Dave Ramsey's teachings touch on nearly every aspect of personal finances. So it's no surprise he has something to say about Thrift Savings Plans (TSP), the government's version of a 401(k).
In a nutshell, Ramsey advises federal employees to invest at least 5% in a Roth TSP, then invest the rest in a Roth IRA. He also recommends investing in a handful of TSP funds -- funds C,S, and I -- with a higher percent in the C Fund (at least 60 to 80%).
Much like his teachings on credit cards and investing, Ramsey has a "one-size-fits-all" approach to TSPs. His reasons are sound and logical but, in the real world, his advice won't apply to everyone.
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Let's first look at Ramsey's advice on TSPs, then offer some counter advice for federal employees who are earning high incomes.
Roth vs. traditional TSP
Ramsey wants you to choose a Roth TSP over a traditional one. Basically, he thinks it's better to pay taxes now rather than wait until retirement, since the federal government could increase tax rates between now and then.
If your head is spinning, here's the difference between the two accounts:
- Roth TSP: You pay taxes on contributions before they enter your account. Your taxes are calculated using your marginal tax rate.
- Traditional TSP: You don't pay taxes on contributions. Instead, you pay taxes on withdrawals. Your taxes will be calculated using your marginal tax rate at the time of withdrawal.
How much should you invest in a TSP?
Ramsey recommends investing at least 15% of your take-home pay for retirement. But he doesn't recommend investing the full amount in a TSP. Instead, here's what he would do:
1. Invest 5% in your TSP
Most federal employees will get a dollar-for-dollar match on 3% of their take-home pay, then $0.50 for every $1 on the next 2%.
That's an excellent deal, which is why Ramsey doesn't want you to leave the 5% match on the table.
For example, if you earn $70,000 annually, he would advise you to invest at least 5% in your TSP, or $3,500. At the same rate, your agency or service will gradually add its match -- $2,800 -- for a total of $6,300.
2. Max out a Roth IRA
Once you invest 5% in a TSP, Ramsey advises you to switch to a Roth IRA. His reason here is simple: A Roth IRA has more investment choices than a TSP.
Ramsey recommends investing the remaining 10% of your income in a Roth IRA. But he knows this isn't possible for everyone. Roth IRAs have annual contribution limits, which can cap you at an amount lower than 10%. For 2023, that limit is $6,500, or $7,500 if you're 50 or older.
So, let's return to our example from above. Assuming you're younger than 50, you can max out your Roth IRA with $6,500.
If we add that to your TSP contribution ($3,500), then you've invested $10,000 for retirement. That's short of 15% of your income ($70,000 x 15% = $10,500). So if you follow Ramsey's advice and invest 15% for retirement, you'll need to invest the remainder outside your Roth IRA.
3. Invest the rest in your TSP
After maxing out your Roth IRA, Ramsey recommends investing the remainder of your 15% back in your TSP. Again, using our example from above, that means investing at least $500 into your TSP.
Should you listen to Dave Ramsey?
Ramsey's advice might work for some people. But it doesn't apply to every situation.
For example, if you earn a higher income, you might save more on taxes over your lifetime if you invest in a traditional TSP, rather than a Roth. Why is this?
For one, because contributions are taken pre-tax from your paycheck, they'll lower your taxable income. This could potentially put you in a lower tax bracket and help cut your tax bill.
Secondly, the tax deferral on a traditional TSP can work in your favor if your current marginal tax rate is high. If you think your tax rate will be lower in retirement -- which, if you're not earning as much income, it should be -- you'll save more money by waiting to pay taxes on withdrawals.
Either way, if you're a high-income earner, it's a good idea to sit down with a tax or investment professional to understand which choice is better for you. While investing in a Roth TSP means you don't have to pay taxes in retirement, you may save on lifetime taxes if you defer them until your tax rate is lower.
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