:max_bytes(150000):strip_icc()/federalemployeehealthbenefitsinretirement-5b318b32ff1b78003744aee5.jpg)
Daniel has 10+ years of experience reporting on investments and personal finance for outlets like AARP Bulletin and Exceptional magazine, in addition to being a column writer for Fatherly.
Updated May 14, 2024 Reviewed by Reviewed by David KindnessDavid Kindness is a Certified Public Accountant (CPA) and an expert in the fields of financial accounting, corporate and individual tax planning and preparation, and investing and retirement planning. David has helped thousands of clients improve their accounting and financial systems, create budgets, and minimize their taxes.
Fact checked by Fact checked by Vikki VelasquezVikki Velasquez is a researcher and writer who has managed, coordinated, and directed various community and nonprofit organizations. She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area.
For decades, Americans working in the private sector have relied on 401(k) plans to fund their retirement. However, if you take a job in the federal government or the military, you can expect a different investment vehicle as part of your benefits package: the thrift savings plan (TSP).
The TSP was modeled on the 401(k), so the two plans have many similarities. However, there are some important distinctions, including which investments you can select, that can have important implications for building your nest egg.
Now a cornerstone of retirement investing, 401(k) plans were first introduced in the early 1980s. Eager to lower their expenses, private employers used a new provision in the Internal Revenue Code that allowed them to sidestep taxation on deferred compensation.
Soon, many companies began shedding their pension plans in exchange for employee-directed accounts, which allowed them to contribute funds but not have to guarantee the amount that workers would receive in retirement. Workers could add their own funds to the account, up to allowable limits, and choose the stock and bond funds through which they would invest.
A few years later, Congress latched onto the same concept for uniformed service members and employees of the federal government, passing the Federal Employees’ Retirement System Act of 1986. The law created the TSP, which provided self-directed investment options and similar tax benefits to the 401(k).
The two retirement plan options are nearly identical in many ways, including how much employees can contribute each year. However, those who work in the public sector will notice that in other ways, such as where they get to invest their dollars, there are important differences.
Both the 401(k) and TSP offer traditional and Roth versions. If you choose the traditional route, money that you kick in is tax deductible and tax deferred. So while your money is invested, you don’t have to pay taxes on any gains that accumulate when, for example, a mutual fund sells shares of stock for a profit or earns dividends. However, you do pay ordinary income tax on money that you withdraw after age 59½.
Unlike with traditional retirement contributions, those made to a Roth 401(k) or Roth TSP account will not reduce your taxable income. However, your money grows on a tax-deferred basis, and you can make withdrawals without paying tax or early withdrawal fees as long as you’ve had the account for at least five years and are age 59½ or older.
Employer contributions, whether to a 401(k) or TSP, are typically allowed to be used as deductions from the employee’s taxable income, up to identical limits set by the Internal Revenue Service (IRS).
Employee contribution limits to a 401(k) or TSP are identical. These amounts are revised every year.
For 2024, employees can contribute up to $23,000 to either a 401(k) or a TSP. If you are age 50 or older, you can use the catch-up provision to contribute an additional $7,500. For 2023, these numbers were $22,500 and $7,500.
Both 401(k)s and TSPs create powerful incentives for employees to leave their money in the account until retirement. Traditional accounts will slap you with a 10% early withdrawal penalty on the entire balance—both principal and earnings—that you withdraw before age 59½, and you may have to pay income taxes on that money as well.
With a Roth 401(k) or Roth TSP, you’ve already paid income taxes on the amount that you contribute. This means you can withdraw your principal at any time without incurring taxes. However, you may have to pay income tax and the 10% penalty on earnings that you pull out if you haven’t both reached age 59½ and owned the account for at least five years.
If you have a 401(k), you can avoid the 10% hit if you qualify for a hardship distribution, as determined by your employer. Doing so requires you to prove an “immediate and heavy financial need” that you can’t meet by other means. But even if you can escape the penalty, you’ll still have to pay applicable taxes on the amount that you withdraw.
The TSP is not as lenient. While you can make hardship withdrawals if you meet certain criteria, you normally still incur the 10% penalty, plus applicable taxes.
As with some 401(k) plans, a TSP allows employees to take loans from their retirement funds, which they have to repay to their account with interest. And like 401(k) loans, the amount that you can borrow from yourself is equal to half of your vested balance, up to $50,000. For TSP loans, however, the borrowed amount cannot exceed the employee’s own contributions to the account plus earnings from it.
These loans ordinarily have to be repaid on schedule over one to five years. However, you can repay loans made for the purchase of a primary residence over a longer period. For TSP participants, the repayment period for residential loans can be anywhere from one to 15 years.
Private-sector employees with a 401(k) typically have a few options for withdrawing funds when they retire, depending on the rules of their specific plan. These may include taking a lump-sum distribution, making periodic distributions of a specific amount, or rolling over the money into an individual retirement account (IRA). Some plans also allow you to buy an annuity from an insurance carrier that has partnered with your employer. This enables you to convert your balance into payouts over a specific time period or a lifetime stream of income.
A TSP similarly provides a good deal of flexibility when it comes to accessing your retirement money. Federal employees can set up installment payments, which can be fixed dollar amounts or an amount calculated based on life expectancy data. You can also make single withdrawals.
A third option for TSP participants is to convert their balance into an annuity that guarantees payments to you for the rest of your life. Retirees have multiple options for the annuity, such as adding a joint annuitant (typically a spouse) or selecting a “10-year certain” feature that guarantees funds to a beneficiary if you die within a decade of receiving payments.
TSP participants can annuitize all or part of their balance in retirement, guaranteeing a set monthly income for life.
Like 401(k)s, federal employees with a TSP account can also roll over their balance into an IRA once they leave the federal government.
Both plans impose required minimum distributions (RMDs) for participants in retirement. Those who don’t make these minimum withdrawals are faced with a steep 25% tax on any required distribution that wasn’t made in time.
Whether you worked for a private company or the federal government, you have to start making RMDs at age 73. They’re pushed back, however, if you’re still working for the government or—in the case of a 401(k) participant, for the company sponsoring the plan.
If you turned 72 by December 31, 2022, you would have needed to start taking RMDs in the year you turned 72 or retired—unless you’re a 401(k) participant born prior to July 1, 1949. Then you would have needed to start taking RMDs at age 70½.
Perhaps the most striking difference between a 401(k) plan and a TSP is the choice of investments. With a 401(k), the employer hires an administrator to manage the plan and provides a menu of investment options. Employees have an average of 28 options, according to research conducted by the Investment Company Institute (ICI). The options often include mutual funds, stable-value funds, and target-date funds. Some plans offer access to brokerage services, opening up your choices to literally thousands of funds.
Investment options within the TSP are more limited. You’ll have access to several target-date funds, which the TSP calls “lifecycle funds.” They’re essentially a basket of stock and bond funds that automatically adjusts your asset mix in favor of more conservative choices as you approach the target retirement date.
The average number of investment options in a 401(k).
Service members and federal employees also have access to five individual funds that they can mix and match:
While they may not have as many funds to choose from, TSP participants do have one big advantage over most 401(k) investors: lower fees. The total expense ratio, which covers both investment and administrative fees, is 0.066% for individual TSP funds. So if you have a $1,000 account balance, you’re paying a paltry $0.66 to the administrator every year.
Investment fees for private employees vary from one 401(k) plan to the next, but, according to the ICI, the average plan cost for participants was 0.58% in 2017 (though it’s often lower at larger companies). This means that a typical 401(k) plan charges roughly 10 times what the federal government does for its employees. Because those fees are taken out every year, they have a compounding effect and can make a substantial impact on your returns over the long run.
A TSP offers a 1%-of-salary automatic employer contribution to each employee’s account, and it will match up to 4% of your salary, resulting in a potential contribution totaling 5%.
That compares pretty favorably with most 401(k)s. According to the ICI, the most popular benefit for large plans is a 50% match on up to 6% of the employee’s salary, making the maximum employer contribution equal to only 3% of your wages.
A thrift savings plan (TSP) is a defined-contribution retirement plan for federal employees and uniformed service members. It offers similar tax benefits to 401(k) plans that many private employers offer, but the investment options and fees differ.
In many ways, the two tax-advantaged retirement plans are similar. However, there are some important distinctions. For example, 401(k) participants choose from a menu of investment choices—typically a dozen or more—selected by their employer.
The choices for TSP participants are more streamlined; the plan includes several life cycle (target-date) funds and five individual index funds. However, the investment fees within the TSP are lower than those of most 401(k) plans.
The IRS limit for annual contributions is the same for a TSP and a 401(k). Federal employees can invest up to $23,000 in 2024. Those ages 50 and older can contribute an additional $7,500 in 2024.
The Thrift Savings Plan is similar to a 401(k), but there are important differences. Investment options are more limited, but the expense ratio is much lower than at many private employer funds. And the employer match is a bit more generous than average.
If you have access to a TSP, max out the match before you explore any other tax-advantaged retirement accounts, such as a traditional or Roth IRA.
