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Odd Aspects of TSP
The Thrift Savings Plan is widely known as one of the best retirement plans available. It excels at being simple and having low cost, but that doesn’t mean there aren’t some frustrating aspects to it.
The decision to keep TSP in retirement is an important one. The odd aspects of TSP should definitely be a factor in one’s decision to keep your TSP or transfer to an IRA.
Mandatory withholding – Isn’t this one fun? The IRS is going to tax you regardless of how and when you pull money out of TSP, but the TSP has their own set of rules for how much they will withhold on distributions. Be sure to become familiar with how withholding works.
Can’t specify funds for distribution – The TSP doesn’t allow you to determine where your distributions come from. Any TSP distribution will be proportionate to your TSP allocation. For example, if you have 60% in the C fund and 40% in the G fund, your distribution will come from 60% C fund and 40% G fund.
Many people plan to use the bucket or barbell strategy in retirement. These strategies are based on discriminating from stock and bond withdrawals. To summarize the strategy, a retiree would withdraw from bond investments in years when the market is down and continue to do so until the stocks recover. With the prorated distribution method of TSP, a retiree would have to rebalance after every distribution. In other words, it would make these strategies more difficult to implement in retirement.
Required Minimum Distributions (RMDs) on Roth TSP – This is very unfortunate since many people with Roth TSP plan on leaving the funds to their beneficiaries income tax free. What makes it even more frustrating is that Roth IRAs don’t have the same rules. The glimmer of light here is that participants have the option of rolling Roth TSP to a Roth IRA to avoid RMDs.
Beneficiaries of a Beneficiary Participant Account (BPA) can’t do an inherited IRA – This is potentially a BIG deal. Surviving spouses can maintain TSP as a Beneficiary Participant Account if the TSP holder passes first. At the surviving spouse’s death all funds must be withdrawn from TSP.
A beneficiary can typically move an IRA or retirement account to an inherited IRA which gives them a 10-year window to remove funds. This 10-year window can potentially save the beneficiary tens of thousands of dollars, versus withdrawing all of the funds in one year.
The TSP does not allow a beneficiary to transfer funds from a BPA TSP to an inherited IRA. Per TSP:
If a beneficiary participant dies, the new beneficiary(ies) cannot continue to maintain the account in the TSP. Also, the death benefit payment cannot be transferred or rolled over into any type of IRA or plan.
This could make a beneficiary pay the top current tax rate of 37% on distributions versus a lower tax rate that could be as low as 12%.
Lifecycle funds are overly conservative – The is one of the reasons that I’m not a fan of Lifecycle funds. The TSP’s Lifecycle funds are much more conservative than comparable target date funds. Here is a quick comparison to other target date funds (approximate allocations according to each company’s website).
- Fidelity’s 2040 fund = 92% stocks / 8% bonds
- Vanguard 2040 fund = 82% stocks / 18% bonds
- Blackrock LifePath Index 2040 = 84% stocks / 16% bonds
- TSP Lifecycle 2040 = 72% stocks / 28% bonds
The Lifecycle 2040 fund has at least 10% more bonds than each of the other three funds. What I have found is that this can lead to federal employees and retirees being more conservative than they intend to be, or than they should be.
Won’t allow TSP conversions – TSP does not allow in plan conversions, therefore there is no way to get your traditional TSP dollars into Roth TSP. Conversions are easy to do once your money is in an IRA.
Won’t allow a Qualified Charitable Distribution (QCD) – A QCD is a method of charitable giving from an IRA. Those age 70.5 and older can give up to $100,000 a year to a charity directly from their IRA. This essentially enables people to take distributions from IRAs without paying taxes on them. The QCD can also count for as all or part of a Required Minimum Distribution (RMD) for those that are age 72 or older. Utilizing QCDs from an IRA can be a very tax efficient way of giving.
Figure out what is best for you!
Some people may be fine with the nuances mentioned above, yet others may not be. If there are a couple of characteristics that you don’t like, you should look at transferring to an IRA. Whatever you choose, remember that it’s not an all or nothing choice. If you like the benefits of an IRA but love the security of the G fund, you could do a partial transfer to an IRA and leave some funds in TSP. Eliminating all of the noise and helping people make informed decisions is what we do here at Bobb Financial Inc.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.