TSP Expense Ratios

Costs are the "drag" on your investment airplane as it flies through the sky.  They "slow" your airplane by reducing the amount of return the market offers.  For example: assume during the span of a year where investment returns 6%.  That 6% is the fund's return, but you don't get receive the full benefit of that return.  The reason - costs.

Those costs appear in the form of an "expense ratio", where each year a percentage of your return is used to keep the fund operating (light the building, pay the employee salaries, market for new business, mail statements and - in many cases - profit).  A typical mutual fund may have an expense ratio of 1% or more - many funds exceed this.  While 1% sounds tiny compared with 100%, that 1% reduces your return to 5%.  Meaning on a $100K investment, you earn not $6K but $5K.  That's not a 1% loss, that's a 17% loss!  

Without getting a vote, you're paying $1K of your return to the mutual fund company.  This hurts.  A even more painful example: the next year when you lose 2% before fees and, after the 1% fee is tacked on, a $2K loss becomes a $3K loss. Fees do not help you unless the fund provides enough 'excess return' to compensate for the fees it charges.  Many - in fact most - don't.

Low expense-ratio mutual funds minimize these draggy fees, and some of the lowest fees are associated with index funds - typically around 0.25%.  Index funds simply track a market index - for instance the S&P 500 index.  Instead of attempting to 'beat the market' by selecting specific stocks and hoping to provide excess return through superior stock selection, index funds simply 'match the market' by buying everything tracked in a specific index.  This requires very little skill. Therefore, there is no need to heavily compensate funds managers to hand-select stocks and - voila - a lower expense ratio is the result.  However, even though all index funds provide the same product (the index return), those index funds also vary in their expense ratios.  Kind of like paying $100 per day for the exact rental car you could have rented for $65. 

So, it makes good financial sense to pick index funds because of their low costs.  And, since these index funds exactly mimic index returns, it makes even better financial sense to select the index fund with the lowest possible expense ratio to allow you to retain as much of the index return as possible.   

The Thrift Savings Plan is made up of index funds and therefore benefits from index fund expense ratios.  However, TSP is able to attain even lower expense ratios due to employee forfeitures, explained on the TSP website: 

TSP expenses are paid from the forfeitures of Agency Automatic (1%) Contributions of certain Federal employees who leave Federal service before they are vested, other forfeitures, loan fees, and — because those forfeitures are not sufficient to cover all of the TSP’s expenses — earnings on participants’ accounts.

These forfeitures further reduce the already low index fund expense ratios to a fraction of a percent.  The TSP expense ratio most recently was 0.038%, or 25 times lower than the 1% in our example.  On the same $100K investment, your yearly expenses wouldn't be $1K - they'd be $38.  Big difference.

Tax Advantages

401K investing allows you to save in a 'tax-deferred' manner, meaning the interest, dividends, capital gains from the investment are not taxed in the year they are earned, but instead taxed when the funds are withdrawn in retirement.  That means those funds can continue earning compound interest for years or decades, a big benefit over taxable accounts.  Additionally, you are able to reduce your taxable income for the year by every dollar you save into your 401K, because your contributions are pre-tax.  That means saving $10K in your 401K will yield a $2500 bump in your tax return.

Roth TSP

TSP's Roth 401K differs from a traditional 401K in one important way.  

The contributions the a Roth TSP are contributed post-tax, so you don't get the tax return boost when filing that year's return; instead your withdrawals are tax-free, meaning you avoid a tax bill in retirement.  Every cent in your Roth TSP account will be yours on withdrawal - no need to pay taxes.

Deciding whether to opt for the Toth TSP or the traditional TSP then is a bit of a 'pay now or pay later' proposition. 

This article does a pretty good job of explaining the differences:

https://www.futureadvisor.com/content/blog/traditional-vs-roth-thrift-savings-plan-tsp-contributions

Ultra-low Expense Ratios

TSP has a limited number of funds to choose from and they simply track market indexes, limiting investor choice and ability to specialize.  What TSP lacks in variety, it makes up for in its industry-leading expense ratios