Thrift savings plans (TSPs) and 401(k) accounts are two vehicles used to save and invest for retirement. Both operate similarly in many ways, including tax advantages, caps on contributions and requirements for minimum withdrawals in retirement. However, TSPs are only available to federal government employees, while 401(k) plans are only available to employees of private-sector companies. Beyond that, TSPs and 401(k)s have some other differences including availability, costs and matching contributions. Consider working with a financial advisor as you create a retirement savings plan.
Retirement Plan Basics
Tax advantages are a key feature of both TSPs and 401(k)s. Employees can contribute part of their paychecks pre-tax, giving them a deduction in the current year. This allows them to grow account balances without paying taxes. They also have the potential opportunity to withdraw funds at lower tax rates in retirement.
Post-tax varieties of both TSP and 401(k) plans let savers pay taxes on contributions now in exchange for the chance to withdraw them and any earnings later at lower tax rates. The post-tax versions of these plans are called Roth 401(k) plans and Roth TSPs.
Both TSP and 401(k) plans have annual limits on contributions. The IRS adjusts these limits upward every couple of years. For 2022, the limit is $20,500 for most contributors. In 2023, that limit jumps to $22,500.
The plans also share similarities when it comes to withdrawals. Beginning at age 70.5, both TSP and 401(k) plan savers have to start taking required minimum distributions and paying any taxes due.
Beyond these similarities, there are differences, such as with vesting. Some private-sector 401(k) plans vest employees with 100% ownership of employer contributions immediately. Others may take up to six years. TSP employer matches are vested immediately, and the automatic employer contributions are vested in two to three years. The employees’ contributions are vested immediately with both types of plans.
TSP Pros and Cons
The major limitation of TSPs is that participants must be employees of the U.S. federal government. This includes part-time and full-time employees of the civilian branches, as well as military service members. One of the pluses of TSPs is the very low fee structure. TSP annual fees are typically about 0.05% of the money in the account.
On the downside, TSP plans offer limited investment choices. Participants can direct their money toward any of 10 funds, including four target-date funds and six that invest in sectors ranging from government bonds to international equities.
One of the major pluses of TSPs is that federal employees are automatically enrolled in the plan. They don’t have to choose an option to participate, although they still must choose how much of their pay to contribute.
Even if employees don’t choose to contribute money deducted from their paychecks, the federal employer automatically puts an amount equal to 1% of each employee’s pay into the account. These contributions aren’t deducted from employee pay.
In addition, the employer will match employee contributions up to 5% of the employee’s salary. This amount is higher than most private-sector 401(k) plans, some of which don’t match employee contributions at all.
TSP funds can be moved to an IRA or similar retirement plan if the employee has one. Similarly, funds can be moved from an IRA or other plan to the TSP.
401(k) Pros and Cons
Since most people don’t work for the federal government, the fact that 401(k)s are open to private-sector employees is a major benefit. As a significant limitation, however, not all employers offer 401(k) plans. Employees whose employers don’t offer 401(k) plans can’t have them. Also, while 401(k) plans are tightly regulated and most plans are similar, employers can make significant decisions about how their plans are implemented. This means that, unlike the TSP, which is open to all federal employees, 401(k) plans can differ widely in their features. Some are better than others.
For instance, employees are not automatically enrolled in all 401(k) plans. It’s up to the employer whether the 401(k) will have automatic enrollment, and most choose not to make enrollment automatic. Without automatic enrollment, many employees who could benefit from the plans do not participate.
Also, not all employers match employee contributions. Those that do generally match less than the 5% that is standard for TSP participants. And there is no automatic 1% employer contribution with a 401(k).
One of the benefits of many 401(k) plans, especially for retirement savers who want more control of their investment portfolios, is the opportunity to choose from a wider section of investments. While a typical 401(k) will have a similarly limited number of investment choices as the TSP, consisting of a handful of mutual funds, some will allow participants much greater latitude, even including the ability to purchase individual stocks and bonds.
Finally, 401(k) plans generally have significantly higher fees than the TSP. Private sector 401(k) plans charge administrative fees on top of the fees charged by mutual fund companies. These can run as high as 1.5%, which is enough to have a significant impact on a fund balance over time.
TSPs and 401(k) plans are alike in giving employees tax advantages over other approaches to saving for retirement. For federal employees, TSPs’ automatic contributions, higher employer matches and low fees probably make them a superior choice. For people who don’t work for the federal government, 401(k) plans are still a good choice for retirement savings and can be central parts of individual financial strategies.
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