A thrift savings plan (TSP) is what the government offers to federal employees and members of the military who do not have access to a traditional 401(k) in the private sector. The TSP is one of the biggest in the world, with over $735 billion in assets under management, as of 2020. A TSP is similar to a 401(k) in that the funds are taken directly out of your paycheck. The next question you might have is, are TSP contributions tax-deductible?
Type of TSP Contributions
The purpose of the TSP is to give government employees similar retirement benefits to the private sector. In many ways, TSP deductions act like an IRA contribution.
In the past, the TSP was treated like a traditional individual retirement arrangement (IRA). Your contributions were made with pre-tax dollars. You would have to pay taxes when you begin making withdrawals in your retirement years. The taxes paid are based on your tax bracket at the time. In 2012, the government added a Roth option to the TSP that allowed you to make after-tax contributions, similar to a Roth IRA. If you choose this option, you will not have to pay taxes when you start making retirement withdrawals.
Does TSP reduce taxable income? The answer to this question depends on whether you choose the traditional or Roth option. If you chose the traditional option, then your contributions will reduce your taxable income, but if you choose the Roth option, they do not. Other factors might affect the amount of the deduction. For instance, just like an IRA, certain contribution limits apply. For 2021, the maximum TSP contribution is $19,500; after the age of 50, you can contribute an additional $6,500 per year.
Like a 401(k), you are eligible for matching TSP contributions from your agency or branch of the government. Depending on whether you are in the Federal Employees Retirement System (FERS) or Blended Retirement System (BRS), the agency will begin contributing 1 percent of your pay. You receive this contribution whether or not you make any contribution of your own.
After two years of service, they will match an additional 4 percent. For the first 3 percent you contribute, they will match dollar-for-dollar. They match your contributions 50 cents on the dollar for the next 5 percent. If you contribute 5 percent, you get an additional 5 percent.
Consider Also: How Long Does it Take to Cash Out of a TSP Account?
TSP Contributions and Taxes
What is TSP considered for tax purposes? For the most part, TSP contributions are treated just like an IRA contribution. Many of the same rules apply when it comes to rollovers and withholding. You need to be aware that certain government employees might have different rules that apply to taxation and benefits issues. One example of this is members of the military who served in a combat zone.
If you want to avoid paying taxes on your TSP withdrawal, you should choose to have your contributions taken out using the Roth option when you sign up. This means that you pay taxes on the money now and will not have to pay taxes when you begin making withdrawals. Your paycheck will be a little smaller now, but you will reap the benefits when it comes time to retire.
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The TSP contributions program is an excellent opportunity for saving for retirement. The government offers some nice perks that go beyond what many private sector 401(k)s offer. If you start making the maximum contributions as soon as you can and take advantage of the 5 percent matching, you can enjoy a nice retirement when the time comes.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.