To the uninformed consumer, retirement plans can seem like a confusing jumble of numbers and letters. Are you eligible for an IRA, a Roth IRA and a TSP? What about a 401k, a 403b or a 427 plan? Each plan has its pros and cons for the employees who contribute to it. A Thrift Savings Plan (TSP) helps federal government employees shelter their retirement savings from taxes, and a 401k helps private sector employees do the same.
Private sector employers may offer a 401k plan as a fringe benefit of employment. These plans typically offer tax advantages to employees who are over 21 years of age, who have been employed for one year or more and who are not covered by a collective bargaining agreement that prohibits their participation in the plan. Similarly, the federal government offers TSP participation to federal employees who work in civilian jobs and to uniformed service members. Most eligible civilian employees must be covered by the Federal Employees' Retirement System or the Civil Service Retirement System to participate in a TSP.
Participants in both a TSP and a 401k contribute to these plans by designating a payroll deduction of a certain percentage of their pay to be deposited to the plan. With a TSP, the employer-agency matches a portion of the employee's contribution -- up to 5 percent for FERS employees. With a 401k, many employers offer a matching contribution. A matching contribution by a private employer is entirely voluntary, and it varies from one company to another. The law restricts the maximum employee contribution to both plans, but both types of plans permit employees who are age 50 or older to make larger "catch-up" contributions.
A 401k and a TSP are tax-deferred plans. An employee does not pay taxes on her contributions, or on her employer's matching contributions, until she withdraws them from the plan. Earnings on contributions also grow tax-free in each account until the participant withdraws them. The employee's tax rate at the time she withdraws from the plan applies to withdrawals of all contributions and earnings in the plan. A 10 percent penalty also applies to withdrawals an employee makes before she reaches retirement age.
When an employee terminates employment, he can leave his funds in a TSP or 401k account, or he can roll them over into another qualified retirement plan. Electing a rollover into a traditional individual retirement account (IRA) maintains the funds' tax-deferred status. A departing employee may also convert funds to a Roth IRA by paying taxes on the money at the time of the conversion. Employees make Roth IRA contributions with after-tax dollars, but the IRS does not tax earnings and withdrawals from a Roth IRA during retirement.