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Does Rolling Over Your TSP Account to a Traditional IRA Make Financial Sense?
Edward A. Zurndorfer, Certified Financial Planner
Many federal employees who are getting close to their retirement date or who are
contemplating leaving federal service face the question of what to do with their
Thrift Savings Plan (TSP) accounts.
One withdrawal option is to rollover or to transfer their TSP accounts to a
traditional IRA. The question is: Does a rollover or a transfer of the TSP to a
traditional IRA make good financial sense? This column discusses the advantages
and disadvantages of a TSP rollover to a traditional IRA.
One fact is for certain, namely: there is no lack of companies in the
financial services industry - this includes banks, credit unions, insurance
companies, and broker dealers - that are waiting for the opportunity to rollover
or transfer employee TSP, 401(k) or 403(b) company retirement plans. According
to the Investment Company Institute, more than 50 million employees in public
service and in private practice hold $3 trillion in retirement plans that can
potentially be rolled over to financial service company-directed rollover IRAs.
For these companies, millions of employees could turn over their retirement
accounts resulting in billions of investment dollars and thousands - perhaps
millions of dollars - in commission income. Some discount brokerages are
offering a $500 bonus to individuals who rollover their retirement plans to
their brokerage.
In spite of any monetary incentives for rolling over their TSP accounts,
federal annuitants and employees need to consider the advantages and
disadvantages of TSP rollovers to a traditional IRA before embarking on such a
significant investment decision for their retirement.
First, consider the potential advantages of a TSP rollover:
• The TSP offers a limited number of investment choices. The five TSP funds -
the C, S, I, F and G funds - while a fairly broad-based choice of stock and bond
funds - are still somewhat limited in overall diversification. By rolling over
the TSP to a self-directed IRA, the TSP account owner will have more investment
options and be able to potentially diversify their portfolio.
• There are more withdrawal options and flexibility in withdrawing money with
a traditional IRA compared to the TSP withdrawal options. For example, many IRAs
allow their IRA owners to withdraw the money as needed in a "non-systematic"
manner. On the other hand, the TSP has a set number of ways in which monies may
be withdrawn from a TSP account.
• Having all of one's retirement accounts in a single IRA - this
includes one's TSP, monies from a 401(k) retirement plan or a 403(b)tax
sheltered annuity - make it easier to monitor one's investments, set appropriate
asset allocations, and rebalance the account as needed. It is also easier to
handle minimum required distribution after the TSP account owner becomes age
70.5. With traditional IRAs, one's required minimum distribution (RMD) is based
on the total amount in all one's IRAs. If a retiree also has a TSP account, a
401(k) retirement plan, and/or a 403(b) tax-shelter annuity account at age 70.5
and later, then the retiree must calculate the RMD separately and take the money
from each type of account.
• An IRA has estate planning opportunities, especially with respect to
non-spousal beneficiaries such as children. A child who inherits an IRA can take
tax-deferred distributions spread over his or her lifetime. While the TSP allows
non-spousal beneficiaries to rollover their inherited TSP accounts to an
inherited IRA which will allow beneficiaries to receive lifetime income from
their inherited IRAs, TSP rollovers to "inherited IRAs" can be tricky. A TSP
account owner could therefore best off handling the transfer from the TSP to
their own "rollover" IRA himself or herself rather than leaving it up to his or
her heirs to handle an inherited TSP account rollover to an inherited IRA.
Now consider the advantages of not rolling over a TSP and instead
keeping the money in the TSP account, at least initially:
• There is no 10 percent early withdrawal penalty for TSP withdrawals for
account owners who left or retired from federal service in the year of and after
the account owner became age 55. If the TSP account owner rolls over TSP money
to a traditional IRA, then the account owner must be 59.5 years or older to
withdraw the IRA account without being subject to a 10 percent early withdrawal
penalty. Keep in mind that this is not an "all or none" proposition. The TSP
allows account owners to leave some of their monies in the TSP while moving the
rest to a rollover IRA. This could leave sufficient funds in the TSP to cover
expenses or possible emergencies until age 59.5, while moving the remaining TSP
fund to a rollover IRA.
• Protection from creditors. Those TSP account owners who have credit
problems should consider keeping their TSP accounts and not roll them over to an
IRA. That is because creditors in bankruptcy proceedings and plaintiffs in civil
lawsuits cannot touch the TSP. IRA have limited protection and these limitations
vary from state to state.
• An individual who is still a federal employee at age 70.5 does not have a
RMD for the TSP. Those federal employees who work past age 70.5 are not required
to take the annual RMD from their TSP. An IRA owner must start taking RMDs
starting at age 70.5 and every year thereafter, whether the IRA owner is working
or not.
• Non-spousal beneficiaries can transfer their inherited TSP assets to a Roth
IRA (and paying the taxes due on the transfer). On the other hand, if a TSP
account owner rolls over the TSP account to an inherited traditional IRA, then a
non-spouse beneficiary cannot convert the inherited traditional IRA to a Roth
IRA.
Another important factor in deciding whether or not to make a rollover is
comparing TSP expenses versus the expenses of a traditional IRA. This may be a
difficult task because an IRA's administrative and record-keeping fees are not
listed on individual investment statements. One way to compare costs is to
compare fund expenses, usually expressed as the "expense ratio", of the TSP to
the fund expenses of an IRA invested in a mutual fund. An "expense ratio" is
determined through an annual calculation in which a fund's operating expenses
are divided by the average dollar value of its assets under management.
Operating expenses are taken out of a fund's assets and lower the return to a
fund's investors. The expense ratio of a mutual fund's various funds should be
listed on the fund's Web site. A fund expense ratio of one percent or less is
desirable. The TSP expense ratios for the C, S, I, F and G funds have averaged
less than 0.06 percent over the last 20 years, most probably the lowest expenses
in the investment industry. Another potential cost to TSP account owners who
transfer their accounts through a financial service or investment company -
commissions. The TSP does not charge commissions when employees contribute to
the TSP. On the other hand, a transfer through a licensed broker to a
mutual fund will most likely result in the TSP account owner paying a commission
to the broker.
Finally, when moving money from the TSP to a rollover traditional IRA, TSP
account owners should be sure to follow the strict IRS rules governing
rollovers. The TSP will only send TSP money to a traditional IRA that has been
previously established with an IRA custodian. The money should be sent
"directly" - meaning a direct transfer - from the TSP to the IRA. If, on the
other hand, the TSP sends a check made out to the TSP account owner in his or
her name, it is considered a taxable distribution and the TSP must withhold 20
percent in federal income taxes. The TSP account owner must then come up with
the 20 percent withheld and, within 60 days, send the entire withdrawn amount
from the TSP to the IRA. If the 60 day deadline is missed; then the IRS will tax
the entire withdrawn amount, thereby losing the chance for additional
tax-deferred growth.
About the Author
Edward A. Zurndorfer is a Certified Financial Planner, Registered Health
Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in
Silver Spring, MD and the owner of EZ Accounting and Financial Services, an
accounting, tax preparation and financial planning firm also located in Silver
Spring, MD. He is an instructor at federal employee retirement
seminars throughout the country for the National Institute of Transition
Planning, Inc. and writes numerous columns and books on federal employee
benefits.
Posted: 06/28/2010
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