money in the account in fees. This is not terrible, but more than twice as much as a low-cost fund like VOO, which has an expense ratio of 0.03%
Are there better options in the TSP? Only a little better. It looks like there's some sort of mutual fund window option, but if I'm reading the rules right you'd need to have at least $40k invested to use that. The other option is individual funds. The fund most like VOO would be the C fund. It will likely give you almost identical investment returns, except for the fees which are still higher (0.059%).
What's the difference between 0.03% and 0.059%? Doing some quick spreadsheet calculations (and assuming the average market return of 6.7%), if you contribute the TSP max ($22,500) over 40 years, the difference between the two expense ratios is about $30,480. More than a full year of contributions! In the VOO case you end up with $4,126,918 (awesome!) and in the C fund case you have $4,096,438 (still really good). So in either case, consistenly saving money and letting compound interest work for you is going to give you good results. If you stick with the L fund, it's hard to compare apples to apples because the underlying investment is not the same. But assuming the performance was exactly the same (unlikely), with the L fund fees you'd be left with $4,088,073 ($38,844 less than VOO).
So, just comparing funds it looks like not investing in the TSP is slightly better if you aren't going to hit the contribution limits for a TSP/401k or an IRA. BUT, TSP offers at least partial matching for your first 5% contributed which will dwarf the effect of higher fees. This only applies, "If you’re a FERS or eligible BRS participant" (and TBH I have no idea what that means).
So in summary, it looks like the TODO list in order should be:
- Contribute at least 5% of each paycheck to the TSP (they only match on a per-paycheck basis, so you want to split your contributions equally throughout the year). This is by far the most important.
- If you are okay with higher volatility and want to minimize fees, change the investment election in your TSP from the target date L fund to the C fund. This won't make a massive difference, but is still worth the 10/15 min. it should take to potentially have ~$8K more in 40 years. Since I don't have access to my own TSP, I can't give advice on how to actually navigate their website to do this, but searching something like "change investment election TSP" might help.
- If you still have money to spare after hitting the 5% match, decide where to invest the rest. It's worth your time (spend 30 minutes now to have thousands more in 40 years) to open up a separate IRA with a brokerage (there's a lot of good options like Schwab, Fidelity, etc). Your IRA has a separate contribution limit of $6,500 for 2023. If you have a 401k as well, this will share a limit with the TSP, so you'll need to weigh which one is better to contribute to. You can contribute $22,500 split across a TSP and a 401K, so make sure you get any matches and then contribute the remaining dollars to whichever account has better investment options.
- In your separate IRA, choose VOO or something similar with low fees to invest in.
- After you've maxed out your IRA contributions, increase your contributions in your TSP and/or 401K (remember to spread the contributions out evenly over the year so you get your full match).
That's my understanding of how to maximize long-term returns with a TSP based on 30 minutes of Googling and reading the TSP website. Hopefully it's helpful, if so feel free to share with any of your military friends!