On your service’s physical fitness test, if you earn a passing score on each event, is that called “maxing out?” No. There’s the standard to “pass,” and there’s the standard to “max.”
The same logic applies to how we should think about our military thrift-savings plan (TSP) funds. Contributing 5% of basic pay to your TSP account is not maxing out, it’s meeting a standard. You’re doing only what’s necessary to reap the initial benefit – a 5% government match returned to you.
But in stopping here, you will never get ahead with your financial goals.
A PT stud ignores the test standards and looks only at the scores required to max out each exercise. Likewise, a TSP stud pays little attention to the required amount to receive the government match, but instead aspires to reach the IRS annual contribution limit.
IRS savings limits
Each year, the IRS sets a cost-of-living adjusted contribution limit for workplace retirement plans. In 2022, retirement savers with a 401(k), 403b, and yes, the government’s TSP, can contribute up to $20,500. (Those who are age 50 or older are also eligible for “catch-up contributions” up to $6,500.)
This amount does not include the employer/government match and is therefore the benchmark for truly “maxing out” when it comes to retirement savings.
Just as not every service member is going to max out push-ups or the running portion, not every service member is financially capable of reaching that IRS savings limit. And that’s OK. But that does not mean it shouldn’t be the goal.
Achieving financial independence
In Spencer Reese’s “The Military Money Manual”, the sixth of his nine principles to achieve Financial Independence (FI) is “Savings rate beats rate of return.” In this particular section, he shows a graph that demonstrates “your time until FI is a function of your savings rate.”
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He assumes a constant 6% investment return, and the graph shows that people saving 5% of their income would need to work 60 years before reaching FI. But crank that savings rate up to 10%, and your working years number goes down to 45, while 20% brings it down to 35. And if you can manage to save 50% of your income, you only need to work for 15 years.
In the same way increasing your PT test score sets you up for faster promotions, increasing your TSP savings rate can set you up for faster financial independence – a fancy way of saying you have enough wealth to live off of for the rest of your life without needing to work.
How to increase TSP contributions
If you’re currently contributing 5% to your TSP and 20% sounds like too much, consider increasing 1% each month. This will take some of the sting out of having 15% less going into your checking account each pay period if you gradually ease into it. After a little over a year, you’ll be contributing 20% and likely won’t feel the difference.
Another good strategy is to increase your contribution whenever you get an increase in pay, whether it’s a time-in-service raise, promotion, etc. Avoid “lifestyle creep” – spending more because you’re making more. A good rule of thumb is to live at least one rank below your current rank.
Lastly, for those thinking you’ll bypass the TSP and do all of your saving in a brokerage account, consider the tax benefits you’re missing out on:
1. Lower your taxable income
Your contributions to the TSP come directly from your basic pay and are made with pre-tax dollars, lowering your taxable income. (That is, if you use the Traditional TSP. If you contribute to the Roth TSP, your tax benefit comes later when you go to pull the money out.) The larger your contribution, the more you lower your taxable income.
2. Grow more money tax-deferred
The tax-deferred money you put into your TSP will also grow tax-deferred; whereas, if you put this away in a taxable brokerage account, you would be responsible for paying taxes on your dividends as well as your gains (if you were to sell those investments) come the end of the year.
This is not to say that contributing to a taxable brokerage account is a bad idea. But for tax purposes, you want to prioritize maxing out your TSP contributions before you do so.
Reservists and guardsmen who have a stable civilian job have the opportunity to use two income sources (military and civilian) and potentially two retirement savings accounts (401(k) and TSP) to reach the IRS annual contribution limit. The more they save in their TSP accounts, the less they have to deduct from their civilian paychecks and direct to their 401(k)s to reach that limit. Those who can cover their living expenses with just their civilian pay can contribute up to 92% of their Military Basic Pay to the TSP while still receiving the 5% matching contribution.
This could get any service member a decent portion of the way to the ultimate goal of reaching the annual contribution limit.
Why should the IRS annual contribution limit be the goal? Consider that $20,500 equates to a maximum monthly contribution of $1,708. With a compound interest calculator, you can estimate the time it will take to turn a $1,708 monthly contribution into $1 million of savings. With that monthly savings total, assuming a 7% average annual growth rate, one can reach $1 million in just 22 years. And that’s before factoring in the employer match.
Remember, the military wants us to be PT studs. But for your own sake, be a TSP stud, too.
