Thrift savings plans: Retirement plans done right

NEW YORK (Money) -- As an active duty Marine, I'm eligible to contribute to the thrift savings plan. What are its pros and cons, and how should I take advantage of it? -- Master Sergeant D.E.W., USMC

I like to think of the thrift savings plan -- or TSP -- as the financial program the federal government got right.

I know it may be hard to believe considering the latest brouhaha over the debt ceiling and looming shortfalls in Social Security and Medicare. But I think TSPs, which are like a 401(k)s for federal employees and people in the military, could actually serve as a model for private-sector retirement savings plans.

One of the TSP's biggest attributes is its razor-thin costs. The all-in expenses (management fees, administrative costs, record-keeping, etc.) for each of the plan's investment options are just 0.025%. That's 25 cents for each $1,000 invested. To put this in perspective, consider that this amount is less than half what Vanguard charges for its lowest-cost ETFs.

Another big plus is that TSPs offer a menu of investing options that are broad enough to build a well-balanced portfolio, but not littered with niche investments that are unnecessary (and unhelpful) distractions.

There's a roster of five basic stock and bond funds (four index portfolios and one government bond fund) you can use as building blocks to build your own portfolio. Or you can choose a lifecycle, or target-date fund that gives you a ready-made mix of stocks and bonds that become more conservative as you approach retirement.

Low-risk retirement

A third TSP feature that I like is that it has no percentage-of-salary limit. While many 401(k) plans may limit your contribution to a certain percentage of your pay, TSPs allow you to put as much of your salary into the plan as you want -- up to the maximum elective deferral ceiling, which is $16,500 this year (just keep in mind that you can't contribute more than you earn).

Military guys -- like you -- may be able to contribute even more thanks to some special exemptions from the IRS. Plus, anyone 50 or older can also throw in up to $5,500 in matching contributions.

The plan also has a pretty generous matching contribution policy, although members of the uniformed services aren't eligible for those contributions unless special exception is made. The rationale is that service members who put in 20 years qualify for a generous pension.

Finally, if you're ready to retire and would like some guaranteed income beyond pension and Social Security payments, TSPs have several annuity options that are worth looking into.

So what's the downside? I suppose you could argue that military personnel should be eligible for matching contributions as a matter of course. After all, not everyone who serves will put in enough time to be eligible for a pension.

You could also carp that TSPs don't have a Roth option. But that drawback is scheduled to be remedied in the second quarter of next year.

In order to take full advantage of a TSP, the same rules apply as when you're maximizing a 401(k): contribute as much as you can, hold the line on costs and invest your savings in a well-rounded portfolio that's appropriate for your age and risk tolerance.

The difference is that TSPs are designed to make it easier to follow those rules. Given TSP's miserly expenses, you won't have to worry about frittering away your money on bloated fees. The 0.025% expense ratio in the investment options is all you pay.

By contrast, if you're in a regular 401(k) plan, it can be harder to get a handle on how much you're shelling out in expenses (although a new rule that will require 401(k) plans to explain their fees and disclose them should help on that score).

When it comes to building a TSP portfolio, the best thing to do is keep it simple. You don't need all the "alternative" investments many advisers push. A basic mix of domestic and international stocks, plus some broad exposure to bonds is sufficient.

You can achieve this by investing in a basic lifecycle fund. But if you prefer, you can use a lifecycle fund for someone your age as a guide, and then create a portfolio more tailored to your tastes using individual stock and bond funds.

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The same approach makes sense for a 401(k). But because the fund expenses in many 401(k)s can vary substantially, you'll want to avoid loading up on funds with onerous fees. One way to do that is to stick to index funds and institutional portfolios -- to the extent they're available.

Finally, even the best investment options and lowest fees in the world don't mean diddly-squat if you don't save. So make an effort to sock away as much as you possibly can.

If you hit the contribution max -- whether it's $16,500 in a TSP or a lower figure in the case of many 401(k)s -- and can still afford to put away more, then see whether you can plow additional savings into an IRA by using this calculator.

And there are always tax-efficient options for taxable accounts, such as index funds and tax-managed portfolios.

Bottom line: whether you're saving through a TSP or a regular 401(k), success ultimately comes down to saving regularly and investing in a reasonable way -- and having the discipline to stick to that strategy year after year. Since you're a Marine, I suspect you'll be able to handle the discipline part just fine.