For most of you, the Thrift Savings Plan (TSP) will be a vital source of income in retirement. To maximize the potential of this investment vehicle, it is up to the individual participants to make themselves aware of several common mistakes, which if not avoided may threaten their future wealth.
Some of these mistakes are simple to explain while others require lengthier explanations; therefore I have broken this article into two parts, with part two to be posted next week.
Mistake #1: Inter-fund and Contribution Mistakes
Make sure that if you want to change your existing TSP allocation that you do an Inter-Fund Transfer. If you want to change how your contributions are going into TSP do a Contribution Election change. If you want to change your existing TSP allocation and your contribution elections you do BOTH: Inter-fund Transfer and Contribution Election.
While this seems pretty basic, many people intending to change how their money is allocated mistakenly only do a contribution election.
Imagine Darrell is one year away from retirement and currently has his TSP allocated between the C, S and I funds. He is concerned that a potential downturn in the market would jeopardize his ability to retire next year.
Darrell has decided that the L Income fund is appropriate for his risk tolerance, giving him 80% exposure to fixed income: G and F, and 20% exposure to equities: C, S and I funds. Now imagine the stock market repeats its performance of 2002 with the S&P 500 falling 23% in one year. Darrell pats himself on the back for reducing his exposure to riskier funds, but when he gets his year-end statement is shocked that his $500,000 TSP portfolio has dropped by $100,000.
Looks like Darrell may not be retiring for a while longer.
Mistake #2: Failure to Update Beneficiary Forms
Failure to keep beneficiaries current can have enormous negative consequences.
Beneficiary forms override any beneficiary designation you have stated in your will. If you pass without completing the beneficiary form (TSP-3), TSP will pay out your account in order or precedence:
- To your spouse;
- If none, to your child or children equally, and to the descendants of deceased children;
- If none, to your parents equally or your surviving parent;
- If none, to your appointed executor or administrator of your estate;
- If none, to your next of kin who is entitled to your estate under the laws of the state in which you resided at the time of your death.
But what if you have completed a beneficiary form and no longer want that person to be the beneficiary of your account?
On January 31st 2005, the New York Post reported the story of a man from Brooklyn, NY. Bruce Friedman was left destitute when his late wife’s pension, worth nearly $1 million, was awarded to his sister-in-law on a technicality.
Bruce, age 61, lost his wife Anne suddenly from a massive heart attack in September of 2001. He said of his late wife Anne that he lost the best thing that ever happened to him. Bruce said he never doubted that he would be entitled to the lump sum survivor payment of $900,862 because the Teachers’ Retirement System sent out annual statements that indicated his wife had no named beneficiary.
Anne’s teachers’ retirement rules stated that if there was no beneficiary listed, the funds would go to the surviving spouse; if none then to a similar order of precedence as TSP.
Now here is where it gets ugly. After Anne died, officials found a form which had been filled out 27 years prior, four years before the couple met on a 1978 blind date, listing Anne’s mother, uncle, and sister as her beneficiaries. Since Anne’s mother and uncle had died, the money was awarded to the remaining beneficiary, Anne’s sister.
Bruce adamantly opposed the decision and subsequently took his case to the Supreme Court, which ruled that Anne’s intention of making her husband the beneficiary could not be assumed because the paper work in file had designated her sister as the beneficiary.
The NYC Teachers’ Retirement System was not an ERISA plan. If it were, Bruce would have been awarded the money, unless he had signed paperwork waiving himself as beneficiary prior to Anne’s death. TSP is also not an ERISA plan, so the same outcome would have occurred if these funds were in TSP.
If you have not named your beneficiary and contingent beneficiary, or are not sure whom you named previously, submit a new TSP-3 beneficiary form which will supersede any previous beneficiary designations.
Mistake #3: Having an Outstanding Loan Balance at Retirement
If you leave federal service with an outstanding loan balance, you have the option to pay it back within 90 days of the date of your separation. If you do not repay the outstanding balance within 90 days of separation, the IRS will declare this a taxable distribution.
Also, you may be subject to the IRS 10% early withdrawal penalty, unless you have separated from service in the calendar year you turn age 55 or older.
Mistake #4: Not Owning Responsibility for your TSP
The TSP is a valuable savings plan, but unlike your CSRS or FERS annuity there is not a formula for knowing what your benefit will be upon retirement. The Responsibility to Make the Most of this Savings Vehicle is on YOU!
- You determine how much (up to the IRS limits) to contribute.
- It is up to you to decide what is best: traditional TSP, Roth TSP, or a combination of both.
- You determine how your TSP funds should be allocated based on your determined risk tolerance or comfort level.
Mistake #5: Not Keeping Any Funds in TSP After Retirement
For many individuals, there are distinct advantages to rolling over their TSP funds to an IRA (additional investment options that may be better suited during the distribution phase, more flexibility and better stretch options for your beneficiaries are some examples).
If you rollover all of your TSP funds to an IRA and later decide you want to bring them back to TSP, you will not be able to do so. If you choose to rollover your TSP to an IRA, be sure to leave some money in TSP (minimum of $200, although I would recommend minimum of $1,000) in case you ever decide you want to roll those funds back into TSP.
