There are two phases to any retirement savings plan. There is the growth phase when the account is intended to grow and deposits are being made. Then there is the distribution phase when the money is being used during retirement, presumably to augment retirement income.
There can be little argument that the Thrift Savings Plan (TSP) works tremendously well during the growth phase. It is a superb way for federal employees to save for retirement. Still, there are some blatant disadvantages that should be considered before settling on the TSP for the distribution phase.
First, for the pros offered by the TSP:
The employer match (for FERS employees) is among the best available, up to 5% match of your annual wages.
Tax Deferred Gains
Tax deferral is available for any gains in the account. This allows for potential compounding growth, without Uncle Sam taking a cut.
Easy Contribution System
Minimal effort is needed to save for retirement. You schedule an amount to come out of your check each pay period, and the contributions are on autopilot.
The most popular advantage is low costs. The TSP likely has the lowest fees of any employer sponsored retirement system available. According to the TSP website, the average net expense during 2016 was 3.8 basis points. That means the management cost was was .38 ₵ for every $1,000 invested.
Going Beyond the Growth Phase
These are all very strong reasons for feds to participate in the TSP during the growth phase of their retirement plan. But, for our purposes, the retirement planning question is about the TSP’s benefits beyond the growth phase.
Once a federal employee turns 59 ½ years old or when they retire (whichever comes first) the disadvantages start to stack up.
At 59 ½ the TSP becomes eligible to “rollover” (one time) to any qualified IRA, without creating a taxable event, or if a fed leaves federal service prior to turning 59 ½ they can also perform a “rollover” without creating a taxable event. These are key triggers that should encourage federal employees to research the best options for their personal needs.
When feds are hesitant to roll over their TSP into an IRA, the number one reason given is costs. The low cost of the TSP is the number one driving force for keeping retirement savings in place. But, what price are feds paying for this low costs?
There are several important pieces to a retirement plan within the TSP going unaddressed. The reason they go unaddressed is to keep costs low.
Cons of Low Costs
No Investment Strategy Support
The one question I receive from feds more than any other is, “Am I invested correctly?”
This is a very good question, arguably the most vital question a person could ask about their retirement savings.
Regrettably, this is one question that will continue to go unanswered by the Federal Retirement Thrift Investment Board (FRTIB). They are not given the budget to hire the staff that could provide such answers. Adding knowledgeable individuals to the FRTIB that could answer this question would be expensive. That cost would have to passed on to the overall cost of investing in the TSP.
Retirement investing/planning education
Most feds I speak with indicate great difficulty in finding reliable information on how they should invest and how to plan (financially) for retirement. Many federal employees state that the endorsed training they receive starts late in their careers and is incomplete.
Limited investment choices
Within the TSP, there are only 4 index funds to choose from. Even the Lifecycle Funds are merely a mixture of those same 4 index funds.
This is a problem for anyone desiring greater diversification. This type of limited diversification may create a hole in a comprehensive retirement plan seeking personal balance.
The TSP doesn’t offer the options for investing in individual sectors such as healthcare, technology, precious metals or emerging markets, to name a few.
Since 2009, the FRTIB has had the “green light” to add mutual funds to the mix to add diversification and expanded choices. As of now, no additions have been applied.
Why is this important? A more robust collection of options may allow feds to expand their retirement savings in both breadth and scope.
With the perceived advantage to adding more TSP options, why haven’t they been implemented? Costs! Mutual funds would cost more than the current mix of index funds.
Complications in tracking “true” gains
Cost basis is a key component in tracking the gains you are receiving in an investment. This tells how much that investment originally cost.
Without a starting point, it is virtually impossible to determine true rate of growth. The TSP system does not track this for you. This simple feature is not included in the TSP because it would cost money to install it. For many feds, it becomes difficult to distinguish between deposit growth from investment growth.
Linking to home finance programs
There is no automated download from TSP into programs such as MS Money or Quicken. That means a manual change would need to be completed each time anything happens in your TSP, i.e. new investment, rebalancing (changing percentages), etc. Low costs are the reason for this lack of a modernized feature.
The question of retirement savings ownership arises when we consider the unfettered ability of the Secretary of Treasury to “borrow” G-fund assets whenever “it is deemed necessary.”
Per Webster’s, the word “own” means, “to have power or mastery over.” If employees are unable to prohibit the borrowing of their retirement funds, does the employee really “own” those assets? Using Webster’s definition, it appears that ownership is only released from government dominion when a fed’s savings has been removed from the G Fund.
The biggest complaint I hear from retired federal employees concerns their withdrawal options. Most don’t understand what their needs will be throughout retirement, nor that they cannot later change their distribution options as their needs change.
When it comes to employer sponsored retirement plans (401k, 403b, TSP, etc.), a plan participant leaving an employer typically has four options (and may engage in a combination of these options), each choice offering advantages and disadvantages:
- Leave the money in his/her former employer’s plan, if permitted;
- Roll over the assets to his/her new employer’s plan, if one is available and rollovers are permitted;
- Roll over to an IRA; or
- Cash out the account value.
The TSP offers two distinct withdrawal options:
- Full distribution has 3 choices:
- A “rollover” is performed to remove all TSP assets and place them into IRA’s.
- Monthly payments to be withdrawn from the TSP balance.
- Purchase an annuity through the TSP.
- One time only withdrawal – A fed is allowed ONE partial withdrawal. This may happen as an “In-service” distribution (a distribution taken after age 59 1/2, but while still employed as a fed) or a partial distribution, after retirement, but, before taking a full distribution.
Once you make your full distribution choice, there are no mulligans or do-overs.
When Craig retired from federal service, he began taking monthly payments from his TSP. He enjoyed those payments for over 5 years. Then, one day his old furnace stopped working. His HVAC company suggested he replace both the furnace and his 20-year-old AC unit as well. Altogether, the complete job was going to cost him more than $10,000.
Craig decided to withdraw the money from his TSP account. That is when he learned that this one action would forever end his monthly payments. In order to get to any of his TSP retirement savings, Craig would have to take it all out.
Withdrawal choices are excessively restrictive because it would cost more to provide feds with more options.
I want to reiterate: I believe the TSP is a fantastic place to grow retirement assets. For some it may well be an acceptable place from which to make their retirement distributions. But, it is obvious that the low costs are crippling benefits that many feds will need/want during their retirement years.
There is an old saying, “You get what you pay for!” Unfortunately, the TSP is no exception to this rule.
The FRTIB has done an amazing job of keeping cost low, but costs alone should not be the only determining factor in deciding if your retirement savings are best served by staying in the TSP, post retirement.
I encourage those that are looking to retire soon, who are already retired (but haven’t started the full distribution) or are at least 59 1/2, to find out if the cheapest way is really the best way for them to manage their retirement distributions.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risks, including the loss of principal. No strategy assures success or protects against loss. Securities offered through LPL Financial, member FINRA/SIPC. Investors should consider the investment objectives, risk, changes and expenses of the mutual fund carefully before investing. The prospectuses and, if available, the summary prospectuses contain this and other important information about the mutual fund. You can obtain prospectuses and summary prospectuses from your financial representative. Read carefully before investing. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.