In honor of Memorial Day, The Motley Fool salutes current and former military personnel and their families with a series of articles addressing common financial issues they face. Check out all of the Fool's Memorial Day articles.
There's a lot of debate about whether our troops get the best we can give them. But when it comes to retirement planning, there's no doubt: the Thrift Savings Plan (TSP) is the cream of the crop.
You've probably heard about the controversy over conditions at the Army's Walter Reed Medical Center, and the arguments over whether Pinnacle Armor's Dragon Skin vests protect soldiers better than the DHB Industries (Nasdaq: DHBT.PK ) Interceptor vests currently supplied to our troops. But the TSP is better than 99.44% of civilian 401(k) plans that private employers offer. Like 401(k) plans, the TSP is a defined contribution plan that allows elective deferrals. The TSP shares the same contribution limits as 401(k) plans, and participation is optional. While matching contributions are authorized for certain military specialties, none is currently being funded.
Tiny costs, simple plan
What makes the TSP superior is its simplicity coupled with minuscule costs. All of the options in the TSP have annual administrative expenses of just 0.03%. That's just $30 a year on a $100,000 account. Compare that to fees that could exceed $1,000 per year for 401(k) plans holding traditional mutual funds.
The TSP has just five investment choices (G, F, C, S, and I Funds), along with five lifestyle funds (L) that offer blends of those five choices based on when you'll need to start using the money.
The TSP options span the range of typical investment securities. The G Fund is comparable to a money market fund and is invested in short-term U.S. Treasury securities sold only to the TSP. The G Fund consistently outperforms Treasury bills with lower volatility. The F Fund is essentially an intermediate-term bond index fund that tries to match the performance of the Lehman Brothers U.S. Aggregate Bond Index. The fund has done a good job of tracking the index closely.
The C, S, and I Funds are all stock index funds. The C Fund tracks the S&P 500, while the S Fund tracks the Wilshire 4500 index of small- and mid-cap companies, and the I Fund tracks the MSCI-EAFE index of international stocks. All three stock funds, along with the F Fund, are managed by Barclays (NYSE: BCS ) .
The Lifecycle Funds (L 2010, L 2020, L 2030, L 2040, and L Income) have asset allocation targets based on a projected time horizon. Each quarter, the funds adjust to a slightly more conservative allocation. When an L fund reaches its target date, it will roll into the L Income fund. You don't have to choose the fund that matches your retirement date; instead, you can pick whichever fund is in line with your particular financial goals. For instance, the L Income fund is only 20% invested in stocks, which may be more conservative than you want even if you're already retired.
Making contributions and taking distributions
Elective deferrals from basic pay can be made to the TSP and are subject to the same 401(k) limits as in the private sector: $15,500 in 2007 with a $5,000 catch-up provision if you're over 50. Also, any incentive pay or combat pay can be contributed; however, you cannot defer incentive or combat pay unless basic pay is being deferred first. Combat pay is tax-exempt and not subject to tax when you take retirement distributions. That means that your distributions will be partially taxable and partially tax-exempt if you contribute combat pay to your TSP. If you separate from the service at age 55 or later, distributions are not subject to a 10% penalty. Civil Service employment will negate this option.
Sticking with a good thing
In general, if you have a TSP account, rolling it over into another employer's 401(k) is a huge mistake. While rolling a TSP into an IRA may give your heirs the option to stretch their tax deferral over a greater number of years, the investment options are often much less suitable. Don't forget the annual expense ratio of actively managed mutual funds is often 1.00% or more versus just 0.03% with the TSP.
Once you retire, you'll want to start taking withdrawals of your TSP. You have several options, including taking a single payment, a series of monthly payments, a life annuity, or any combination of the three. If you want advice on how to choose from among these options, the Fool's retirement newsletter, Rule Your Retirement, can help. A 30-day trial may give you all the answers you need.
The TSP is not a perfect retirement vehicle, as you don't have access to every asset class available, including high-yield bonds, REITs, and emerging markets funds. But when coupled with the defined benefit plan offered to military retirees, the two can ensure an exceptionally safe and secure retirement.
Buz Livingston, CFP, appreciates your feedback and believes most people will benefit from professional advice. This column is in memory of Lt. Joseph Taylor Laslie Jr., USMC, killed in action, Republic of Vietnam, Quang Tri Province, May 23, 1968.