One of the most common questions I get after a federal employee retires is what to do with the TSP after retirement. Is it okay to start drawing some money out of it, and if so, how much? How should you manage the investment allocations? Should you keep it in TSP, or move it to an IRA for more flexibility? If you do move it, should you pay someone to help you manage it? What strategies should you consider going forward? These are all very important questions which will have an impact on your financial situation in retirement, and I’ll discuss each of them here.
Is it okay to take money out of the TSP?
In a word, YES. Otherwise, what was the point of saving it in the first place? The amount you can take out, however, can vary greatly depending on the rest of your situation. In some instances, you may find that your federal annuity, Social Security, and other guaranteed sources of income are sufficient to maintain your pre-retirement budget. If that is the case, virtually the entire TSP balance could be available without much restriction. If TSP distributions will be an integral part of the overall budget, however, it is important to spend the time up front creating an income plan. The withdrawals should then be only according to the plan and adjusted regularly for changes. Monthly withdrawals often work well, since you set the budget ahead of time on a monthly basis and the funds aren’t available to overspend.
One other important consideration when looking at spending the TSP funds is whether the expense is ongoing or if it is a one-time occurrence. Buying a car might have an initial purchase price, but will have ongoing expenses for gas, insurance, maintenance, eventual replacement, etc. Going on a vacation, however, will not cost anything at all down the road once the trip is paid for. As you look at how to spend some of your savings, the distinction between one-time and ongoing expenses should be looked at closely along with your overall plan.
The final decision on withdrawing TSP funds is yours to make, but you may wish to consider some assistance in putting together the comprehensive income plan if you are not experienced in doing it. You want to make sure you are comfortable with the path you are on, because it’s very hard to recover if you’ve been withdrawing too much for too long.
How should you manage your investment allocations?
The TSP is rightfully regarded as one of the best retirement plans around for people while they are working. It is very low cost, has broad diversified investments, and allows significant employee contributions to go with a match of up to 5%. It is also wonderfully simple. My typical recommendation for most people is to find an appropriate L fund or combination of the other five funds, decide on traditional vs. Roth contributions, set up the highest contribution level you can muster, and then avoid making changes until you are about ready to retire. That steady strategy takes advantage of dollar cost averaging for contributions and avoids the emotion-based decision making that keeps many people from making the returns they otherwise could.
The equation changes a bit in retirement, though, and it becomes extremely important to pay much more attention to what is going on. Adding simple concepts such as a regular rebalance can significantly improve long-term returns.
Going even further, I recommend that you look at your comprehensive income plan to determine your planned withdrawals for the first five years and keep that money in the G fund. The remainder can be invested as aggressively as you are comfortable with. That first portion can be looked at as a “buffer” account, which will be drawn down over time and only refilled when the rest of the investments are doing okay. For example, the buffer account with five years’ worth of withdrawals in it starting in 2008 (before the market crash) could have been drawn down for five years before being “re-filled”, by which time the market had rebounded to all-time highs. Using the C fund as the alternative for the rest of the account, that means that the retiree would not have actually realized a loss in any of his investments during this time frame. He would have only sold the G fund that increased each year, and the C fund would have bounced back by the time the buffer was used up. This type of strategy is a bit more complex, though, and would require you to look at your fund balances just before and after each distribution, and reallocate according to your desired strategy. Otherwise, the TSP follows the rule of simply distributing the funds from each fund proportional to their balances.
There is a significant benefit, both financially and psychologically, to paying attention to your TSP every month in retirement and making the changes you need to work with the plan you have set up. These benefits also lead to the discussion of whether the management would be better done in the TSP or an IRA account.
Stay in TSP or transfer to an IRA?
Even though the TSP is an excellent savings plan, it does have some limitations when it is time to make withdrawals. Many people decide to keep their money in TSP regardless, while others opt to transfer the funds out to an IRA. I will give some of the reasons and deciding factors to consider here. Keep in mind that individual situations may vary, and some people may benefit from multiple strategies.
Benefits of staying in TSP
- The primary benefit of keeping your retirement funds in the TSP is to minimize fees and expenses. It would be difficult to match the same investments for lower costs elsewhere.
- The TSP offers excellent creditor protection in the case of bankruptcy, etc. An IRA would offer some protection, but not to the same extent.
- If you retire between the ages of 55 and 59 ½, withdrawals from TSP are not subject to the 10% early-withdrawal penalty that would apply to the same withdrawals from an IRA (without having to follow a 72(t) program).
Benefits of moving funds to an IRA
- One of the most common reasons to move money from the TSP to an IRA is the flexibility of withdrawals. From the IRA, you can take any amount at any time, rather than the one lifetime partial and annually adjusted monthly amounts.
- For those doing more strategic planning, the IRA allows you to select where withdrawals come from. That includes which investment and whether it comes from the Roth account or the traditional pre-tax account. In the TSP, every withdrawal comes proportionally from every fund and the Roth account, sacrificing some of the planning ability. For this reason alone, I often recommend taking either the traditional or the Roth balance out of the TSP before taking withdrawals. This allows you to control which tax treatment the withdrawals will be subject to.
- Another strategic planning option not available within TSP is the ability to make Roth conversions. For many retirees, it can make sense to convert a portion of the pre-tax balance to a Roth account each year, and that is not possible within TSP. The reasons to make a conversion can include maximizing a lower tax bracket or reacting to a drop in the market.
- An IRA offers almost unlimited investment possibilities, while the TSP is restricted to the 5 primary funds. This may not be an issue for most people, but could be an issue for those with specific investment desires. There is also the opportunity for much more frequent trading. Again, that may not be appropriate for everyone, but is at least an option for those interested.
- Law enforcement officers who retire prior to age 55 may look at utilizing the IRS 72(t) program to pull from their retirement accounts. Since this withdrawal rate is based on individual accounts, it often makes sense to split the primary account into two so that the 72(t) formulas will only apply to one of them. That affords a bit more flexibility for minimizing the impact of any potential 10% early withdrawal penalties.
- For a surviving spouse who inherits a TSP account, it is very critical to look at a move to an IRA. Unless that person is also a fed and can transfer the money into their own TSP account, the subsequent beneficiaries are the ones that should be considered. With a beneficiary TSP account, when the first beneficiary dies, the subsequent beneficiaries must withdraw the entire account and pay the associated income taxes (often a higher rate than they would otherwise). Using a beneficiary IRA allows the subsequent beneficiaries to withdraw the funds over the course of their lifetimes, potentially greatly reducing the tax burden by spreading it out over many years.
Examples of people who may be better off staying in TSP
- Someone who doesn’t need to access their funds for while
- Someone with challenging credit or at risk of bankruptcy
- Someone who retires in the calendar year they turn 55 or later, but before 59 ½
Examples of people who may be better off moving to an IRA
- Someone who wants to regularly actively trade their account
- Someone who needs flexible withdrawals
- Someone who will benefit from additional tax planning strategies
- Someone who wants access to a broader selection of investment types or products, such as commodities, real estate, annuities, etc.
- A surviving spouse who inherits a TSP account
Manage your own IRA or hire an advisor?
If you do decide that moving money out to an IRA makes sense in your particular situation, you then need to consider whether you want to manage it yourself or whether you should hire an advisor to assist you. Here are some guidelines to help with that decision.
Benefits of managing your own IRA
- The primary reason to manage your own IRA is to save on expenses. Any financial professional will charge for their services, whether it is a commission to a broker or fees to an advisor or planner. If you have the ability to do the same things for yourself, you can save fees that can add up over the long run.
- Managing your own assets is also appropriate if you want to maintain complete control. That could include doing the research and picking long term investments for yourself or even day trading your favorite stocks (which I do not recommend). With that level of involvement, it can be cumbersome to have someone else involved with your account.
Benefits of hiring an advisor
- The main reason to hire an advisor is that you think the value of the advice they bring to the table will outweigh the fees they charge. In making that calculation, it is important to consider what you are actually comparing. For example, it may make sense to pick strictly the lowest expenses if you are considering two large cap growth funds. It is a different issue if you need to pick the allocation between growth and fixed income investments, whether they should be in traditional or Roth IRA accounts, and which one you will draw from over time. You may find that the cost of missed opportunities is higher than the cost of the advice.
- Many people also hire an advisor to assist with the overall financial planning. An advisor can assist in deciding whether you can afford to retire and when, and what your lifestyle will look like going forward. This can be a daunting task for those who haven’t done it before. Working with a professional can ease a lot of fears and add peace of mind.
Examples of people who may be better off managing their own accounts
- Someone who has always actively traded their TSP
- Someone who is familiar with investment concepts and strategies
- Someone who is familiar with taxation rules and how they apply in retirement
- Someone who is comfortable putting together their own retirement income plan
- As an example, if you know which fixed income investments are less susceptible to rising interest rates, why you would consider a Roth conversion at a market downturn, and at what age you can file a restricted application for spousal Social Security benefits, you are likely well equipped to manage your own accounts successfully without assistance.
Examples of people who may be better off hiring an advisor
- Someone who gets nervous making their own financial decisions
- Someone unfamiliar with all of the various investment options
- Someone unfamiliar with taxation rules in retirement, and how to use them to reduce the overall tax burden
- Someone who wants access to a particular investment product that they don’t have access to themselves
- Someone who is susceptible to making emotional financial decisions that may not be in their long-term best interests
- Someone looking for a bigger picture plan, to find out how retirement lifestyles will be affected by such things as a spouse’s income and retirement savings, part-time work, rental properties, whether to sell a home, moving to a different state, Social Security, insurance and survivor decisions, estate planning, travel, one-time purchases, etc.
The decision on whether to hire an advisor often hinges on fees. We pay fees for services all the time in our daily lives, and make the determination each time whether it is worth it. You could think of an advisor as a plumber, and the investments as a new faucet. It makes sense to shop around for the best deal on the faucet, but you should only attempt the installation yourself if you have the necessary time, knowledge, and tools.
Retirement income strategies to consider
Whether you keep your money in TSP, manage your own IRA, or work with an advisor, there are many different concepts and strategies that should be considered on an annual basis. These strategies are often more important than investment returns, and the opportunities available can add significantly to the quality of retirement. I’ve listed several of them here briefly to get the discussion started.
- Begin the process with a comprehensive retirement income plan, including your federal annuity, Social Security, and any other expected sources of income.
- Review your options within the federal benefit system, including FEGLI, FEHB, survivor benefit elections, etc.
- Maximize your benefits through Social Security by considering strategies such as “file and suspend” or others. This decision is best made in the context of your overall retirement income plan.
- Consider which portions of your overall investment allocation should go into the pre-tax accounts, Roth accounts, or taxable accounts. As an example, it often makes sense to put the highest growth investments in the Roth account, investments that are eligible for long-term capital gain treatment in a standard account, and fixed income investments in a pre-tax account.
- Evaluate which investments to liquidate every time a withdrawal is made. This can have large impact on overall returns. Strategies can include rebalancing each time, using a “buffer” account, and strategically realizing gains on investments that have done well.
- Similar to the decision on which investments should go into which account (pre-tax, Roth, taxable), the same consideration should be given to which type of account withdrawals should come from. Income needs, tax brackets, and overall balances should all be considered.
- Consider allocating a small portion of your investment portfolio into alternative style investments.
- Look at Roth contributions or conversions each year. This may make sense to help maximize the utilization of lower tax brackets. It can also be useful at a market downturn to reduce the taxes paid on a possible rebound.
- A good way to minimize your long term income tax burden is to spread it out over time. Paying taxes earlier isn’t necessarily bad if it is at a lower rate. This can be accomplished by strategic withdrawals or Roth conversions.
- Review your fixed income investments and what risk factors are involved with each. For example, how will they react in a rising interest rate environment?
- Review your estate planning to make sure you have something appropriate in place and that your other decisions are consistent with the plan.
- Investigate options for long-term care insurance, and whether it may be appropriate for your situation.
- Stay on top of any changing regulations that may change your plan or offer new opportunities.
Other than the federal retirement annuity, the TSP is the largest asset for most fed retirees, and one that plays an important part in their retirement plan. Managing that account is critically important, especially once you begin the process of making withdrawals and working it into the overall plan. The ideas presented here are intended to be food for thought, and should be considered in the context of your particular situation.