The Thrift Savings Plans (TSPs) is a defined contribution plan for the US Civil Service and members of the US Uniformed Services. The retirement savings plan is similar to 401(k) plans, with which most people are familiar. The TSP is currently designed to be portable between the public and private sectors. In fact, the largest source of IRA contributions is from individuals transferring their money from a TSP or similar 401(k) or 403(b) plans when they leave a job, according to the Employee Benefit Research Institute. Rolling out of a TSP into an IRA is a popular choice, but just because so many people rollover funds does not necessarily mean you should too. Here is what you should consider before you act.
Understanding Your Options
TSP limits your options while you are an active employee. Additional options are available once you are no longer employed with the US Civil Service or Uniformed Service. There are four basic options when you leave service:
- Keep some or all your savings in the TSP.
- Roll to a new employer’s plan. You may have to consult with the new company’s benefits or human resources office to see if they accept rollovers.
- Rollover your TSP plan assets into an IRA.
- Cash-out the TSP’s balance.
Each option has its pros and cons, and your personal situation will help dictate which option makes the most sense. Let’s break them down...
Keeping the TSP
Just because you are no longer an active participant in the TSP plan doesn’t mean you have to take your plan assets. Unless you are subject to required minimum distributions or have a balance of less than $200, there is no requirement for you to take distributions or close your account. You can decide to leave your account balance in the TSP and continue utilizing the benefits.
Not only can you leave your plan assets in place, but as a separated participant, you also have the option to transfer into your TSP. While not as common as rolling assets out of the TSP, you can transfer money from traditional and Roth eligible employee plans and traditional IRAs.
The most significant advantage of the TSP is it is cheap. Cheap in a good way. The expenses for TSP funds are among the lowest to be found anywhere. The TSP currently charges a service fee of 0.04%. Even index shares, which are known to have low service fees are often higher than those of the TSP.
The tradeoff for low-cost is the limited investment choices and services. The TSP currently has 5 core investment choices and then offers the lifestyle funds that automatically allocate funds among the 5 core investment choices based on your target retirement date.
Transfer to an Employer-Sponsored Plan
Employer-sponsored retirement plans often act similar to the TSP account by providing the same tax advantages and usually similar rules. Understand, though, that not all plans are created equally.
Employer plans often provide limited investment options, although the offerings can be more extensive than the core options available within the TSP.
There may also be additional investment-related expenses and plan or account fees. Investment-related expenses can include increased expense ratios on pricier funds. Plan fees can include administrative costs like recordkeeping and compliance fees. In some cases, employers pay for some or all the plan’s administrative expenses, but each plan is different.
The Plan Sponsor governs Employer-Sponsored Plans. Rules and regulations regarding the plan will be mapped out during the plan’s creation. Understanding the guidelines for rollovers, deposits, withdraws, and loans could prove important before selecting the rollover option.
Transfer to an Individual Retirement Account (IRA)
As with both your TSP and an employer-sponsored retirement plan, Self-Directed IRAs continue to allow your money to grow tax-deferred or tax-free, depending on the type of account. Consolidating retirement accounts into one self-directed IRA can simplify your retirement accounts and make planning easier.
Compared to most employer-sponsored plans, self-directed IRAs typically offer increased freedom and flexibility regarding investment choices. Diversification among companies and industry sectors can prove to be valuable. Of course, the extensive investment options could also prove to be overwhelming depending on your knowledge or professional management options.
IRAs offer the possibility of special tax benefits once you attain age 70.5, which are not available with the TSP or an employer-sponsored plan. Qualified Charitable Distributions provide unique benefits for distributions given directly to the charity. If you are charitably inclined and would like a tax benefit for your gift without having to meet the itemization guideline, this could prove to be beneficial.
Perhaps the biggest benefit of transferring to an IRAs is having a choice in how to manage the account. You can continue to manage and monitor the account on your own. You also have options to work with an advisor to help you integrate the account into a holistic financial plan. While not for everyone, working with a financial advisor, even with the extra costs, can be valuable and makes sense for many people.
While transitioning from civil service or uniformed service to civilian life will probably incur many expenses, cashing out your TSP can seem tempting; it may be your most expensive option. Especially for young investors.
First and foremost, keep in mind the reason to participate in the TSP or any retirement plan is to accumulate wealth to last through your golden years. Retirement plans are designed to provide long-term tax benefits. Even if your separation from Civil Service or Uniformed Service is retirement-related, you most likely will not need all your TSP savings in the very first year of retirement. You will also want to continue the tax savings benefits.
Your TSP withdrawal may be subject to federal income taxes. The tax treatment of TSP withdrawals depends on the type of account you have, traditional or Roth, and your age. The IRS deems most withdrawals before the age of 59.5 as early distributions. As a result, you may be subject to an early withdrawal penalty of 10%, on top of any applicable federal, state, and local taxes. Special rules carve out penalty-free withdrawal options from the TSP if you leave your job between the age of 55 and 59.5.
Lastly, understand once you transfer or withdraw all your funds from the TSP your account will be closed. Participation in the plan will only re-instate with active employment with the US Civil Service or become an active member of the Uniformed Forces.
The Bottom Line
Former federal employees have a few choices regarding funds in their TSPs when they transfer to a private-sector job or retire. Understanding the distinctions between various retirement accounts and taxation can be confusing. Applying the applicable rules and techniques for your situation only makes your decision more complex. Mistakes can be expensive and can impact your ultimate retirement goals, so the decision to move your retirement nest egg or stay put is essential. It is necessary to do your homework and ask questions to determine what is best for you. Retirement planning is our specialty if you need assistance, and we are happy to help. Please shoot us an email at firstname.lastname@example.org or give us a call at 904-374-9098.
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