Editor's Note: Whether they retire or leave government, most federal workers have a tough, long-range investment decision to make. Should they leave their retirement nest egg in the government's Thrift Savings Plan or transfer it to an outside individual retirement account? Most choose the latter. Financial planner Arthur Stein compares the TSP to IRAs in this guest column.
By Arthur Stein, CFP
Bethesda, MD
There are many advantages to the Thrift Savings Plan for federal employees who are growing their investments. The TSP offers a variety of funds with low expenses.
But retirees who are withdrawing funds will find the TSP to be extremely restrictive compared to most IRAs. These restrictions impede retirees' ability to alter withdrawals over time, make withdrawals based upon current stock and bond market levels, and minimize taxes. The Federal Retirement Thrift Investment Board spells out details on withdrawing funds from the TSP on its website.
Retirees who want greater withdrawal flexibility can transfer some, or all, of their TSP funds to an IRA. IRAs offer a larger range of investment choices. IRAs do have higher fees. The differences can be small or large. Comparison-shopping is advised.
TSP v. IRA: Partial withdrawals
Many of my retired clients occasionally make partial withdrawals to fund trips, weddings, major purchases, home renovations or family emergencies.
The TSP allows only one partial withdrawal. After that, you must make a lump-sum withdrawal that includes all remaining funds. Then your account will be closed.
IRAs place no restrictions on the number or timing of withdrawals.
TSP v. IRA: Withdrawals based on market conditions
Withdrawals from the TSP must come from all the funds owned in the account, in proportion to fund values. You cannot make withdrawals from only one fund. Nor can you withdraw different percentage amounts from different funds.
For example, say Jane wants to partially withdraw her savings to pay for a trip. The stock markets are in severe decline, but bond markets are stable. Jane wants to avoid selling TSP stock funds (C, S and I) when they are down. Instead, she wants to take money out of her G and F funds.
The TSP does not allow that. Jane must withdraw the same percentage of her savings from all the funds she owns. IRAs make no similar restrictions. With an IRA, Jane could withdraw only from bond funds. She could choose a different percentage for different bond funds.
TSP v. IRA: Monthly payments
If you choose to receive monthly payments from your TSP account, you can change the amount only once a year, according to TSP rules. If you stop monthly payments, the TSP closes the account. You have to transfer all your funds.
IRAs typically offer flexible options for monthly payments. You can change the amounts. You can start, stop and restart payments as often as desired.
TSP v. IRA: Roth TSP is the most restrictive option
TSP rules are least favorable to retirees who own both traditional and Roth TSP accounts. There are two important differences between those options. First, employee contributions to the traditional TSP are tax deductible. Employee contributions to the Roth TSP are not tax deductible. Second, withdrawals from traditional TSP accounts are taxable. Withdrawals from Roth TSP accounts are not taxable, if five years have passed since your first Roth contribution and you are age 59½ or older, or are permanently disabled.
The problem when withdrawing is that the same percentage amount must be withdrawn from both the traditional and Roth accounts. Roth TSP account holders cannot choose to minimize taxable income by withdrawing only from the Roth. On the other hand, withdrawals from one IRA do not force withdrawals from any other IRA, including a Roth.
This TSP requirement includes Required Minimum Distributions. Once they begin for a traditional TSP account, participants are required to take the same percentage from their Roth TSP. There are no RMDs for Roth IRAs. Funds never have to be withdrawn from a Roth IRA.
You can transfer the accounts to IRAs to avoid the TSP requirement. Withdrawals can then be made from one account and not the other. RMDs from the regular IRA do not force withdrawals from the Roth IRA. Note, you cannot transfer just the Roth TSP account; the TSP requires you to transfer the same percentage amount from both accounts.
TSP v. IRA: Taxes
For retirees, traditional TSP and IRA accounts share the same tax rates and RMD requirements.
There is a difference for employees older than 70 1/2, the age when RMDs normally start. There are no RMDs for the funds in the TSP for employees older than 70 1/2. If you roll the funds into an IRA while you are still employed (age-based withdrawals), the funds in the IRA become subject to the RMD rules and withdrawals must begin, even though you are still working.
TSP v. IRA: And the winner is…
The TSP is a great vehicle for employees who are investing and for capital accumulation. But once you retire and begin withdrawals, the TSP is no longer the best available option. Think carefully. The lower fees might not be as important as the greater flexibility offered by IRAs.
Neither the TSP Strategy group, nor individual members, are licensed or authorized to provide investment advice. Any statements made herein merely reflect the personal opinions of the individual group member. Please make your own investment decisions based upon your personal circumstances.
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