TSP—Take it or Leave it?
You’re soaked in champagne, or the $4.16 version of it that the casual lieutenant picked up at the Class 6. You’ve got a few thousand hours (hopefully) under your belt and landings are pretty much equal to takeoffs. As you wrap up the fini-flight celebrations, there’s probably nothing more pressing on your mind than: “Should I leave my money in the TSP, or roll it over to an IRA,” right?
Unfortunately, the question isn’t as easy to answer as something like, “Should I take the bonus?” or “Should I go straight to guns off the perch?” But this article will give you some ammo to help mow down this choice, and the nice thing is, you’ve got time.
!!! WARNING !!!
Before coming down firmly on both sides of this argument, it’s critical to remember that unless your 59.5 years-old (or have another narrow exception) you can’t start spending this money without paying your current marginal bracket, e.g. 22% or higher, plus a 10% penalty tax for early withdrawal. If you do want to move your money out of the TSP, you must do a rollover, preferably direct to the institution that you’re moving it to. (e.g. Vanguard, Fidelity, Schwab, etc.) If you accept the money into your checking account, even as part of the rollover process, the TSP must withhold 20% for taxes. You have 60 days to put the entire amount (including the 20% that you won’t see again until next April 15th) into the new custodian’s account or you’ll effectively have taken the entire amount as a distribution—read: pay 22% or higher plus 10%. Don’t be that guy or gal. The TSP has the forms you’ll need on their website and if you have both Roth and Traditional money, and potentially some after-tax dollars from combat deployments you’ll want to make sure you work with the TSP and your new custodian to properly segregate that money into Roth and Traditional IRAs, rather than comingling it. If something goes plaid and it ends up comingled, don’t let the issue go. You could have a tax nightmare on your hands if you let that hot mess simmer for a few years. For simplicity in the rest of this article, I’ll talk about rolling the TSP over to an IRA, but you’ll likely be rolling it over into two IRAs—one for the Traditional dollars and another for the Roth dollars. One final tip—it’s generally best to open the new IRA accounts with the receiving custodian before initiating the transfer from the TSP. This is an easy online procedure.
The Case for a TSP Rollover to an IRA
The TSP has been good to you for 12-20+ years, why mess with a good thing? If you wanted, you could leave your money with the TSP until you die. But, even though the TSP is a pretty reliable workhorse, there are some reasons to consider just rolling your money over to an IRA.
- Simplicity. A few decades of financial activity can leave you with dozens of accounts, statements, 1099s, logins, fees to track, investment options, etc. Chances are that you already have an IRA open for you and your spouse. Closing down the TSP could be some Marie Kondo for your financial life. Why leave a rat’s nest for your heirs to sort out?
- High Pk IRA anyway. Chances are, you are eventually going to move it to an IRA anyway. The TSP doesn’t give you near the flexibility that most custodians do for how to start taking withdrawals to buy your hearing aid batteries. Why not just do it early and enjoy some streamlined financial life?
- Investment Options. As you know, the TSP only has 5 core index funds. Most major custodians have hundreds of funds and access to thousands more. Rolling your TSP to an IRA opens up a lot more ways to diversify your investments. Want to buy crowd-funded real estate with your retirement dollars, you’ll likely need a self-directed IRA for that. No such options in the TSP.
- ROTH RMDs. Wait, what? Required minimum distributions (RMDs) are the other half of the devil’s bargain that you make with Uncle Sam when you put tax-advantaged dollars away for retirement. For traditional accounts (IRA, 401(k), TSP) you’ve usually not paid taxes on the principal or earnings. Uncle Sam demands that you start doing so when you turn 72 so that he gets revenue and those dollars start flowing through the economy. With a Roth IRA, this is not the case. You can leave the money in the IRA until you die and your heirs have 10 more years before they finally need to liquidate the account. Roth 401(k)s and the Roth TSP have the disadvantage that they require RMDs at age 72, just like Traditional accounts. If you’re building a sizeable nest egg, you may not want to have to start taking away the Roth punch bowl when you could still have 20+ years of retirement and you’re able to live off of other less tax-efficient dollars first.
- Withdrawal Symptoms Options. You can’t choose to cash $5,800 out of the C-Fund in order to buy some sweet Bitcoin, Dogecoin, NFTs, GME or pogs. Distributions are a peanut butter spread of your TSP investments. So much for buy low, sell high. With the TSP, it’s buy low or high… won’t know for a long time… sell as allowed by TSP rules… That’s probably not the best TTP for your retirement dollars.
- Withdrawal Frequency. You can take and change your distributions as often as you like as long as that’s no faster than monthly. The TSP currently takes 30 days to administratively adjust to your distribution requests. This could be a significant LIMFAC if you have a life event or opportunity that requires a large distribution shortly after changing your normal distribution preferences.
- Turns like a BUFF. The TSP has changed for the better in recent years. There’s more Lifecycle fund options, you can change withdrawals every 30 days, not every 365 days, etc. But it’s pretty slow to keep up with commercial custodian practices to give you flexibility, so you might find better options on the outside.
- Professional Advice. In general, if you work with an advisor, that advisor can’t directly manage your TSP for you, if that’s what you’re hoping for. The advisor can recommend actions such as rebalancing, but you’ll have to take them. Depending on what you want from your advisor relationship, that may defeat the purpose of having a professional help you.
Okay, so there’s a lot of reasons to rollover your TSP to an IRA. But before you start slinging paperwork, let’s hear what the defense has to say.
The Case for Staying in the TSP
Sure, the TSP’s got some warts, but it’s been a pretty good autopilot for your wealth-building flight plan. Why mess with a good thing any earlier than you have to? I agree and here’s some reasons to stay with the TSP for now.
- The G-Fund. The G-Fund, an index fund of U.S. government bonds, is unique among investment vehicles. It is essentially guaranteed to never lose value even if its returns are unimpressive by stock fund standards. You will find no analog outside the TSP. While you may not currently need a heavy bond allocation, one day, you’ll probably want some lower risk securities. Keeping at least some of your money in the TSP gives you access to this unique animal.
- Low Costs. As you’re probably aware, the expense ratio arms race has finally reached zero with some custodians. Thus, the TSP’s costs, which vary but are generally around .04% to .06%, are no longer the de facto cheapest index fund options. Personally, I stop splitting cost atoms below .1% and chances are, other parts of 4-I-4-T are driving your returns long before you choose between a fund that has a .5% and a .03% expense ratio. But if you’re not careful, you could easily rollover your TSP into an IRA with funds carrying expense ratios well over 1% without the returns to make up the difference. Costs matter, so you need to pay attention to this.
- Backdoor Roth IRAs. You’ll want to brush up here for the whole story, but when you start making too much money on the outside ($208K AGI, Married Filing Joint in 2021), you’ll have to fund your Roth IRA through the “backdoor.” Depending on what other accounts you’ve opened over the years (e.g. a Traditional IRA, SIMPLE IRA, SEP IRA), you may be effectively prevented from a tax-efficient Backdoor Roth IRA strategy. But if you have a qualified plan like the TSP (or a 401k from your new employer) that accepts rollovers, you can flush other Traditional accounts (IRA, SIMPLE, SEP) into the TSP/401(k) and enable Backdoor Roth IRAs. Keeping your TSP open keeps this door open. It could save you thousands, if not hundreds of thousands in lifetime taxes—if that kind of thing is important to you…
- Simplicity. Does your IRA custodian offer more options than the Cheesecake Factory? Do you like that analysis paralysis feeling when you’re trying to decide which funds to buy? Me neither. The TSP has 5 funds that are a good core for most people. If simplicity is a priority, the TSP can be your friend.
- Strong Lobby. The TSP has friends in Congress and other lobbying organizations. Since pretty much the whole government and its retirees have access to the TSP, there’s a very strong lobby to protect it, suppress costs, and improve it over time. Your custodian might have different interests pulling the strings.
- Cushy GS Job? If your future involves the Civil Service, you’ll now receive a match for future TSP contributions. It could simplify your financial world to let your military TSP dollars lash up with your civilian TSP dollars until you hang up your spurs for good.
- FAM (Fee Avoidance Maneuver). If you self-manage your investments and use a low-cost brokerage, this is N/A. However, military retirement and separation come with a lot of financial complexity, so it’s common to start reaching out to a financial advisor to get some help with the various decisions you face. Unfortunately, “financial advisor” is about as standardized of a term as airplane, and there are a lot of salesmen/women that masquerade as a “financial advisor.” It should suffice to say that there are always conflicts of interest in financial relationships. Specific to the TSP question at hand, an advisor that charges you a percentage of the assets that s/he manages for you can’t charge you on TSP dollars that s/he can’t directly manage (unless you allow it, and few would do so). Salespeople can be pretty slick with their reasons why you should let them manage your dollars after moving them from the TSP to an IRA, but at the end of the day you need to have a good sense of “can this financial advisor really beat my TSP performance after adding in his/her costs such as trading commissions, ongoing management fees, account maintenance fees, higher expense ratio funds, potential market mis-timing, etc.?” This is a tough question to resolve, but if you’re getting a hard sell to let a financial services person rollover your TSP so that they can manage it, think twice. If you want to work with that person, maybe hold shots on the TSP rollover for a few years until you’re more confident in that relationship.
Summing it up
As with all good questions, the answer is usually, “it depends.” The TSP rollover choice is no different. The most critical part is the execution and avoiding unintentional tax consequences. Leaving your money in the TSP, at least for a few years, is generally a good do-no-harm strategy. Unless you just retired after 50 years of service and are literally staring at Roth TSP RMDs (I didn’t think so) then you probably have some time to revisit this decision. Eventually, it probably will be best to move your TSP dollars into an IRA, but you have time, so no need to make an unforced and costly error at a time in your life when you’re already juggling a few flaming chainsaws. Fight’s On!
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