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Leaving the Military: What To Do With my TSP?


As pension plans go, you can do a lot worse than the Thrift Savings Plan. The costs are rock-bottom, compared to what you’d pay for similar mutual funds. The fund options allow you to diversify among various asset classes reasonably well. And the loan options are a nice sweetener – if you stay in federal service.

Assuming you don’t live out your days in uniform, though, eventually you’re going to ETS or retire. And then you’ve got a decision to make: Do you keep your TSP where it is? Do you cash out? Do you roll it into an IRA? Or do you roll it over into another eligible employer’s retirement plan?

The answer, as always, depends on your specific goals and financial situation.

For the most part, this discussion is on traditional TSP balances. They just started rolling Roth TSP accounts out to service members this summer, so they still represent a very small percentage of total plan assets. We will discuss Roth TSP considerations later in the post.

Staying Put

The simplest thing to do, of course, is just leave the money where it is. Your account balance in a traditional TSP will grow tax-deferred, until you start taking the money out presumably in retirement.

You will pay income taxes on all withdrawals from your TSP, however. If you make the withdrawal before turning 59½ you will also have to pay a 10 percent penalty on anything you withdraw from the TSP. Actually, if you retire, you can avoid the penalty on withdrawals as long as you are over age 55.

The advantages of staying put:

  • Simplicity
  • Good, basic, low-cost fund options
  • Loan provisions: You can make a general purpose loan from your TSP at the same rate the G-fund pays, and take up to five years to pay it back. Or you can borrow from your TSP and make a down payment on a house, pay the same rate as the G-fund pays you – and take up to 15 years to pay it back. However, these options are only available to federal employees. The loan question is moot if you leave federal service.
  • Your TSP balance enjoys watertight asset protection from creditors.

The disadvantages of staying put:

  • Limited investment options
  • You may prefer to simplify your statements by combining them into a single IRA or a single company.
  • No deferred annuity options

Warning: Be careful about the TSP’s withdrawal deadline, which has no real parallel in the private sector, so lots of retirement planners aren’t even aware of it. They frequently assume that it’s similar to the penalty on failure to take required minimum distributions from traditional IRAs, 401(k)s and annuities. It isn’t. It’s far more harsh. Specifically, your TSP withdrawal deadline is one of the following:

  • The year you turn age 70½, if you are separated from Federal employment or the uniformed services, or
  • The year you separate from Federal service, if you have already reached age 70½.
  • If you forget, and blow the deadline, you wind up forfeiting your entire balance back to the government. It is possible to reclaim it, but you can only reclaim the original balance forfeited. You don’t get to keep the earnings.

Cash out

Cashing out is perhaps the least tax-efficient option. Most planners would caution you not to withdraw your TSP balance in cash. But sometimes you don’t have much choice. Here’s what you need to know about cashing out your TSP:

  • The TSP will withhold 20 percent of your balance to offset the expected income tax bill. (This doesn’t include Roth TSP balances, which have already been taxed).
  • You will owe the IRS a 10 percent penalty on any distributions under the age of 59½. That includes the 20 percent the TSP withholds and sends to the IRS. You pay the 10 percent penalty on the whole kit & caboodle.
  • You give up future tax-deferred compounding.
  • A large withdrawal could throw you into a higher tax bracket than you would be in if you spaced out the withdrawal over many years.

You might consider taking a TSP withdrawal to buy a house after leaving the service. But consider this: Home mortgage interest is deductible. It doesn’t make as much sense to pay down a loan with assets in a tax-advantaged account if the interest on the loan is deductible to you.

However, the first $250,000 on gains in a personal residence is exempt from income tax ($500,000 for married couples.) So that’s a point in favor of taking cash out of a TSP to buy a home. But that’s a very small point: You get that exemption even if you leave the TSP in place.

Roll over to an IRA

This is the most common practice, among those with significant balances who don’t elect to stay in the TSP. Executing a rollover to a traditional IRA has the following advantages over staying put:

  • Infinitely more investment options. Your TSP is limited to a few government-chosen funds. You can invest your IRA in nearly any mutual fund, stock, bond or annuity. You can even use a ‘self-directed’ IRA to buy nearly anything you can imagine, including rental real estate, gold and precious metals, foreign currency (FOREX), raw land, small businesses and private placements, or anything else. The IRS only prohibits life insurance, certain forms of precious metals, jewelry, alcoholic beverages and collectibles in IRAs. Nearly any other asset class you can name is fair game. Self-directed IRA rules are complicated, though. Work with an experienced professional to avoid making a mistake that can cause nasty taxes and penalties.
  • You retain the same tax treatment as you do with your TSP.
  • You can convert any traditional IRA to a Roth IRA at any time, simply by filling out some paperwork and paying the income taxes.
  • Fees may be lower with certain IRA investments. However, the TSP expenses are already very low, so this is not a major concern.

Roll over to a qualified employer plan

Once you find a new employer, you may consider rolling all or part of your TSP balance into the new plan. Do it with your eyes open, though: Few 401(k) plans offer funds with expenses as low as the funds available within your TSP. However you may want to roll over your TSP under the following circumstances.

  • Your retirement plan at work allows you to take loans, (some, but not all employers allow this in their 401(k)s, and you may want to borrow from your plan in the future.
  • You want to consolidate all your retirement plan balances in a single account for convenience.
  • Your new plan offers annuities that are not available in the TSP, and you want the guarantees you can get with annuities – and you are willing to pay for those guarantees with higher fees and expenses.
  • Your 401k plan has excellent investment options not available in your TSP.

Annuitize

You can convert your TSP balance to a guaranteed stream of income that you and your spouse can not outlive. There is no tax consequence to doing so – you just pay income taxes on the income as it comes in. You don’t pay early withdraw penalties on your income using this option, even if you are under 55 years of age when you do so. However, it’s a commitment. Once you take the annuity option, you cannot undo it. You also give up the opportunity for future growth. However, this option can make terrific sense for some retirees. We’ll be taking a closer look at the TSP annuitization option, and some alternatives, in an upcoming post.

Considerations for Roth accounts

As mentioned, Roth accounts, whether they are a TSP, an IRA or a designated account within a 401(k), grow tax-free – forever. You just have to leave the money in the Roth account for at least five years before you are eligible for tax-free treatment of withdrawals. However, a 10 percent penalty on earnings from Roth accounts still applies.

Roth accounts have no required minimum distributions. You already paid the tax, so the IRS doesn’t make you pay income tax again on the same money. They also come in handy for minimizing the estate tax – currently 35 percent on estates over $5 million.

You might want to consider rolling your TSP balance to an IRA and then converting to a Roth IRA if you believe your income tax rate in retirement will be higher than it is now. The younger you are, the more likely it is that this election may make sense for you.

Paperwork

If you elect to remain within your TSP, you don’t need to do anything. If you want to move your entire plan balance, then you need to fill out and send in a TSP Form 70.

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