Episode 73 TSP Quirks

Today's content comes directly from  Brian O'Neill’s recent blog post Top 10 TSP Quirks You Need to Know.  Brian is a fellow Military Financial Advisor Association member , former Air Force fighter pilot, and Certified Financial Planner who writes a great weekly blog with a fighter pilot twist. Thanks, Brian.

If you’ve ever compared the Thrift Savings Plan (TSP)  to a civilian 401(k), you probably noticed the TSP has quite a few quirks:

1. Minimum balance: As long as you leave at least $200 in your TSP when you seperate from service, you can keep your TSP account open.  This is great because you never know when a change in employment or the tax law will make it advantageous to roll money into the TSP. 

2. Accepts rollovers: Except for a Roth IRA dollars, you can roll a Traditional IRA, and most other employer plan (e.g., 401(k)) funds into the TSP.  This can be great for simplifying your roster of retirement accounts.
3. Three Withdrawal options after separation:
Fixed or life-expectancy-based installment payments. For installments of less than 10 years, you can rollover the distributions to an IRA.  Single withdrawal: The minimum is $1,000 and you can only do one every 30 days.  Purchase an annuity. This locks in a fixed stream of payments for life, but you forfeit any right to leave the annuity balance to your heirs.

 4. Roth or Traditional withdrawals: You can choose Roth, Traditional or pro-rata withdrawals.  If you have contributions from a combat zone, your contribution is not taxable but the earnings are. Withdrawals from your Traditional balance will always be pro-rata from pre-tax and after-tax dollars.

 5. Processing delays.  Along with the military and civil service human resource bureaucracy delays, the TSP can be pretty slow processing any request.  Plan ahead, it’s not an ATM.

6. Spouse rights. If you choose to receive your TSP as a separately-purchased annuity, your spouse will need to consent to anything other than a 50% survivorship feature.

7. Death Treatment: Your balance will go to your beneficiaries on file with TSP, and NOT according to your will. And you must use form TSP-3 to change the d default beneficiaries.  A surviviing spouse's TSP account is automatically invested in an age-determined Lifecycle Fund. A non-spouse beneficiary can't keep the TSP account and will need to receive the funds in an Inherited IRA. If your beneficiary then dies, the TSP will pay the balance directly to that beneficiary’s beneficiary allot once, potentially creating a “tax bomb.”  If you inherit a TSP account, roll it to an Inherited IRA so a successor beneficiary keeps the tax-advantaged status.

8. The G-Fund. The G-Fund invests in special government bonds that its guaranteed to never lose principal value. But the G-Fund is usually the lowest performer of the 5 core TSP funds.  It can make sense as part of a portfolio, but usually is  NOT all.

9. Withdrawals are pro-rata from all funds. You can’t take a distribution from only the G-Fund or C-Fund, for example. A withdrawal is pro-rata across all them.  For a work around  after your withdrawal comes out, log into TSP and rebalance your funds to the allocation you want to keep. 

10. Roth RMDs. A Roth IRA does not have a Required Minimum Distribution (RMD).  Traditional IRAs, 401(k)s, and the both Roth and Traditional TSP all require you to start taking RMD every year starting age 72. Evaluate moving of Roth TSP dollars into a Roth IRA prior to 72.

Transcript

Announcer: 0:14

Welcome to the Money Pilot Financial Advisor podcast where you team up with Money Pilot founder, former Army helicopter pilot and your host Katie Cannon, you put your money where your heart is. Together, we'll tackle issues big and small so you can take charge and land your financial life.

Kathleen Cannon: 0:53

Hello, and welcome back to the podcast. The other day, I was reading some blog posts on financial advisor Brian O'Neill's website, wingedwealth.com. Brian's a fellow Military Financial Advisor Association member, former Air Force fighter pilot, and Certified Financial Planner who writes a great weekly blog with a fighter pilot twist that is recommended reading for any of our military service members and family members. His October 21 blog The Top 10 TSP Quirks You Need to Know is a good example. So with Brian's blessing, today I'm shamelessly sharing his insights with you. I'll put a link to his blog, his website and the MFAA website in the show notes. Thanks, Brian. All right. The Thrift Savings Plan is the largest employer sponsored retirement plan in the country. But if you've ever compared it to a civilian 401k, you've probably noticed some differences. As a quick recap of TSP, the TSP is like a 401 K. But for federal employees and military service members, it mimics many of the same rules. The TSP basics feel a lot like your IRA or your friends 401 K. You put money in, you get favorable tax treatment, and you use the money in retirement. As a quick recap, for 2022 you can contribute $20,500 a year to TSP. Or if you're 50 year older$27,000 a year. BRS military and FERS civilians receive up to 5% in matching contributions to your TSP and you can contribute to traditional TSP or Roth TSP. And by industry standards. TSP expenses are very transparent, and very low. But the TSP has quite a few quirks that can leave you scratching your head if you're not tracking them ahead of time. Some of these quirks are great, and a good argument for staying in the TSP to the bitter end. others not so much. So let's get started with Brian's top 10 list of TSP quirks. Quirk number one, the minimum balance as long as you leave at least $200 in your TSP when you separate from service, you can keep your TSP account open. And this is great because you never know when a change in your employment or the tax law may make it advantageous to roll money into the TSP. Which brings up quirk number two, the TSP accepts rollovers except for Roth IRA dollars, you can contribute a traditional IRA and most other employer plans like other 401 K's into your TSP. This can be great for simplifying your roster of retirement accounts and taking advantage of those lower fees. TSP quirk number three, there are three withdrawal options after you separate installments. The TSP can send you fixed or life expectancy based payments in any amount of at least $25. The number of years you choose for your installment payments has some side effects. If you choose installments of less than 10 years, you can roll over the distribution into an IRA over 10 years you can't you can also take a single withdraw. The minimum is $1,000 And you can do this every 30 days, but only 30 days due to the slow TSP processing times. And number three, you can purchase an annuity. While this is kind of uncommon. Some retirees choose to trade all or part of your TSP balance for an immediate annuity. This locks in a fixed stream of payments for life, but you forfeit any right to leave the annuity balance to your heirs. Alright, so that was withdrawal options after separation. On to quirky Tip number four, Roth or traditional withdrawals. A great feature of the TSP is that you can choose Roth traditional or pro rata that some of each withdrawals. If you're trying to fill up tax brackets, this strategy can help. Remember, if you're making only Roth contributions to TSP, and our BRS military or FERS federal employee, you will have a traditional TSP balance as well, because your government match is always a traditional contribution. If you have contributions to your traditional TSP from a combat zone, your contribution is not taxable, but the earnings are. So then withdrawals from your traditional balance will always be pro rata from the pre tax and after tax dollars. This usually doesn't result in a large tax benefit because most members don't contribute large tax free sums, but it's something to be aware of. Also, the ability to withdraw or rollover, Roth dollars separately is excellent. Moving a Roth TSP balance to a Roth IRA, for example, prevents forced required minimum distributions or RMDs. On the Roth balance at age 72. We'll talk a little bit more about this below. And you may remember last week's podcast was about required minimum distributions. So if you want more information on that, you can go back to last week's podcast. All right, TSP quirk number five, processing delays now in the government are probably pretty familiar with things moving a little slowly. If you've ever tried to change your TSP contributions or asset allocation, you've probably noticed a bit of a delay from flash to bang, along with military service and civilian service human resources, bureaucracy delays, the TSP can be pretty glacial in processing, withdrawal request, change requests, beneficiary change requests, but basically all requests you'll need to plan and some lead time when accessing your funds because it's not going to operate like an ATM machine. All right, Quirk number six spouse rights. If you choose to receive your TSP as a separately purchased annuity, your spouse will need consent to anything other than a 50% survivorship feature.

Unknown: 8:26

Quirk number seven death treatment. The TSP has interesting rules surrounding the death of a participant. First, the default beneficiaries are automatically listed as your spouse, then your children and their descendants, then parents, then the executor of your state, then next of kin by state law, you must use Form TSP three to change this. And remember your will a prenup agreement or any other legal document will direct the flow of TSP dollars after death. But the TSP rules supersede these contracts. Keeping your beneficiaries up to date is crucial after family changes like a divorce or if you have a blended family. So remember to keep those beneficiaries up to date. Number two, a spouse that receives your TSP account after you pass will find that it's automatically been invested in an age determined lifecycle fund. A non spouse beneficiary cannot maintain the TSP account and will need to receive the funds in an inherited IRA. Warning. If you're a beneficiary participant then dies. The TSP will pay the balance directly to that beneficiaries beneficiary, potentially creating a tax bomb. So here's an example how that might happen. Let's say you're a TSP owner and you die with your spouse listed as a beneficiary of your $500,000 traditional TSP balance. So after your death, your spouse receives a beneficiary account within TSP, and they list a child as a beneficiary. But let's say unfortunately, your spouse then dies, and the TSP pays the beneficiary that child the$500,000 balance all at once. So the child's tax bracket skyrockets to 35% or more for that year. So if you inherit a TSP account, it's well worth it. In this example, $175,000 worth it to investigate rolling a TSP beneficiary account into an inherited IRA. This will allow that second beneficiary to keep the tax advantaged status of the IRA in accordance with the current tax law, which probably means a 10 year delay before they have to withdraw. Otherwise, you may be leaving the taxman a hefty tip. ll right, TSP Quirky Tip number eight, the G fund, the G Fund invests in government bonds, but it doesn't in a way that's guaranteed to never lose principal value. And you'll have an extremely difficult time or impossible time finding such a guarantee and a commercial investment. The downside is that the G fund is usually the lowest performer of the five core TSP investment, it can make sense as part of your portfolio, but it's usually not the best for your entire portfolio. Quirky Tip number nine, withdrawals are pro rata from all funds. While you can specify that you want to take a withdrawal from only pre tax or after tax dollars, that is a Roth or a traditional account, you can't specify that you want to make a distribution from only the G fund or the C fund. For example, if you own all five funds, are withdrawal as pro rata across all of them. This makes a lot of strategies difficult in the TSP. For example, if you like to use separate buckets for near term midterm and long term dollars in retirement, the G fund would probably be a major part of that near term bucket. But every withdrawal would also include funds from the C fund, for example, as well. If you're trying to let your C fund recover from a market downturn, and want to take only G fund dollars out with your withdrawal, no soup for you. Now a workaround is just after your withdrawal comes out. You can log into TSP and rebalance your funds to the allocation that you want. It's a hassle and markets can change in the meantime, but it is a workaround. All right. And now we're rolling into quirky TSP tip number 10 Roth required minimum distributions. So we already mentioned this above, but it bears some repeating a Roth IRA does not have a required minimum distribution at age 72. Traditional IRAs 401 Ks, and both the Roth TSP and traditional TSP all require you to start taking life expectancy based distributions every year starting at 72. You lose some control with this about how much income you're getting. And that impacts your taxes. RMDs on a Roth account, like TSP forces you to essentially put those dollars back in circulation and then spend it or invest it into a taxable account. Your growth on those reinvested RMDs is now taxable, you lose that continued Roth tax free growth. Roth our RMDs also prevent one of the greatest Roth advantages, passing tax free wealth onto your heirs. So with good planning, you should at least evaluate moving Roth TSP dollars into a Roth IRA prior to reaching your RMD age which again, is 72. All right, wrapping things up. The TSP is inexpensive, that is it has very low fees and is elegant in its simplicity, but it does have some quirky rules or acquire some people Planning to manage. It may seem fire and forget during your working years. But a head in the sand strategy won't help you maximize the performance of your retirement dollars after you separate or retire from military service. You'll want to update your TSP planning every year to make sure your money goes where you want it. And don't leave the IRS a big tip. Thank you again to Brian O'Neill. Today's podcast was entirely his insightful work. You can read more on his website, wingedwealth.com/insight. And again, those links will be in the show notes. And we'll talk with you again next week.

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