If you’re a federal employee then chances are you have a Thrift Savings Plan (TSP) account. If leaving federal service for retirement is just around the corner, you may be wondering how to handle your TSP account investments.
In this article we'll cover your options for the TSP when you retire and the pros and cons of each of those options. By the end of this article, you will have a clearer understanding of the best options for your TSP when you retire. If you're looking for a more general overview of the Thrift Savings Plan, check here.
Understanding your TSP
The Thrift Savings Plan (TSP) is the government’s version of a 401(k). It allows you to save for retirement, and the contribution limits are identical to those for a 401(k).
One key way in which TSP differs from a 401(k) is in the limited investment options. TSP’s have five different core investment options plus L or Lifecycle funds which are automatically allocated based on the fund date you choose. The core investment options are essentially low cost index funds covering broad areas of the market, while the L funds are combinations of the underlying core funds and the allocation of each L fund changes as the target date of the fund approaches. Although the TSP investment options are limited, given their low cost and broad market coverage, they are generally good options.
TSP accounts also differ from most 401(k)s and IRAs as far as withdrawal choices once you retire. More specifically, there are a variety of options beyond just an ad hoc or partial withdrawal, and the ad hoc withdrawal options expanded in late 2019 as we’ll explore below.
The optimal choice for you depends upon your specific circumstance, and if you haven’t put together a retirement plan, a good first step is to think about how you will layer your retirement income. Unless you were on the legacy CSRS, you’ll likely receive a FERS annuity in retirement along with Social Security. If that’s the case, the TSP account can be used to cover expenses your retirement income won’t cover -- and knowing what that gap is (if any) and understanding income tax in retirement can help you make the optimal choice.
As for the TSP retirement options, they are:
Option #1 – Leave Your TSP Where it Is (For Now)
The benefits of leaving your money in the TSP are that the fund options are low-cost and straightforward. Once you reach age 70½, if you are separated from service, you’ll need to begin taking withdrawals from your TSP account.
Your distribution options in that year are the standard TSP distribution options – begin withdrawing your funds on an ad hoc or systematic basis,purchase a life annuity or roll over your runds. If you chose regular monthly payments but the amount isn’t sufficient to meet the required minimum distribution, the TSP will send a one time distribution to make up the difference. The same is true if you chose another withdrawal option - if the amount you withdraw falls short of the IRS requirement, the plan will send you a check to cover the shortfall.
Things get a bit more complicated if you have multiple retirement accounts. If, for example, you have several IRAs or other pre-tax retirement accounts like 401(k)s, the IRS will allow you to withdraw funds from just one account to satisfy the total required minimum distributions from all accounts. However, this isn’t allowed with the TSP – the plan administrators for the TSP require you to take the minimum distribution based on the TSP balance regardless of the amount you’ve withdrawn from any other pre-tax retirement accounts. Furthermore, the TSP requires you take distributions from both the traditional and Roth account, while rules for IRAs only require RMDs from traditional IRAs and not Roth IRAs (though rules for beneficiary accounts differ).
The upshot of this is that when you are cobbling together sources of income in your retirement plan to cover your retirement needs, you need to ensure you include required distributions from the TSP as one of the income sources. You’ll also want to account for the fact that any pre-tax contributions you’re withdrawing will be taxed as income and will likely increase your Federal and State taxes accordingly.
Option #2 – Begin withdrawing from your TSP
The biggest limitation on TSP withdrawals has been lifted. Previously, you were only able to make one partial withdrawal post-separate in your lifetime. This often made keeping funds in the TSP challenging, as cash needs often change in retirement. Now, however, you can make multiple post-separation withdrawals of differing lump sums, and you can choose whether the withdrawals come from your traditional balance or your Roth balance. It is worth nothing, thought, that you can only make one partial withdrawal every 30 calendar days.
Periodic payments are still an option, and you can continue to choose a specific dollar amount or an amount based on the balance in your account and your life expectancy. With the recent plan changes, you can stop, start or change the amount of these payments at any time, but the old rule prohibiting switching to life-expectancy based payments after choosing dollar amount payments remains in place.
Option #3 – Purchase an Annuity with Your TSP
A third option for your TSP account is to use the proceeds to buy a life annuity. On the plus side, you don’t have to make that decision at retirement, but on the minus side, locking yourself into an annuity without being reasonably certain of your cash needs is a bad idea.
If you are married or have someone else dependent upon your retirement income, you also need to make a decision about survivor benefits.. What happens to your annuity income if you pass away?
If your money is in the TSP and you haven’t chosen to purchase an annuity, the account will pass to your beneficiary. However, if you have annuitized your TSP, what happens to the annuity depends upon the payment option that you take for the annuity.
There are three most common payment options for your annuity:
1.) Single Life – If you choose the single life option, which is typically going to pay you the most each year, then your designated beneficiary gets nothing after you pass away unless you have purchased the cash refund feature. In this scenario, there is no guarantee that the total principal you invested will be paid back
2.) 100% Survivor Option – This option pays less than the single life option, but if you pass away, the income to your beneficiary does not decrease
3.) 50% Survivor Options – The initial payment in the 50% joint option is between that of the single life option and the 100% survivor option. However, if you pass away, your beneficiary’s payment will drop to half the original payment.
There are other payment options as well as two additional features available, but the most popular choices I’ve encountered are Single Life payments and 100% Survivor option . Single life can work well when your spouse has a good income on his or her own and would not have to adjust their lifestyle if the annuity payment ceased.
In those cases, the annuity payment for the couple that I’m working with is “fun money” spent on entirely discretionary items. But in situations where income is lower — particularly in situations in which the deceased spouse earned more than the surviving spouse – the annuity income is critical and the 100% survivor option is often optimal.
Whether you choose to take monthly distributions out of your TSP or annuitize your TSP, pre-tax dollars that are withdrawn are taxed as income.
Option #4 – Roll Your TSP Into an IRA
The pros of rolling your TSP into an Individual Retirement Account (IRA) include more flexibility in terms of withdrawing your money and a greater breadth of investment options. Fortunately, although the TSP plan options are limited, the options that are available are generally good ones. Lastly, if you are planning on retiring early, the TSP does allow withdrawals with no penalty beginning at age 55 as long as you have separated from service.
If cost is a primary concern, you could roll your TSP funds into an IRA, and replicate your TSP investments using low-cost index funds. The one fund that can’t truly be replicated is the G fund, which provides a return higher than that of cash with no risk to principal. If the G fund isn’t a critical part of your investment strategy, putting together an IRA version of your TSP portfolio should be straightforward.
With the recent changes, the TSP now has a robust of withdrawal options if you are retiring from the Federal Government. Make sure you understand the choices, and if you’re still not sure which TSP withdrawal option is best for you, we would be happy to speak with you about building a retirement plan.
As a Federal Employee, Your Retirement Benefits Are Complex.
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