The History of Thrift Savings Plan - Research Paper Example

12 December Understanding Thrift Savings Plan Apart from the Social Security and other saving plans, the Thrift SavingsPlan is one of the greatest saving plans of the United States government. The Thrift Savings Plan is an investment plan for federal workers including the members of the uniformed service such as, the Public Health Services, the Coast Guard, and the National Guard. The plan is equally the same as the 401 (k) plan, offered in the private sector whereby, employees make a contribution as an investment plan. These funds therefore are the property of employees. An employee contributes at will, which means they can elect not to take part in the Thrift Savings Plan. However, as part of the retirement strategy, the employees choose to invest their funds into the Thrift Savings Plan. The funds are not controlled by the government. When the government money is at stake, one place it cannot bump into is the federal employee retirement program for saving. This makes it secure for all federal employees. This review is sought to investigate the purpose of the Thrift Savings Plan, the contributions of both the employers and the employees and its benefits to the employees. It will also explore on the problems and challenges of investing in this particular Savings Plan. History of Thrift Saving Plan The Thrift Savings Plan is a product of the Congress. It is established under the Federal Employees’ System Act of the year 1986 specifically for the federal employees and the military. The Thrift Savings Board is controlled by the Federal Retirement Board, an agency of government that is independent. The Plan is managed by five members of the Board together with a Director, legally appointed by the president. This plan is equivalent to the private 401k and the 403b retirement plans. The tax benefits and saving options offered in The Thrift Savings Plan are similar to other retirement plans (Thrift Savings Plan Website). Main Purpose and Benefits The main purpose of this Plan is to allow government employees and the uniformed services to participate in long-term retirement savings and investment plans. Most of the benefits offered include matching funds contributed by the employer on behalf of the employee. The Plan has a number of advantages for the employees, these include: 1. Automatic deductions on income. 2. A diverse choice of investment options for instance professional designed Lifecycle funds 3. A wide range of tax treatment contributions such as: -Traditional tax contributions and tax-referred investment earnings - Roth contributions with tax-free earnings at retirement 4. Low administrative and investment expenses. 5. Contributions of an agency if the employee is covered by the Federal Employees’ Retirement System 6. At some point employees can access their money while still employed by the Federal Government. 7. A beneficiary participant account established for an employee’s spouse in case of death 8. A wide range of choices of withdrawal 9. A widened term of deferred tax on contributions and their growth. According to the Thrift Savings Plan, an employee covered by the Federal Employees’ Retirement System forms part of the package that includes basic annuity and Social Security Fund (Nestler 44). The Thrift Savings Plan explains it this way: For those covered by the Civil Service Retirement System, the Thrift Saving Plan is a supplement to their unity. The benefits offered by the Thrift Saving Plan depend on the retirement system one is registered in. However, in all the systems, the Thrift Saving Plan increases their retirement income. (qtd. in Form tsp-3) When the employee funds the Thrift Savings Plan with traditional tax (pre-tax), the amount of income tax is lowered, hence decreasing the burden of tax when working. This can be beneficial if the employee contributes the maximum amount in the income tax bracket. When the employee or the member has invested in the Plan, no tax is made on the earnings until a withdrawal is made. A clear opportunity is brought out that allows earnings to create extra earnings in a form of compound growth (qtd. in Nestler 64). Choice of Tax Treatments As a beneficiary of the employee, the Thrift Savings Plan offers two choices of tax treatment when they make a contribution election. These are: 1. Traditional Thrift Savings Plan 2. Roth Thrift Savings Plan Traditional Thrift Savings Plan When an employee makes Traditional Contributions, all taxes involved during contributions and earnings are put forward until withdrawal. For the military and other uniformed members making tax-exempt contributions, all contributions are regarded tax-free, and only earnings will involve tax during withdrawal. Roth Thrift Saving Plan When making Roth Contributions, a member is subject to tax during contribution, unless made tax-exempt contributions from the combat pay. In this case the earnings are not subject to tax during withdrawal, as long as the required qualification is met. Difference between Traditional Thrift Savings Plan and Roth Thrift Saving Plan Effect on Current Income When making traditional contributions, an employee is entitled to tax benefits such that, the Thrift Savings Plan contributions are not taxed. This means that, it is tax-deferred until withdrawal time. Moreover, the money contributed is automatically deducted from the payroll before the Federal income taxes are calculated. In this case, the amount used to calculate the tax is generally reduced, as less money is withheld from paying taxes (Thrift Savings Plan website) When Roth contributions are made, assuming the same amount as the tradition contribution to the Thrift Savings Plan, more money will likely come out annually. Effects on Long-Term Savings Choosing between the traditional and Roth contributions depends on the employee’s choice between paying taxes on contributions at the current time or later. In simple terms, the marginal tax rate at the current time verses the rate at retirement. In general, the traditional contributions are more beneficial if the tax rate will be at minimal during retirement. The Roth contributions on the other hand are beneficial if the tax of an employee will be higher in retirement. Eligibility for Thrift Saving Plan Any federal employee or military is eligible for Thrift Savings Plan. Any person who qualifies in the Thrift Savings Plan should fit into the following categories: 1. Should be on the Federal Employees’ Retirement System Employee 2. A Civil Service Retirement System Employee 3. Should be a member of the uniformed services 4. For a civilian, must be in particular government service In order to qualify to make contributions to a Thrift Savings Plan for up to the maximum amount allowed, one must be: 1. An active Federal Government employee 2. In pay status 3. Working at part-time I the Federal Government Establishing a Thrift Saving Account According to Thrift Savings Plan website, for employees under the Federal Employees’ Retirement System hired after the July to 31st, 2010, the agency automatically enrolled them to the Thrift Saving Plan. A 3% of the basic pay is automatically deducted from the payroll and deposited to the Thrift Savings Plan account, unless the employee made a contribution election to prevent or change contributions. If one is enrolled in the agency, up to 7% contributions are made to the Thrift Savings Plan, meaning the agency contributes 4% of the employee’s contributions. For employees under the Federal Employees’ Retirement System hired before August 1st, 2010 and are not contributing any money, they still automatically give a Thrift Savings Plan account with accruing Agency Automatic 1% Contributions. Employees, who have not done that, have an option to contribute their own money and receive agency matching money. In this case, the employer makes a contribution election through the agency to start contributing money to their own accounts and receive Agency Matching Contributions (Thrift Savings Plan website). The Thrift Savings Contribution Election These are payroll deductions that an employee makes through the agency enrolled, for the following reasons: 1. To begin making contributions when not enrolled automatically 2. Increase or decrease contributions if automatically enrolled 3. Employer to change the amount of the employee’s contribution on their tax treatment, either in Traditional or Roth Treatments 4. Stop making contributions Investment Funds Contribution Limits and Rules When contributing funds to invest, there is a set limit of investing. The maximum allowed contribution to the Thrift Savings Plan for age under 50 years is $16,500 and $22,000 for those over 50 years. The increased amount after 50 years is attributed to an increase of contributions when nearing retirement. Eligible employees are free to make their contributions at their will, or any time without conditions (Thrift Savings Plan website). Normally, contributions are continuously made from traditional treatment payrolls deductions unless an employee does the following: 1. Make a new election hence changing the amount 2. Elect to stop contributions 3. Reach the limit set by age 4. Take a withdrawal due to some forcing personal situations Thrift Savings Withdrawals and Taxes Employees pay taxes to contributions and for the growth of their taxes. However, they are not taxed until they withdraw their funds during retirement. Retirement is normally set at the age of 59 and half years. As a rule, any withdrawal made before the set age, will require an employee to pay a 10% additional tax penalty together with the regular tax (income tax) and the whole withdrawn amount. However, Thrift Savings Plan provides a choice of early retirement. This can be specifically allowed at the age of 55. Under this circumstance, an employee can withdraw funds from the Thrift Savings Plan without paying the penalty of 10%, though there will be regular income tax during every withdrawal. Tax Liability When funds are withdrawn from the Thrift Savings Plan, taxes are accumulated together with the earnings accrued in traditional contributions; except if contributions are made from tax-except pay. These taxes can be deferred by transferring over the withdrawal payments to a traditional retirement account. It is also possible to roll over funds from traditional contributions to Roth contributions. This can be only necessary if taxes are paid in full amount within the year of transfer. When one has Roth contributions in a Thrift Savings Plan account, it means all taxes are cleared of them. No taxes will be paid to the Roth contributions on earnings if the withdrawal is justified as cleared. The Thrift Savings Loan Any member of the Thrift Savings Plan is entitled to loans while still working, if eligibility requirements are met. When a loan is taken, it is repaid in full amount with the interest to the account of Thrift Savings Plan of the person. Loans are repaid in a period of between 1-15 years depending on the type of loan. There are two types of loans. 1. General Purpose Loan- Has a repayment period of 1-5 years, and is free to use for any purpose. 2. The Residential Loan-Has an extended repayment period of up to 15 years. This type of loan is only used in the construction of a primary residence, and requires a proof in documents. The accrued funds in the loan may lead to doubling the tax if the interest on the loan is regarded as after-tax. Death Benefits Under death circumstances, the Thrift Savings Plan will be given to the beneficiary as indicated by the employee in the form. However, if the account is not designated for anyone and death occurs, the spouse will be accorded the account. If the spouse is not available, the child/children will have an equal share, the chain may go on to the followers if the above the spouse and children are not available as prescribed by the Act of Law of the United States (Richard 55). From the overview of the Thrift Savings Plan, it is an advantageous way to save for retirement. This mode of savings is essential, making the Social Security look less beneficial. Alongside many benefits attributed in the Thrift Savings Plan, there is an option of matching funds, compound growing, agency automatic contributions, and tax incentives. Generally, the benefits of joining greatly outnumber the limitations. Work Cited Nestler, Scott T. Empirical Analyses on Federal Thrift Savings Plan Portfolio Optimization. Maryland: University of Maryland, 2007. Print. De Guzman, Richard G. A Cost-Benefit of a Military Thrift Savings Plan. California: Naval Postgraduate, School, 2000. Print. “Thrift Savings Loan.” https://www.tsp.gov/index.shtml. Summary of Thrift Savings Loan, May 2012. Web. 8 December 2013. Read More