Is a TSP Reliable for Retirement?

When you contribute to a federal pension plan, you get a guaranteed return relative to your salary and contributions. With the TSP, the only thing that is guaranteed are your holdings. Once you put money into it, its value can fluctuate up or down with the market and based on the investments that you choose. In addition, you get to choose how much you put in, which have a direct impact on how much you'll have to take out. With this in mind, the TSP, like all defined contribution plans, has more risk to you than a pension. On the other hand, if your investments do well, you could also end up coming out ahead with a defined contribution plan like a TSP.

Compared with comparable tax-deferred plans like a workplace 401(k) or a personal IRA, the TSP is similar to those plans in terms of its benefits and drawbacks, but has two key advantages. First, since the TSP is managed by a federal agency, there is essentially no chance of it going bankrupt. Second, because of the size of the TSP and the limited number of investment choices, you're able to choose funds that have extremely low expense ratios. According to the TSP, the expense ratio across the six funds or fund groups offered in 2012 was just 0.027 percent. Paying less in expenses means that you keep more of the return for yourself in good and bad markets.

The TSP has five core funds as well as a group of life-cycle funds that invest in the five main funds to achieve a pre-balanced portfolio for retirement planning. The G fund offers a guaranteed return from special Treasury securities. The F fund buys fixed income bonds that track the Barclays Capital U.S. Aggregate bond Index. The C, S and I funds are invested in common stock index, small cap stock index and international stock index funds that, respectively, track the Standard and Poor's 500 index, the Dow Jones U.S. Completion Total Stock Market Index and the Morgan Stanley Capital International Europe, Australasia and Far East MSCI EAFE Index.

The G fund is extremely reliable since it is guaranteed -- your returns might fluctuate, but your money won't lose value. The other funds aren't guaranteed and have varying returns. While the G and F funds did not lose value on an annual basis between 2003 and 2012, the stock funds all had down years during which your investments would have lost value. As such, they're similar to investments that you'd make outside of the TSP.

While you can create a more reliable TSP portfolio by only investing in conservative vehicles like the G fund or the F fund, inflation can become a risk. If the inflation rate is higher than the return on the fund, you could actually lose money on your investment. For example, the G fund posted a 2.45 percent return in 2011 and a 1.47 percent return in 2012. However, the inflation rates in those years were 3.0 and 1.7 percent.

The TSP poses two additional problems for when you reach your retirement age. The first is that you generally cannot withdraw money without penalty before you reach age 55 or, in some cases 59-1/2. If you want to retire early, in other words, you can't rely on your TSP to fund it without a penalty. The other potential hitch to the TSP is that, while you fund it with untaxed money, you pay taxes when you withdraw from the TSP. Given that tax rates may change between now and when you retire, there's essentially no truly reliable way to calculate how much of your distributions you'll actually be able to keep.