It is one of the major financial decisions confronting older federal employees retiring: What should they do with their Thrift Savings Plan (TSP) accounts which include both the traditional TSP and the Roth TSP?
Retiring federal employees generally have two options as to what to do with their TSP accounts. They can:
(1) Directly rollover their TSP accounts into an individual retirement account (IRA) (traditional TSP directly rolled over to a traditional IRA; Roth TSP directly rolled over to a Roth IRA) and/or to an employer-sponsored qualified retirement account such as a 401(k) plan; or
(2) They can leave their TSP accounts in the TSP. Of course, a retired federal employee can always cash out his or her TSP accounts, but this option is the least attractive for retiring employees seeking to delay paying federal and state income taxes on their traditional TSP account and seeking to have their Roth TSP retirement account continue to grow tax-free as long as possible.
The decision as to what a retiring federal employee should do with their TSP accounts needs to be considered carefully given that there are important consequences that flow from each choice. A study by Olivia S. Mitchell, an economist and professor of the International Foundation of Employee Benefits Plans at the Wharton School, covered some of the key considerations driving the decision as to what retiring employees should do with their qualified retirement accounts.
The following is a summary of the advantages and disadvantages of each option.
Rolling Over the TSP to an IRA
One of the primary advantages of directly rolling over TSP accounts to an IRA (traditional TSP directly rolled over to a traditional IRA, and Roth TSP directly rolled over to a Roth IRA) is access to a larger menu of investment options. IRAs provide more investment choices than are available in the TSP. These IRA investment choices include individual stocks and bonds, open-end funds, closed-end funds, and exchange-traded funds (ETFs). The TSP offers five “core” funds which are the C, S, and I funds (stock funds), and the F and G funds (bond funds). Associated with the five TSP core funds are low administrative expenses. TSP participants also have access to the “mutual fund window” which consists of about 8,000 mutual funds that have not been vetted and have higher internal expenses.
A federal retiree with a TSP account who seeks to buy individual stocks and bonds can also do so by rolling their TSP account into an IRA which holds the stocks or bonds. IRAs can also hold “unconventional” investment assets, including precious metals, physical real estate and hedge funds, all of which the TSP does not offer to TSP participants.
Streamlining Retirement Accounts
Those federal employees with one or more qualified retirement accounts from past employees, such as 401(k), 403(b) or 457 qualified retirement plans, SEP IRAs, SIMPLE 401(k) or SIMPLE IRAs, can simplify their financial portfolio by rolling these retirement plans together with their TSP account into one traditional IRA. This can possibly make it easier to manage their portfolio and track their investments.
Streamlining the number of retirement accounts can also simplify finances for a federal retiree’s spouse and children when the time comes for them to help a federal retiree with important decisions about eldercare, long term care, and estate management. Moreover, streamlining retirement accounts can definitely be important when the time comes for a spouse and children to deal with a deceased federal retiree’s estate.
IRAs Have More Flexible Payout Options Than the TSP
IRAs usually offer more flexible payout options than the TSP. For example, the TSP restricts how often (monthly, quarterly, annually) a TSP participant can withdraw from the TSP and how much the amounts withdrawn can vary over time.
Some Reason to Keep Money in the TSP
Associated with the five TSP core funds (the C, S, I, F and G funds) there are low administrative expenses. For this reason, a federal retiree leaving their money in the TSP potentially could earn more keeping the money in the TSP compared to rolling over their money to an IRA and investing in more expensive investment options.
The TSP also offers access to 10 life cycle funds (L income, L2030, L2035, L2040, L2045, L2050, L2055, L2060, L2065 and L2070) that automatically adjusts the TSP investment mix of the five TSP core funds as a federal employee retiree age.
Greater Fiduciary Protection
Keeping the money in the TSP provides a level of fiduciary protection that is likely as rigid as the fiduciary protection offered by financial advisors who manage IRAs. That is because the TSP is set up to legally act in the best interests of TSP participants. Specifically, the federal government is legally required to oversee TSP plan investment choices and monitor costs for federal employees and retirees who have money in their TSP accounts.
Withdrawals from the Traditional TSP Can be Made Earlier Than Withdrawals from a Traditional IRA
For retiring employees who need to access their retirement assets sooner than later, the traditional TSP offers advantages. This is because a federal employee who retires sometime during or after the year he or she becomes age 55 can make penalty-free withdrawals from his or her traditional TSP account. For traditional IRAs, the earliest age a traditional IRA owner can make penalty-free withdrawals is age 59.5.
Overwhelmed with Options
An abundance of investment choices can overwhelm the average TSP participant who is not financially literate, resulting in some TSP participants making poor investment and spending decisions. For example, past studies show that many individuals aged 50 and over do not understand the basic investment principles of risk diversification, asset valuation, portfolio choice and investment fees. Additional studies have shown that the most vulnerable to such shortfalls are women, the less educated, and individuals over age 75 who have less retirement savings.
For these individuals, the relative simplicity of keeping the retirement money in an employer-sponsored retirement plan such as the TSP would be preferred, rather than rolling over the money to an IRA.