Advantages to a Thrift Savings Plan Rollover
Here are some common advantages to a Thrift Savings Plan rollover. These apply to rollovers from a qualified plan – like the TSP or a 401k – to an Individual Retirement Arrangement/Account (IRA). By no means is this an exhaustive list. For sure we’ll add to it as we move forward. But for now, it’s a pretty good start to get you thinking about what to do with your TSP when you’re close to or in retirement!
IRAs have a smorgasbord of investments
The TSP has only five (5) true investment options (G, F, C, S and I Fund). The Lifecycle funds are simply a mix of the original five funds. And the Mutual Fund window option is too loaded with fees to even discuss any further. Arguably, during your career these five funds are likely all you need.
However, in retirement if you were to rollover your TSP into an IRA then you’d have a ton of investment choices. Individual stocks, Exchange Traded Funds (ETFs), mutual funds and the list goes on. The two main investments that you can’t hold in your IRA are life insurance and collectibles. Not a big deal since you probably have no interest in putting either of these in your IRA anyway. Aside from these two no-nos, you’re free to diversify and select from investments that best suit your wants and needs.
IRAs have lower fees – potentially
While the TSP is pretty low cost (and it should be given the large number of participants), equivalent funds at Charles Schwab (the custodian we use for clients) are less expensive for the most part. The exception is the TSP’s G Fund. A Schwab equivalent in U.S. short-term debt securities (Schwab’s U.S. Treasury Money Fund – SNSXX) is more expensive than the G Fund.
The G Fund is also principal protected, meaning the principal on the debt is guaranteed by the U.S. government. You won’t lose money on the principal unless Earth explodes. This type of guarantee doesn’t exist in the public sector. However, the risk of loss with a public sector equivalent is still certainly low. Schwab has other alternatives as well, like their Value Advantage Money Fund – SWVXX. This is simply a money market fund that invests in high-quality, short-term securities. It has a slightly higher yield than SNSXX – at least as of this writing. But the G Fund beats both of these on fees.
IRAs can have access to professional advice
If you are looking for guidance and advice in retirement, then you should consider hitching your wagon to a financial planner that provides a financial plan first and foremost. Consider your plan the center of the wheel. Spokes off that wheel include areas such as risk management (think insurance; not necessarily selling it, but being sure that you are properly covered – and FYI, I don’t sell insurance or any other financial products), expense management, tax planning, investment management, retirement planning and estate planning (one of our favorites for Federal Agents).
If you’re a Do-It-Yourselfer (DIY’er) then you can operate with either the TSP or a broker such as Schwab, Vanguard, Fidelity etc. You’ll just have to decide which way works best for you and yours. In this paper, I’m not going down the rabbit hole of the value of a financial planner and what they may charge. Suffice it to say, I chose this profession because I believe the value to clients to be tremendous. I also believe the job satisfaction for helping my own community is immense. But if you go with a financial planner then be sure to do your homework. Use FINRA (https://brokercheck.finra.org/) for help and choose a planner that you know, like and trust.
Taxes, Part 1: IRAs offer better control over tax withholdings
When you take a distribution from your TSP, you’ll have 20% withheld automatically for federal taxes. The TSP doesn’t withhold state taxes. Not sure why exactly. Maybe it’s too much administrative work…and lord knows we don’t want to over-stress their workload in any way. Anywhoo, this means that if you withdraw $10,000, then $8,000 will end up in your pocket and $2,000 goes toward federal taxes. Again, we aren’t going too far down this rabbit hole, but the idea of this is kind of…well…wonky. I mean if you’re in a tax bracket below 20%, then you gave the government a loan for some portion of the year.
If you’re in a tax bracket above 20%, then we’re talking about you having to make estimated payments. This can be a bit tricky and come with a penalty if you underpay the IRS. Of note, it appears from the literature that, generally speaking, the TSP will allow you to withhold more than 20% if you make a special request, but not less than 20%. Go figure. This is much simpler and much less of an issue with an IRA.
Moving money from the TSP into an IRA means that you have complete control over federal and state withholdings such that any apprehension around estimated payments fades away. An IRA will typically set their withholding percentage to 10% as a default. However, you can simply change this amount, usually in whole percentage point increments (e.g., by 1%, 2%, 5% etc.). This may make it much easier to deal with both federal and state taxes (if applicable to the state in which you live) in retirement.
Taxes, Part 2: Don’t let the tax man to punch your heirs in the face
This one can be a TSP dealbreaker. Let’s say you die a few years after retiring (sorry to kill you off so quick). Your spouse inherits your TSP. Your spouse will now have a Beneficiary Participant Account (BPA). This will operate just like your account, including the ability to remove the monies and roll them to an IRA. No big deal so far. But here it comes. If the next in line as a beneficiary (to what is now a TSP/BPA) is your adult child, then the TSP is going to dump the contents of the account onto your kid’s front lawn. But before he/she can touch any of it, the tax man will pass by in a dump truck. They’ll take a HUGE cut because this money is fully taxable to your adult kid in the year distributed.
A rollover to an IRA by either you or your spouse can potentially avoid this giant tax bill for your heirs. I’m certainly an advocate of the DIY approach for many things. However, for this you should really consider having a cup of coffee with your legal and financial professionals. (https://www.tsp.gov/for-beneficiaries/).
Similarly, if the first beneficiary to your TSP is a non-spouse beneficiary (let’s say you leave your TSP to your childhood friend), then that person does not get a Beneficiary Participant Account (BPA). Only your spouse can have a TSP/BPA. What they do get is a temporary TSP account with a 90-day life span.
So the same scenario. You die a few years into retirement. Now the childhood friend has a choice to make within 90 days. They can receive a disbursement check from the TSP for the balance of your account. The IRS loves when you do that because that money is fully taxed in the year it’s received by your friend. A potentially monster tax bill. The other choice is that the friend can rollover the balance of the TSP account into an Inherited IRA. This has some rules around it that are complex enough that you should probably start the coffee pot. Invite your financial and legal professionals over for some Death Wish Medium Roast and chocolate frosted doughnuts (https://www.tsp.gov/for-beneficiaries/).
Withdrawals, Part 1: IRAs have more withdrawal options
TSP will allow you to take withdrawals monthly, quarterly or annually. You can take a lump sum if you need a new pair of skis in retirement. Or you can take partial distribution if you need money for a surf board. While the TSP has improved its posture in this regard, with an IRA (especially at Schwab), the world is your oyster for the most part. You can withdraw money electronically or even sell securities to cash and have check writing capability. Moreover, with an IRA you can move money pretty much as often as you like or need. We are big fans of simplicity and less mess. IRAs check all the boxes here.
Withdrawals, Part 2: IRAs have more withdrawal options
But here is another potential TSP dealbreaker for many of us. And this single reason is enough to push most of our clients out of the TSP in retirement. The TSP makes withdrawals on a pro rata basis. This simply means that it pulls any money that you request proportionally from your TSP funds.
For example, suppose your TSP is 70% C Fund, 20% S Fund and 10% G Fund. If you request $10,000, then $7,000 is coming from the C, $2,000 from the S and $1,000 from the G. What’s the big deal? The big deal is that if your C Fund is down that year, it’s generally not a good idea to lock in those losses. In a perfect world, you’d be able to tell the TSP to pull entirely from your G Fund (the conservative portion of your money). This would avoid locking in losses. The TSP doesn’t work this way. It’s another no-no. Yet on the other hand, if you have an IRA you are free to sell from whichever of your investments best suits your needs. Here again, the IRA scores a touchdown, spikes the ball and then gets the two-point conversion.
IRAs have less Required Minimum Distributions to manage
If you have money in a pre-tax/Traditional TSP, then you have a tax bill that will come due when you reach a certain age (as of this writing, for most of you we are talking about age 73 or 75, depending on when you were born). When you reach this certain age, the IRS says that you must start taking money from your qualified plan (i.e., your TSP or 401k). As in, either you take it out or we start nailing you with an additional tax (as of this writing, it’s 50% of the amount not taken out that should have been taken out if you don’t correct the mistake in time). This is called a Required Minimum Distribution or RMD.
Well each employer plan has its own RMD. Meaning that when you reach that certain age, you have to make the RMD calculation for each employer plan that you have. So that’s one calculation for your TSP. If you worked a job with a 401k prior to the government and kept it open all these years, that’s another RMD calculation. If your spouse has worked three jobs over the years and has three 401ks sitting around, then guess what? That’s three more RMD calculations for each account.
Enter the IRA. For whatever reason (and most times it’s hard to explain the tax code, you just have to go with it), the IRS treats all of your IRAs in aggregate. So if you rollover money into an IRA and you have a few other IRAs sitting around, they are all treated as one for the RMD. Meaning, you can do the RMD calculation for each IRA, but then you are free to withdraw money from one IRA to satisfy the RMD for that year. You can also take a little from each of your multiple IRAs to satisfy the total RMD for that year. If you wish. The point being, IRAs offer less complexity and more flexibility when it comes to taking your Required Minimum Distributions (RMDs).
Less financial clutter and more convenience
I’m a fan of simplicity wherever I can find it. Life moves very fast and can be very noisy. Whenever I can I slow life down and reduce the outside noise. Having your financial accounts, or most of them, under one roof is a lot easier to manage. Rolling over your TSP into an IRA allows you to have accounts under one custodian such as Fidelity, Vanguard, or our favorite of course, Charles Schwab. Here we can park and manage Traditional IRAs, Roth IRAs, Brokerage Accounts etc. all in one place. We can do so with less clutter, fewer logins and more organization.
Along the lines of convenience, remember that it’s generally much easier to take a withdrawal from an IRA. For example, when you take a distribution from your TSP your spouse must consent. Probably a minor inconvenience, but nonetheless I’d rather be able to freely move around money.
Now don’t get me wrong. You should be involving your spouse in ALL money decisions. He/she should know the basics of your financial plan even if you are driving the bus when it comes to your finances. I’m a BIG advocate for BOTH spouses being involved in the finances. The shared nature of money in a marriage.
However, it feels a little like kindergarten when I’m told that I need my wife’s permission to remove money from my TSP. I mean we already know women rule the world (<— put that in here in case my wife reads this). So I just think it’s a bit silly to also go through one extra step of getting permission before I make a TSP withdrawal. IRAs avoid this nuisance. With an IRA, I get to have a conversation with my wife and we can decide together that removing money is the right decision. I can then remove the money freely and she can go on ruling the world. Done and done. No permission slips. Just adult conversation and simplicity.
IRAs offer Qualified Charitable Distributions (QCDs)
If you are charitably inclined then the IRA is the way to go. A Qualified Charitable Distribution is allowed from an IRA. It’s when you move money from your IRA directly to a qualified charitable institution. To do this, you have to be 70 ½ years old. So if you have a pre-tax/Traditional IRA, then it’s more tax efficient to use the QCD. The QCD will never hit your gross income.
Why does this matter? Because certain other taxes (e.g., Net Investment income Tax (NIT), medicare surcharges) may be a function of your gross income or modified gross income. So to avoid triggering any of these stealthy taxes, a QCD can be used. Now it will be up to you or your CPA to reflect this IRA distribution as a QCD on your tax return, but this shouldn’t be a big deal. The QCD limit in 2024 is $105,000 and will be indexed for inflation (meaning it will go higher in future years).
The other benefit of the QCD is that if you are of Required Minimum Distribution (RMD) age, then the QCD counts as your RMD. Remember the RMD is a “must-do” thing. You have to take them. If you don’t need the income then you can use the QCD to satisfy your Required Minimum Distribution.
Example please: You have a $1,000,000 IRA and you are turning 73. Your RMD, for argument sake, is $37,000 for the year. Meaning you have to take that much out. You are charitably inclined so you donate (QCD) $20,000 to the Dog Rescue of America (a qualified charity that I just made up). No taxes due. You take a distribution of $17,000 to spend on an Italian vacation with your spouse. Taxes are only paid on the $17,000, not the whole $37,000. You feel like a better human for helping the dogs. And you pay less taxes. Bonus: you enjoy learning the history of the Colosseum while sipping an Italian latte.
Just remember that you don’t want to do this just for the tax break. Meaning that we never let the tax tail wag the dog.
IRAs provide the ability to do Roth Conversions
If you have a large pre-tax/Traditional TSP, then you may wish to consider Roth conversions. At a high level, the goal is to pay taxes when your rates are lowest (you heard it here first folks). To accomplish a lower lifetime tax bill, it may be advantageous to convert some of your pre-tax/Traditional IRA money (pay the tax on it now) by moving it over to a Roth where it will be tax free for you – or your heirs – later in life. The TSP does not allow you to convert pre-tax/Traditional TSP money into a Roth TSP. It’s another no-no.
However, if you move your pre-tax/Traditional TSP to a Traditional IRA, you do then have the ability to start conversions to a Roth IRA if it’s right for you. The conversions themselves are a whole other topic and beyond the scope of this paper. But needless to say, the option of Roth conversions is a big benefit of rolling over money from the TSP to an IRA.
Conclusion
There you have it – the advantages of rolling over money from your TSP to an IRA. I’ll do a complimentary paper on the common disadvantages of rolling over a qualified plan (e.g., TSP, 401k etc.), but spoiler alert, many of them don’t apply to Federal Agents. Meaning that the advantages of a rollover to an IRA, in my opinion, far outweigh the disadvantages.
Two notes before we leave each other. The first. If you are under 59 ½ please consider NOT closing your TSP. You can follow my “$200 to $2,000 Rule”, which is simply a catchy term I made up to help you remember that the TSP requires you to keep at least $200 in your account to keep it open. We like to play it conservative and have you consider keeping at least $2,000 in the account to be safe. If you plan on a withdrawal strategy using the G Fund, you may wish to have even more than $2,000 in the TSP.
Second note. I’m not against the TSP. In fact, during your accumulation years your main goal is earning more than you spend and then being able to save an adequate portion of that difference for retirement. Simple enough in theory, but very hard to sometimes carry out. Well the TSP steps in during these years and is really a great financial tool for saving for retirement. It checks a lot of boxes (i.e., simplicity, good investments, not too expensive etc.) on the way to retirement.
However, it’s hard to use this same tool for the decumulation stage of life when you may need to tap that TSP for living expenses. Likewise, it may not even be the best tool for preserving and protecting your wealth because of some of the caveats we mentioned above – like problems with passing on your TSP account and the potential large tax bill that can come with it.
In other words, your personal financial situation is just that, very personal. And your financial plan should reflect what works best for you. Don’t run out and make any moves, including a Thrift Savings Plan rollover, until you weigh all the pros and cons and/or speak to a financial professional. Either way, you’re a leader in your family and you can continue to educate yourself and position yourself to win with money.
Be the Hero for You and Yours!
