Rolling Over Your Thrift Savings Plan(TSP)? Don’t Do That!

Folks, I realize financial planners get a somewhat deserved bad-rap. After all, many are truly little more than investment counselors claiming they are “financial advisors” or “financial planners”.

This ticks me off actually. Don’t hold yourself out as a “Financial Planner” if you’re only doing investment management!  That hurts the people who need true financial planning.

 

A Need For Unbiased Financial Advice

Given that backdrop, it’s hard not to see why many Americans seek a safe-haven for financial planning guidance from other sources, like on a well-known website.  The thought is that a guy, or lady, writing on a reputable website must have been screened by…well, somebody, right? I mean, a website isn’t going to put their reputation at stake by just hiring anyone would they?  The person giving advice must know his or her stuff.   But…what if they don’t?

 

Where “Unbiased” Equals Bad Advice

Which brings me to my frustration at this blog post.   I invite you to leave my page and take a few minutes to click on the link. Read the article. It’s not long.  Read the comments even if you so want.   I’ll be here when you come back.

 

Okay, you’re back.  What jumped out at you??? Anything???   Forget the ethics involved in what the guy is wanting to do.  For this article, that is not my concern. I care about the functionality of what the guy, who asks the questions, is trying to accomplish.

Unfortunately, the answer guy, this Quentin Fottrell, hurt his readership with his answers.  He hurt them badly and if they don’t figure out why, he will have hurt the heirs of these people too.  Why?

Retirement Accounts Should NOT Transfer Via Your Will!

Because retirement accounts do not transfer via WILL!  Your WILL is completely silent on the disposition of your retirement account unless you make the unforgivable mistake of leaving your beneficiary designation form blank or Heaven Forbid, you name your “estate” as the beneficiary!  DO NOT DO THIS!

The guy seeking guidance even states he is thinking of naming his kids as beneficiaries on his life insurance. Thus he KNOWS what a beneficiary designation is.  Yet, he says his WILL is what is going to dictate who gets his money and how.  NO!

To force your heirs, be it your spouse or your children, into a probate court to settle an estate that holds retirement benefits is insane.  First of all, it’s a pain for your heirs that could have been easily avoided. Secondly, they lose ANY ability to stretch out the tax payments they’ll have to make on the retirement money.

 

Huge Taxable Distributions

I can hear the kids now thinking they got one over on their dad’s second wife by receiving an inheritance through Dad’s Will, via probate; “Thanks Dad!  We got the money and step-mom didn’t. HAHA!” Guess what? You’re also going to pay big taxes on those assets within a short period because when you inherit a retirement account via probate your ability to take distributions on YOUR life expectancy is forever gone.

The wonderful folks over at IRAhelp.com have a great article on this exact topic.

When death occurs before April 1st of the year after the account owner turned 70 ½ (this is called the required beginning date or RBD), the IRA must be paid out by the end of the fifth year after death – the 5-year rule. You have no required distributions each year; you just have to make sure the account is empty by the end of the fifth year.

In this case, if the death happened before the owner was taking his Required Minimum Distributions (RMD) the entirety of the IRA MUST be cashed out within 5 years.   That’s not so bad, right? Think again.  Say you’re making $150k a year as a single taxpayer.  Now you get a $200,000 IRA distribution. What does that $200,000 do to your tax bracket? You’re now going to lose well over a third of the amount to the Feds, never mind what your state taxes are.

 

Increase in Medicare Premiums

Oh, let’s say you’re on Medicare. What does that $200,000 distribution do to your Medicare Part B and D premiums the following year? Only increases them by nearly $300 a month, essentially a 300% increase!

Increase in Taxes on Social Security Benefits

Say you weren’t even working and were living on Social Security and had that $200,000 IRA distribution.  What does that do to your taxes on Social Security? Just makes 85% of your benefit taxable as ordinary income.

Retirement accounts are HUGE tax bombs in so many ways. To leave your retirement accounts to your estate so your WILL can deal with it, is horrible, HORRIBLE planning.  Ole Quentin should have seen this and discussed it accordingly.  But he didn’t.

Maybe he doesn’t know about this issue? Hardly. Most likely, because he writes a blog, he just doesn’t have enough space or time to answer each question as thoroughly as he’d like.  Still not acceptable though. Financial planning is a serious business and it’s the simple things that ruin the best laid plans. I’ve seen it time and again.

 

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Social Security Survivor Benefits Not Addressed

Finally, the guy writes “(his) wife is not in the best of health and wouldn’t do well on her current Social Security award.” Guess what? She may not just keep her own “Social Security award.”  She may, and I’m willing to go on a limb here and say PROBABLY, take over the husbands benefit instead.

Social Security Survivor benefits work very, very differently than any other type of Social Security benefit.  See my post here for starters.

If Mr. has a Social Security benefit of $25,000 and Mrs. has a benefit of $12,500, when Mr. dies Mrs. loses her benefit but gets his.  So, now her benefit is what??? If you said $25,000, you are correct.

Does Quentin tell this guy that though? No!  And that piece of info may have a big impact on how the guy considers his estate planning, as it could add another $1,000 a month to the wife’s Social Security benefit.  It’s a hugely important piece of information to understand.

 

Social Security Survivor Benefits For Ex’s

By the way, if you’re the ex-wife of this guy, were married to him for more than 10 years and you are NOT remarried, did you know you are entitled to your ex’s Social Security benefits?  It would be well worth your time to contact your local office and say “Hey, I just read that I could qualify for a Social Security benefit on my ex’s record? Is that true?” And the SSA office will say “yes it is. We just need to compare your benefit to what you’d receive under his benefit and we will pay the GREATER of the two!”

Will your ex ever be notified? Nope.  Do you need to know his Social Security number? Be helpful but nope. As long as you were married  it’s worth checking with the Social Security office.  Shoot, even if your ex is still alive, again as long as you were married over 10 years and are not remarried, give the SSA a call. You may find a lucky break waiting for you.

 

Financial Planning Topics That Should Have Been Addressed

All of these issues should have been addressed by Quentin before he provided any sort of family counseling.  All the family counseling in the world is meaningless if the IRS gets a HUGE part of the pie to begin with.

Secondly, proper family counseling should be done only when all the facts are on the table.  In this case, many were left out and this poor gentleman, his wife, his ex-wife, his children AND his readers could pay a price.

 

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The Thrift Savings Plan(TSP) is the best investment option out there.  Yes, that’s a pretty big claim but I can easily back it up. How?

Lowest Expenses In The Market

The TSP has the lowest expenses of any funds that are out there.  Look at this page from TSP.gov itself.  “For 2016, the average net expense was $0.38* per $1,000 invested.”  That means your expenses for the average fund in the TSP was .038%.  You are not going to beat that, anywhere, anyhow.

How does that compare to the mutual fund industry at large? Well, according to Morningstar, the average fund charges .57% which is literally 15 times as expensive as the average TSP fund.

But it gets worse than that when you factor the varying type of funds that are out there.

 

 

Morningstar provides a nice paper  that breaks fund expenses down for us. The blue line are the expenses for actively managed funds.  The orange for index funds. The green are the average for the two. The combination of the two is what makes the overall fund expense seem relatively low at .51%.

 

Not the Whole Story

But even Morningstar graph doesn’t tell the story. After all, bond funds are included in those numbers too and bond funds should have much lower expenses than stock funds for many reasons I won’t get into here but will in another article.

Investment Company Institute (ICI) Findings

The Investment Company Institute (ICI), which represents the mutual fund industry, published its own paper in 2017 showing the average expense for mutual funds.

 

Notice, the SIMPLE AVERAGE EXPENSE RATIO is 1.28%, whereas the asset-weighted average expense ratio is less than half that.  What is that about?

“The simple average expense ratio of equity mutual funds (the average for all equity mutual funds offered for sale) was 1.28 percent in 2016. The asset-weighted average expense ratio for equity mutual funds (the average shareholders actually paid) was far lower—just 0.63 percent.”

This tells us that because more investors are choosing lower-cost funds the average expense per dollar invested is .63%  But the average FUND expense is still a quite high 1.28%.  There is a huge difference here. If you just throw a dart at a list of funds your average expense will be 1.28% which is 34 times more expensive than the average TSP investment.

 

Comparing TSP vs. The Average Fund Expense

I invest in the average mutual fund. You invest in the TSP. I pay 34 times more money in fees than you.  You pay 38 cents per $1000 invested per year. I pay $12.80 per $1000 invested per year. I must outperform you by $12.52 per $1000 per year to actually beat you in total returns, year over year.

What’s the likelihood of that happening? Well, we know. Not likely at all.  At this late stage in the game, the debate is over.  High cost = lower performance. There is no getting around that anymore.  It’s a proven inverse relationship.  Which is why the TSP shines so thoroughly.

 

Side Note:

(please don’t fall for the idea that higher expense, actively managed funds will do better in a bear market. There is no empirical evidence to show that with any consistency.)

The point is that with the lowest fees available in the investment world, you’d have to have really make the case you should invest in options other than the TSP.  Can you outperform? Possibly, but doubtful. But do your own research on this.  Below are the TSP performance, front and center for all to see, NET of fees and expenses.

 

 

YearG FundF FundC FundS FundI Fund
20074.87%7.09%5.54%5.49%11.43%
20083.75%5.45%(36.99%)(38.32%)(42.43%)
20092.97%5.99%26.68%34.85%30.04%
20102.81%6.71%15.06%29.06%7.94%
20112.45%7.89%2.11%(3.38%)(11.81%)
20121.47%4.29%16.07%18.57%18.62%
20131.89%(1.68%)32.45%38.35%22.13%
20142.31%6.73%13.78%7.80%(5.27%)
20152.04%0.91%1.46%(2.92%)(0.51%)
20161.82%2.91%12.01%16.35%2.10%
10 Yr Compound2.63%4.59%7.00%8.13%1.02%

 

Did you do better than this? I suspect not. WILL you do better than TSP funds going forward with their .038% expense ratio. I suspect not.

Why then would you ever consider moving your TSP to an IRA or another retirement plan provider? Makes no sense…except for one HUGE reason:

 

Thrift Savings Plan (TSP) Withdrawal options are VERY LIMITED

It actually boggles the mind that the TSP is such a good investment program for accumulating one’s assets but so horrible for the distribution of those assets.

 

TSP Account Owner Distribution Options

First and foremost, when you own a TSP you can distribute in the following ways:

  • Partial Withdrawals
    • You can take a ONE-TIME ONLY partial withdrawal over more than $1,000 as long as you did not take an in-service withdrawal while you were employed.
  • Full Withdrawals
    • Lump Sum Payment
    • Specific Monthly Amount
    • Monthly Amount based on your life expectancy
    • Annuity payments

Notice what is NOT included in these distributions options?  The ability for you, the account owner, to take money out when you want. You can’t do that. You can’t just submit a form to take money out when you want. It’s crazy!

Now there is movement to somewhat liberalize the distribution amounts. This bill would allow for multiple partial withdrawals which is huge.

It also would create new options for taking regular payouts: Investors could choose quarterly or annual payments as well as monthly payments, change the amounts at any time rather than just once a year, and, if they begin but stop such payments, could choose an annuity in addition to a lump sum with their remaining balance.

That is an improvement, mind you, but still quite small.  The main thing the TSP needs is to allow for account owners to make multiple partial withdrawals, like almost every other retirement account does.

 

Distributions Must Start By April 1st of Year After You Turn 70.5

Lastly, just remember, that even if you’re still employed you are required to make withdrawals by April 1st of the year after you turn 70.5.

Pro-rata Withdrawals!

Another mind-boggling limit on TSP withdrawal options is that

“withdrawals are paid proportionally from taxable and nontaxable amounts in your traditional and Roth balances.”

This means if you have a Roth TSP and a Traditional TSP and you want to take a partial distribution, the amount you receive will be a percentage from each of the accounts. This is just straight up stupid!   Someone actually took the time to put this rule into effect.  Who did that and why??? Why can’t I just say send me a check from my Traditional TSP and leave the Roth alone??? 🙁

TSP Spousal Beneficiary Withdrawal Options

If you are the spousal beneficiary of a TSP it’s imperative for you to read this 23 page brochure. I will provide some highlights here but you really need to take some time to read this on your own too.

For example, your spouse just died and you inherited his TSP.  You will be automatically set up with a Beneficiary Participant Account(BPA).   Now, if you have your own TSP account you may be inclined to transfer your BPA into your own TSP.  Wait! Before you act understand that:

“In general, once you combine your beneficiary participant account with your existing TSP account, your beneficiary participant account money will be subject to the rules that govern the account to which it was moved.”

There may well be reasons to keep the accounts separate. You may need some money but are not yet 59.5.  If you roll over the BPA to your TSP,  you will have early withdrawal penalties.

But…

“There is no early withdrawal penalty tax associated with withdrawals from the beneficiary participant account established for you after your spouse’s death. There is, however, an early withdrawal penalty tax associated with regular civilian or uniformed services accounts. Therefore, if you have your own TSP account and you want to move your beneficiary participant account into that account, the early withdrawal penalty rules will continue to apply to all of the money in your existing account.”

That’s a big deal. Be advised, ALL retirement accounts operate like this. If you are under 59.5 it usually does not make sense to roll over inherited retirement accounts into your own. Doing so means you’re now subject to penalties you would not have otherwise been if you just left the account as an inherited account, or in the TSP case a BPA.

 

One Time Partial Withdrawals of BPA

Unfortunately, you’re still subject to big restrictions on when you take a distribution out of your BPA, just like the restrictions for the initial account owner; You can only make ONE partial withdrawal.  Just one.

 

Only Three Options for Full Withdrawals of Thrift Savings Plan (TSP) BPA

  • Lump Sum
  • Monthly Payments
  • Annuity

Thankfully you can transfer your BPA to another IRA, or eligible retirement account.  But this is what ticks me off to begin with. I don’t want you to transfer your account to a different plan. I want you to keep the account in the TSP because it is so valuable as it is. But with the restrictions on when you can take distributions, it does pose a huge hurdle to jump.

 

 

Heirs of a Beneficiary Participant Account (BPA) Must Take a Lump Sum

ANOTHER mind-boggling restriction for the BPA is that your heirs can not roll it over to an IRA!

“Death benefit payments made from your beneficiary participant account must be paid directly to your beneficiary(ies). These payments are subject to certain tax restrictions and cannot be transferred or rolled over into an IRA or eligible employer plan. In addition, your beneficiary(ies) will have to pay the full amount of taxes on the taxable portions of the payment in the year it is received.”

So, a Lump Sum will be paid immediately to your beneficiaries and they will be responsible for any and all taxes!

 

Distributions From Retirement Accounts are Taxed as Ordinary Income!

The problem with your beneficiaries being forced to take a lump sum is that the amount is added to their gross income and will be subject to their marginal tax bracket.   If they are a single taxpayer with taxable income of $100k and they receive a $50k lump sum distribution they’re going to pay $11,000 in taxes to the Feds, right out the gate.

Let’s say they live in Georgia. They’re going to pay another $3,000 in taxes.  So, that $50,000 distribution will net them all of $36,000.  That is a lot of taxes!

If they were able to distribute this account in a more strategic fashion they could save a bundle on taxes.  But because of the genius of the folks who design the TSP distribution rules any tax planning options are not allowable to beneficiaries of TSP accounts. Thanks folks!

 

Non-Spouse Beneficiary of a Thrift Savings Plan (TSP) Account

Believe it or not, non-spousal beneficiaries actually have MORE options for taking distributions upon inheriting a TSP. Now, please understand, a non-spouse beneficiary of a TSP is NOT the same as a beneficiary of a BPA.   Remember a BPA is the account set up for a spouse of the deceased TSP owner.  To reiterate, the beneficiaries of the BPA must take a lump sum distribution of whatever is left in the BPA.

 

Point to Remember: BPA  is the Spousal Beneficiary Account of the TSP Owner

Beneficiaries of a BPA can NOT rollover that account to an inherited IRA but BPA account owners can.

Non-Spouse beneficiaries of the TSP CAN roll the account over to an inherited IRA though!

 

Options for Non-Spouse Beneficiary of Thrift Savings Plan (TSP)

Non-Spouse Beneficiary of TSP have all of two options to take distributions:

  1. Lump Sum Distribution
  2. Rollover to an inherited IRA

See this from the TSP brochure on Death Benefits:

“Non-spouse Beneficiary. A beneficiary who is not a surviving spouse cannot retain a TSP account. The death benefit payment will be made directly to the beneficiary or to an “inherited” IRA.”

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Unfortunately, the VERY NEXT PARAGRAPH in that just referenced brochure says:

“If a beneficiary participant dies, the new beneficiary(ies) cannot continue to maintain the account in the TSP. Also, the death benefit payment cannot be transferred or rolled over into any type of IRA or plan.”

To the untrained eye, those two statements may seem directly opposed.  One says Non-spouse beneficiaries CAN rollover to their own IRA. The other statement says “death benefits can not be transferred to any type of IRA…” But there is a HUGE difference.

Difference Between the Beneficiary of Beneficiary Participant Account and a Non-Spouse Beneficiary of a TSP account.

I can not stress enough the critical differences.

First: You are the TSP Owner.  You name your kid, Joey, as beneficiary.  At your death, Joey, has 2 options. He can take a fully, taxable lump sum distribution. Or he can rollover your TSP to his own inherited IRA.

Second: You are the TSP Owner.  You name your wife, Judy, as beneficiary.  At your death, Judy opens up a Beneficiary Participant Account (BPA) and rolls your TSP over to that BPA. She names Joey as beneficiary of that account.

When Judy dies, Joey inherits the account but MUST take a lump sum distribution. He can not rollover the BPA to an inherited IRA.  He can not keep the account open in the BPA.

Ultimately, when Joey (the non-spouse beneficiary)inherits he can not keep the TSP or BPA open. If he inherits the TSP, he can rollover it over to his own inherited IRA.  If he inherits the BPA he must take a lump sum distribution.

Clear as mud???

 

Easy Thrift Savings Plan (TSP) Investing Strategy

Now, do NOT let the complexities of the distribution options turn you off from the TSP.  The Thrift Savings Plan is the best account out there.

I hear some people say there are not enough investment options.  Huh? What more could you possibly need?

You’d be hard-pressed to go wrong with a simple 20% allocation into each of the funds:

C Fund – Large Cap US Stocks

S Fund – Small Cap US Stocks

I Fund – International Stocks

F Fund – US Corporate Bonds

G Fund – US Government Bonds

 

Put 20% in each, and at the start of the year, rebalance so you still have 20% in each. The most simple, and cheapest, investment portfolio in the world.  Will you miss anything by not have more options? No. The only thing you’ll miss are high fees.

 

You want to be more aggressive? Put more into the C, S and I fund and less in the F and G Funds.

 

You want to be more conservative? Put more in the F and G Funds and less in the C, S and I Funds.

 

Nothing could be easier.

 

I can’t predict the future, but a portfolio of TSP funds most likely will dwarf a similarly allocated higher expense portfolio in the future.  Again, your TSP portfolio costs 38 cents per $1,000 per year.  A portfolio with fees of 1% costs $10 per $1,000 per year.  That is a very high hurdle for those expensive investments to jump over.

So, hopefully, I’ve been able to convince you of the value of the TSP.  However, you can’t just casually overlook how you name your beneficiary designations.  There is too much riding on getting this correct.

Remember if you are single, you have limited options on your ability to take distributions.  The most frustrating is you can’t just call TSP and say send you a check for any amount when you like. As of this writing (Feb. 2018) TSP doesn’t allow that.

If you are married and name your spouse as beneficiary, he/she will have some more limits on his/her distribution options.  If she has her own TSP account she can rollover yours to her own when you die.

If she doesn’t have her own TSP, a BPA will be opened. She CAN transfer to her own IRA though, which is good. But like what happens with you, she can’t just call TSP and requests money when she wants. Again, doesn’t work like that.

 

If there is still money in the account when she dies her heirs MUST take a lump sum, they can not roll the account over to an inherited IRA.

 

Lastly, if you, the TSP owner, do not name a spouse as beneficiary but say your kids, or any other non-spouse beneficiary, it’s pretty easy for them: Lump sum distribution or rollover to an inherited IRA. Easy as pie.

 

What Should You Do?

Keep the account as long as possible. Remember you must start taking distributions by April 1st of the year AFTER you turn 70.5.   If it turns out you need more money than the distribution amounts allow, well, in that case just roll the account over to your own personal IRA.

If you do name your spouse beneficiary, when you die and she inherits, at that point it’s probably best she roll the balance to her own IRA so the heirs she names, maybe your own kids, have more flexibility in their distribution options

Ultimately, the TSP is too valuable not to take advantage of.  Just understand your distribution options.

Never hurts to send a nice PERSONAL handwritten letter to your Reps in DC too.  In fact, start a petition to get them to change the rules.  The distribution rules as they are today are dumb. No other way around that.

 

Dumb is not good financial planning.

 

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