It’s no secret that I’ve worked for the federal government since I was 18.
But I’ll never forget a conversation I had with a wage grade employee when I was a teenager. He was bragging about making catch-up contributions to his TSP. While I admired his dedication to retirement savings, in the back of my head I kept thinking “why!?“.
We all know that compounding is the key to retirement savings… So what good is making TSP catch-up contributions when you’re 50 or older? That money is not going to have any time to compound.
I’m now a little bit older and a little bit wiser and I have a better understanding of the benefits of catch-up contributions. While those extra employee contributions may not have as much time to compound, they can still be beneficial. Let’s dive in and see if TSP catch-up contributions might be worth it for you.
Get Gov Worker’s top 4 tips for federal employees!Table of Contents
- What is the Thrift Savings Plan (TSP)?
- What Are Catch-Up Contributions?
- How could catch-up contributions change your TSP balance at retirement?
- Taxes… the biggest advantage of catch-up contributions?
- Summary
Please do not confuse my personal blog for financial advice, tax advice or an official position of the U.S. Government. This post may contain affiliate links. If you make a purchase after clicking on a link, I get a small percentage of the sale at no additional cost to you.
What is the Thrift Savings Plan (TSP)?
The TSP is a qualified retirement plan for federal employees and members of the Uniformed Services who have taken the oath of office. Founded in 1986 through the Federal Employees’ Retirement System Act (FERS), the TSP operates in a similar manner to a 401(k) for government employees.
Federal employees can contribute up to the 401(k) maximum ($22,500 in 2023, not including catchup contributions). They even receive matching contributions up to 5% of their salary; most of it with no vesting period (free money).
Currently, employees can choose between one of 5 index funds with no added fees:
- G Fund– (short term government bonds, guaranteed to increase in value)
- F Fund– (medium term government and corporate bonds, similar to BND)
- C Fund– (“common stocks” i.e. S&P 500)
- S Fund– (small and medium cap stocks)
- I Fund– (international stocks, limited to certain countries that excludes emerging markets)
What Are Catch-Up Contributions?
The IRS allows you contribution extra money to your TSP in the year you turn 50. This extra amount (beyond the regular contribution limit) is catch-up limit.
In theory, these contributions are to help tsp participants age 50 and older increase their thrift savings plan contributions so that they can have the retirement nest egg they want. (i.e. If you’re behind in savings and close to retirement you can “catch-up” to where you should be by contributing beyond the maximum amount set by the internal revenue service for younger employees.)
While the rhetoric around the annual catch-up contribution limit is always about helping older adults make sure they’re ready for retirement, in practice these contributions help wealthy older adults avoid taxes by allowing them to place more money in their TSP account.
What is the maximum TSP catch-up contribution for employees over age 50?
For 2023, the maximum TSP contribution for employees under age 50 is $22,500. Employees age 50 or older can add an additional $7,500; the catch-up contribution amount.
The total contribution amount for TSP participations over 50 is $30,000. If you want to know what you’d need to contribute each paycheck, $30,000 divided by 26 pay periods is $1,154.
Can I contribute 100% of my salary to the TSP?
If you are making contributions to the TSP based upon percentage of your salary rather than dollar amounts, you are able to select a contribution between 0-100%. However, if you make a large contribution in one pay period and reach your elective deferral limit before the last pay period of the year, you will lose out on the government match.
How could catch-up contributions change your TSP balance at retirement?
Let’s assume that we take the government’s justification for these contributions and assume that the money put towards catch-up contributions are actually part of someone trying to dig themselves out of a retirement deficit. How much difference could it make if you maxed out all contributions from the year you’re eligible to make catch-up contributions until you turn age 65.
If you contributed the full catch-up contribution of $7,500 per year from ages 50-65 you would have saved $120,000 in principal. Assuming you had an 8% return on investment, you’d have made an additional $107,000 in gains, for a total of $227,000. (Note this analysis only looks at the amount you’d make from the catch-up contributions alone and ignores the money you’d need to contribute to max out your TSP).
Would most people benefit from an additional $227,000 in retirement? Almost certainly, since over half of the retirement age people have no money saved for retirement. However, this assumes that you are able to start saving $30,000 a year year at age 50… a tall order for someone behind on their retirement savings.
Taxes… the biggest advantage of catch-up contributions?
Now that we have looked at the math, I think it should be pretty obvious that if you waited until you were eligible for catch-up contributions to start saving for retirement, the amount you can contribute toward the catch-up limit won’t help you “catch up” to someone who was contributing through regular contributions for their entire career.
Furthermore, I find it unlikely that someone who has under-saved for retirement until turning 50 or older would be able to magically be able to start putting the maximum amount they can contribute in their TSP election.
When it comes down to it, the main purpose of catch-up contributions is to help the top salary earners save on taxes by allowing them to make more tax-deferred TSP contributions in the last few years of their career. Generally speaking, most people make a lot more money in their last few working years than they will in their first years of retirement. Catch-up contributions can help reduce tax burden during these peak income years.
The statistics bear this out as well. According to Vanguard, only about 14% of people with access to a 401(k) max out their contributions each year. However, nearly 60% of people earning over $150,000 per year and eligible for catch-up contributions make these contributions.
SECURE Act 2.0- a new wrinkle in catch-up contributions
The SECURE 2.0 Act was included in the 2023 Omnibus spending bill passed December 23rd, 2022. This law changed catch-up contribution rules.
The good news: The bill increased the amount of catch-up contributions for those aged 62-64 years old. See section 108 of the bill.
The really bad news: The bill requires all catch-up contributions to be made in a Roth account if you make over $145,00 per year. Here is a direct quote from the Senate Finance Committee’s summary of the Secure 2.0 Act.
Section 603, Elective deferrals generally limited to regular contribution limit. Under current law, catch-up contributions to a qualified retirement plan can be made on a pre-tax or Roth basis (if permitted by the plan sponsor). Section 603 provides all catch-up contributions to qualified retirement plans are subject to Roth tax treatment, effective for taxable years beginning after December 31, 2023. An exception is provided for employees with compensation of $145,000 or less (indexed).
I’m sure we will soon be getting more information about how these provisions work as the bill is implemented over the next few years into the TSP.
While I’m not a financial advisor, on the surface it seems like there is little incentive to make catch-up contributions if you earn over $145,000 per year. Especially if you plan on staying in a 0% capital gains tax bracket in retirement (less than $83,350 if married and filing jointly in 2022).
If you looked at my math in the above section, there would only be about $100,00 of investment gains that would be subject to the favorable Roth treatment. Since you need to pay tax on the principal before saving the money anyway, you’re trading flexibility on that money for what could be no difference in capital gains taxes.
However, don’t take my word for it. I strongly recommend you work with a CPA or other professional to come up with your best retirement savings strategy.
Summary
Catch-up contributions are certainly a nice wrinkle in the tax-code and can help you achieve financial freedom… if you can afford to put away $30,000 of your salary each year. My only complaint about TSP catch-up contributions is the name. Instead of helping lower income people “catch-up” to others before retirement, these contributions help the top income earners “dunk-on” everyone else.
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