As you move toward retirement from a career in federal service, your salary no longer provides the budget for your lifestyle. At that point, investments and income planning begin to take center stage.
Your savings in the TSP constitutes a large part of this process, and deciding what to do with your TSP balance is one of the most important decisions you will make. That decision should not be taken lightly. You do not have to do anything right away, and you should resist doing anything quickly or under a feeling of pressure.
Before you do make any moves, it can be beneficial to speak to someone familiar with both the peculiar rules of the TSP and also financial planning in general. There are many different types of financial planners and advisors, and even a whole subset that focus on federal employees. This detailed knowledge can be very beneficial, provided the overall advice is sound.
The right advice is very personal, and will depend on your particular situation.
Unfortunately, there are some general trends of poor advice that are commonly given to feds, and there are corresponding red flags that may be a clue that you are talking to someone who does not have your best interest in mind.
Here are some important questions you should ask yourself before following through with any advice given:
- Is the person giving you advice a fiduciary? There is a lot discussion about this topic lately, especially when it comes to employer plan rollovers. A fiduciary will be held to a higher standard, and is required to advise what is in your best interests. Insurance salespeople or brokers who simply sell products are not held to the same standard. This all too often results in excessive costs or products that are not the best for a given situation.
- Is your advisor an insurance salesman? Most qualified financial advisors can offer insurance products, but someone who works directly for an insurance company or can only sell insurance products will not be able to offer the complete range of options that might be appropriate. One common insurance sales pitch involves a strategy called “Pension Max”, where you would forgo the survivor benefit on your federal annuity and buy life insurance with the difference. There are some instances in the private sector where this can make sense, but usually not with federal employees. Keep in mind that the survivor benefit is increased annually with inflation, is guaranteed to last until your spouse dies, and provides access for them to continue FEHB coverage after you are gone.
- Were you advised to take all of your TSP funds out? This is RARELY the best idea, and is often driven by what is best for the salesperson, not you. The low cost of the TSP makes it an exceptional place to retain some of your funds, especially for the longer term. It may often be advisable to take some of the TSP out for more flexibility or easier access, but someone who is working with your best interest at heart will consider trying to keep the longer term portion where the fees are the lowest.
- Were you advised to make an in-service withdrawal to an outside account? This is another indication that a salesperson is trying to sell you something sooner than you need it. In-service withdrawals can be appropriate if there is a particular need for the funds, but typically not if it is just to move them out to a different account for the long term.
- Were you recommended an annuity? This is the most common scenario I have seen for people who made decisions that weren’t appropriate. There are many debates regarding the benefits of annuities and their corresponding fees (Google “annuity” and “high fee” together to see what I mean!), but they can be useful tools in some instances. Here are a couple of examples of when annuities might make sense for non-feds:
- An annuity can generate a level of steady income to provide a safety net. For example, if you had a large 401(k) but no pension, buying an annuity with part of your funds could provide you with a baseline income. For federal employees, their FERS or CSRS annuity typically fills that role.
- An annuity can be an option with conservative fixed returns for those who are highly risk averse. The TSP already offers the G fund option that provides comparably safe returns without tying up the money in a long term contract.
If you are considering an annuity, it is very important to note the long term nature of the contract and the restrictions on withdrawing your money without surrender charges. It is critical to look at your overall income plan first to see if that is appropriate.
A common example where it could be a problem is someone who is delaying Social Security and instead taking funds out of their TSP while they wait. This option may not be available if the money is tied up in an annuity with surrender charges.
A final note on annuity sales is to consider the practice of some who advise that ALL of the TSP funds go to an annuity, thereby limiting flexibility and adding additional cost to the entire balance. If that is the case, you can be reasonably confident that the salesperson is more concerned with their commission than your retirement.
- Were you told that moving to an IRA for a 72(t) is your only option to access the TSP funds? The TSP is accessible without penalty to those who retired in the calendar year they turned 55 or later, or 50 for law enforcement officers and other special category employees. 72(t) plans in IRAs used to make more sense for retired LEOs prior to the change last fall, which moved the penalty-free access age to 50. With the current law, there is usually a way to combine withdrawal methods to both avoid the early withdrawal penalties and provide for flexible access later.
- Are you being advised to withdraw the TSP before you actually need any of the money? If you don’t need to start any kind of withdrawals yet, there is usually no need to do anything at all with the TSP. Once you are ready to start distributions, however, the TSP withdrawal limitations mean you should take a broader look at the overall strategy first. Until that time, any move out of TSP will simply increase your cost.
Despite the warnings listed above, not all advice regarding the TSP is bad. It can also be wholly appropriate to take money out of the TSP, provided it is for a good reason. That reason often includes working around the TSP’s withdrawal rules. Here are few examples of things that might make sense and the rationale behind them:
- Take out a TSP loan just prior to retirement to help with immediate cash flow needs for the first year. The unpaid loan will be declared a taxable distribution 60 days after retirement, but will not count as your only available partial TSP withdrawal. This would not be for large amounts, but can preserve some flexibility going forward by preserving the partial withdrawal option. Any unused portion of the loan might even be able to be rolled over into an IRA if it wasn’t needed immediately.
- Take a partial withdrawal to an IRA prior to starting monthly withdrawals from the TSP. Once you begin regular monthly withdrawals, you are no longer able to take a partial withdrawal. That means you cannot access the rest of your money beyond the fixed monthly amount without taking out the rest of the TSP with an immediate full withdrawal. It can often make sense to make a partial transfer to an IRA before beginning the monthly amount, and leaving that in a separate account for flexible access. You can still use the TSP for the regular monthly amount, but a one-time or emergency need would not cause you to have to make the full withdrawal from TSP as it could come from the IRA instead.
- Move a portion of the TSP to an IRA for investment control and flexible access whenever needed, provided you are over 59 ½. This could be enough to last the first 10-15 years, while leaving the rest in the TSP. The TSP portion could remain invested more aggressively for the longer term at lower fees, while you retain more control of the conservatively invested IRA for access in the shorter term.
Retirement can be a wonderful transition, but also comes with its own challenges. A trusted advisor can make a big difference in your comfort level moving forward, but it is important to make sure your trust is well-placed. Asking some of these important questions early in the process can help you avoid some of the common pitfalls that many federal employees face.