Understanding TSP contributions

The Pay and Benefits Watch segment on Thrift Savings Plan contributions last week sparked many questions and comments from readers, so let's look more carefully and closely at the TSP's limits on contributions and how federal employees should spread out their contributions. First, the limits. The Internal Revenue Service each year sets a limit on tax-deferred employee contributions to 401k plans and the TSP. The limit is generally intended to prevent wealthy people from avoiding taxes by putting a lot of their salaries into 401k and TSP accounts. The IRS limit this year is $10,500. The TSP imposes an additional limit on contributions. Under federal law, employees in the Federal Employees Retirement System can contribute up to 10 percent of their salaries to their TSP accounts, up to the IRS limit. Civil Service Retirement System employees, however, can contribute only up to 5 percent of their salaries to TSP accounts. Next month, the limits will increase. FERS employees will be able to contribute up to 11 percent of each paycheck to TSP accounts, still capped at the IRS limit of $10,500. CSRS employees will be able to contribute up to 6 percent. The limits will go up an additional 1 percent per year until 2006. Then the TSP will take away the limits, leaving only the IRS limit in place. Second, taking advantage of the higher limits. Employees will be able to increase their contributions during the spring TSP open season that runs from May 15 to July 31. If you submit a change before July, the TSP will start taking out the higher amount during the first full pay period of July. If you submit a change in July, the change will show up in your paycheck as soon as your agency processes your request. Third, why some employees need to be careful. FERS employees get matching contributions from their agencies on their first 5 percent of TSP contributions each pay period. The match is dollar-for-dollar on the first 3 percent and 50-cents-per-dollar on the next 2 percent. But once employees' contributions hit the IRS limit for the year, agencies stop deducting employee contributions-and stop providing matching contributions. So, for example, let's look at a federal executive making $114,200 in basic pay this year who contributes 10 percent of his paycheck to his TSP account through June and 11 percent beginning in July. Remember that new federal pay rates don't take effect until the first full pay period of the year, so the first two paychecks that the executive received this year were at the 2000 pay rate of $111,200, or $4,262.40 per pay period. The executive contributes the full 10 percent, or $426.24, for those two pay periods. For the next 12 pay periods, at the 2001 salary of $114,200, the executive contributes the full 10 percent, or $437.76 per paycheck. During the open season, the executive switches to 11 percent per pay period, or $481.54. In November, the executive's contributions would reach the IRS annual limit of $10,500. Remember that matching contributions are on the first 5 percent of contributions each pay period, so the executive will miss out on matching contributions during the last few paychecks of the year, denying the executive $175 per paycheck. Fourth, spreading out contributions. To avoid losing out on matching contributions, you basically need to make sure that you can still contribute at least 5 percent of your last paycheck of the year to your TSP account. In our executive's case, that's $218.88, which would trigger $175.10 in matching agency contributions. Let's assume the executive is going into the upcoming open season having contributed 10 percent of pay to the TSP each pay period. That means that through the 14th pay period of the year, the executive will have contributed $6,105.60. Subtract that from the IRS limit of $10,500. The executive must divide $4,394.40 across the last 12 pay periods of the year. So, during the open season, the executive requests that $367 be contributed to the TSP each paycheck (you're allowed to contribute a whole dollar figure rather than a percentage). That ensures the executive will get matching contributions through the end of the year, while still taking advantage of the tax deferral up to the $10,500 limit. Got it? You can use an online TSP worksheet to figure out your own contribution levels. The worksheet is a bit old, so remember that the IRS limit this year is $10,500 and that you could contribute up to 10 percent of pay during the first half of the year and up to 11 percent of pay beginning the first full pay period in July. The worksheet is in PDF format: http://www.tsp.gov/forms/oc91-13w.pdf. Next year will be much easier to plan for, because the limit all year long will be 12 percent of pay. Pay and Benefits Watch will take up that math problem closer to the winter TSP open season.