This post is written to help federal government workers and military members who are eligible for the Thrift Savings Plan decide which investment vehicle is best for their situation - the TSP or an IRA?

First, we should define the investment plans; then we’ll get into the question.

IRA: There are two main types of Individual Retirement Accounts: Traditional and Roth. (I have chosen not to focus on SEP IRAs, SIMPLE IRAs, or other forms of IRAs as they are not applicable to everyone).

  • Traditional IRA: The main benefit of a Traditional IRA is that the money can be fully or partially deductible, depending on your situation. The money is invested before taxes are withdrawn, which can lower your adjusted gross income, and therefore give you a tax break now. The invested money will be taxed when withdrawn at retirement age, and there are stiff penalties for early withdrawal.
  • Roth IRA: Roth IRAs are non-deductible, which means you use post-tax money to fund your account. The distributions (including earnings and gains) withdrawn when you reach retirement age are tax exempt because the money was taxed before you invested it. Many people recommend using a Roth IRA because of the tax free withdrawals in retirement. As with the Traditional IRA, early withdrawals may incur stiff penalties.
  • For both IRAs: These are individual investments, meaning there are no company matches. The investment limit for 2008 is $5000. There may be income limits based on your income, filing, and marital status. Always do your research before investing!

Thrift Savings Plan: The Thrift Savings Plan works on the same premise as a 401k plan, and is similar to a Traditional IRA in that the money is contributed prior to taxes being withdrawn, and the money will be taxed when it is withdrawn at retirement age. The maximum annual contribution amount is the same as a 401k and is set at $15,500 for 2007. Like the Traditional IRA, penalties may also be incurred for early withdrawal.

The TSP differs from IRAs though, because in some circumstances, the money may be eligible for a government match. This is much more common for federal government employees, and less common for military members.

Note: Military members have a special situation that does not often apply to federal workers. Money earned while deployed to tax free zones can be deposited into the TSP as tax exempt funds and withdrawn in retirement age tax free. The earnings from the tax exempt funds will be taxable, but the principle will not be taxable. Members also have the option of depositing any % of special or bonus pay, such as Hazardous Duty Pay, or Imminent Danger Pay. To determine if you have any tax exempt funds in your TSP account, look under the balance and there will be a line that states: “Your tax exempt balance.”

Which Investment Plan is Better?

  • IRA: With IRAs, all responsibility lies completely with the individual. The individual must decide where to invest, how much to invest, etc. There is a lot of flexibility as far as where to invest: funds, stocks, bonds, ETFs, etc. Investing can also be done via automatic deposit so it is easy to set up and manage. The downside is that all the responsibility lies with the individual to find investments that meet his/her needs which can be overwhelming for some people.
  • TSP: The TSP has a limited assortment of funds to choose from: 5 main funds that track major market indexes and 5 Lifecycle Funds which automatically allocate funds in different proportions based on your retirement date. As far as options, there are not many. But it is easy to manage, and the fees are very low. The downside is a lack of flexibility for those who desire it.

Where Should You Invest?

  • Federal Employees (non-military): I would recommend first investing in the TSP to take advantage of the matching dollars from the government. This is free money! After you have put in enough money to get the match, I would recommend investing in a Roth IRA, because you will be able to withdraw this money tax free in retirement. You are also diversifying your future tax liabilities by having a taxable and non-taxable retirement fund.
  • Military Members: Because there is not generally a match for the TSP, I would recommend first maxing out your Roth IRA. This gives you a tax free retirement income. If you have maxed out your IRA and still have investment funds for your retirement, then I would recommend investing in the TSP. There are times when I would consider investing in the TSP first. These would be if you are one of the few people that are eligible for a TSP match (The Army has used this as a retention tool, but only in limited cases), and when you are deployed to a tax free zone. Deployment money is non-taxable to begin with, and when you contribute it to your TSP, that amount will never be taxed! (the gains are taxed, however.)

Always Research Your Options First!

  • These are only my recommendations based on common situations. You should always ensure your investment decisions are based on your needs and the amount of risk you are willing to take.
  • The most important thing is to get started and keep investing. Your future is worth it! :)