What to do with your TSP funds when you leave Military Service
Since most military members participate in the Thrift Savings Plan in some capacity, it is essential to know what your options are when you leave military service, either via retirement or otherwise. There are many options and even more wrinkles to consider.
For a brief history of the TSP, look here. For those leaving military service, it is typically either after an enlistment or service agreement or due to retirement. Whatever the case, when you leave military service, you have many more options available to you for your TSP funds than when you are “in service”. These options range from simply leaving your money in the TSP to “rolling over” your funds to an Individual Retirement Account (IRA). I will review most of the options below with the intent of providing information that will ultimately lead to you making the best choice for your TSP funds.
TSP Investment Options
For a good review of the investments available within the TSP, look here. The rest of the article will deal with what to do with your TSP funds overall, not specific investments.
Before going any further, it is worth mentioning TSP Loans. For those who have chosen to take-out a TSP Loan, you should be aware that when you leave government service, you have 120 days to replay all obligations due for the loan. At the 120-day point, any outstanding balance is treated as a distribution. This “distribution” is treated as ordinary income for tax purposes and also brings a 10% early withdrawal penalty if you are under 59 ½, which is most people leaving military service. So, if you are planning to exit military service and have an outstanding loan, please make sure to take the repayment requirement seriously.
A Few Terms to Understand
Before getting into the playbook, let’s define some key words:
- “Eligible Employer Plan” – this term refers to various employer sponsored retirement plans, including the following: (i) 401(k) plans; (ii) profit-sharing plans (ii) defined benefit plans; (iv) stock bonus plans (v) money purchase plans; (vi) 403(b) tax-sheltered annuities; and (vii) 457(b) plans.
- “Roth”: contributions to your TSP account with pay that’s already been taxed.
- “Qualified Distribution” – for a distribution to be “qualified,” it means your Roth earnings are distributed tax-free by meeting both of the following criteria: (i) Five years have passed since January 1 of the first year you made Roth contributions to your TSP account; and (ii) You are 59 ½ years of age or older OR you have a permanent disability.
- “Traditional” – everything in your account that is not in your Roth balance. This amount includes the following: (i) all your non-Roth contributions; and (ii) any contributions made by your employer, regardless of what type of contribution matched.
- “Transfer” – This is a movement of your funds that goes directly from the TSP to your new Custodian, thus YOU never receive the funds. It is critical to understand this point.
- “Rollover” – This is a movement of funds where you receive an actual check (or electronic deposit) and then deposit the funds into a qualified account within 60 days. This is fundamentally different than the transfer defined above.
- “Proportionality” – It is absolutely essential to understand that ALL TSP distributions are proportional, which means funds are taken in equal portions from your Traditional, Roth, and Roth Earnings balances. The Example below will illustrate this concept.
Let’s assume the following:
- $100,000 Total TSP Account Balance
- $60,000 Traditional
- $40,000 Roth ($15,000 contributions; $25,000 earnings)
- You are 50 Years Old and have no permanent disability
- You desire the withdraw $1,000
The following depicts how this distribution is taxed:
A few points to consider:
- The Traditional Portion is ALL taxable, which is the case for all Traditional distributions.
- The Roth Earnings portion is taxable as well…in this example, you are not yet 59 ½.
- The portion that came from your Roth contributions - $150 in this case – is not taxed regardless of your age as these funds have already been taxed.
In reality, all TSP contributions should be thoroughly examined for the tax implications prior to receiving funds…undoing distributions is a messy affair. If you are in doubt, seek the assistance of a financial professional before pulling the trigger on a distribution.
What Can You Do?
The Thrift Savings Plan has several choices available to you upon leaving Military Service. The choices are as follows:
- Leave Your Funds in the TSP
- Receive a Single Lump Sum Payment
- Move assets to another Qualified Plan
- Receive a Series of Equal Monthly Payments
- Receive payments based on your IRS Life Expectancy
- Full Withdrawal as Life Annuity
- A combination of the above options
Let’s discuss each in a bit more detail.
Leave Your Funds in the TSP
There is absolutely no requirement to move your funds out of the TSP when you leave Military Service. In fact, leaving your funds in the TSP may be the best option for you…the TSP has rock-bottom fees and a diversified selection of Investment Options, including Lifecycle Funds that adjust asset allocation as you age. Moreover, you can transfer funds into the TSP from other Qualified Plans if you like
Who should do this: If you are content with the TSP and have nowhere else better you would like to move the funds, keep it simple and stand pat. Like I said, the TSP is a high-caliber Qualified Retirement Plan. If you are exiting the workforce and want a place where your funds can stay while you enjoy retirement, the TSP is a cozy place. An important reminder for this option deals with Required Minimum Distributions (RMDs). Like with a Traditional IRA, TSP Distributions must begin at age 70 1/2. One wrinkle deals with Roth TSP Funds...distributions must also begin at 70 1/2, which departs significantly from Roth IRAs, where there is no requirement to take a distribution at any age.
Receive a Single Lump Sum Payment
This is a straight-forward option…simply tell the TSP folks you want your money and they send you a check. You can use the example above as a guide for the tax treatment of this type pf distribution.
Who should do this: This option is highly dependent upon your circumstances. Once you choose this option, it cannot be undone, so careful consideration of all implications - tax and otherwise - is essential. If in doubt, please talk to a financial professional before liquidating your retirement account(s)!
Move assets to another Qualified Plan
This option is also relatively straight-forward. Regardless of what type of qualified plan will receive your TSP funds, you must have already established the account in advance of the transfer request. Please note, if you have both Roth and Traditional Funds, in the case of IRA Transfers, you will need to have both Roth and Traditional IRA Accounts. Also, you must verify that the new account is eligible to receive your TSP Funds…not all employer-provided plan accept funds from different qualified plans. And finally (and most important), when possible, you should affect transfers to qualified plans via a Trustee-to-Trustee transfer. Otherwise, you have to deal with personally receiving funds, which has its own set of gotchas. Keep it simple and avoid receiving the funds if you can.
Of note, if you are married and want to transfer your TSP Funds, you will need to attain your spouse’s consent to this action. The TSP Transfer Forms have specific waivers spouses must consent to in the presence of a Notary Public. Please make sure to do this step as the transfer requests will be disallowed without it.
Who should do this: For those who like simplicity in their account management, consolidating accounts may be an attractive option. Moreover, if your new employer plan has more (or in your opinion, better) investment options, this may also be desirable for you. For those moving funds to an IRA, you will have considerably more investment options available to you. Moreover, if you employ a financial professional to manage your funds, she will be able to directly manage the funds on your behalf in an IRA. As of this writing, Financial Professionals cannot manage TSP Funds directly on its platform.
Receive a Series of Equal Monthly Payments
With this option, you will receive a set amount of money defined by you until all funds are exhausted. For example, if you have $100,000 in your account and desire $10,000 per month, you will receive 10 monthly payments of $10,000. The taxability of the payments will be proportional as they were in the previous example.
Who should do this: Whenever you have an exact expense for a defined period, this may be an option for you. A residential mortgage is a good example. Let’s say you have a mortgage with 20 years remaining of $1,000 per month payments. And further assume, you have $240,000 of all Roth funds in your TSP and you are over 59 1/2 and have met all the criteria for “Qualified” distributions. You could simply say you want $1,000 per month for 20 years and match your mortgage payment with your TSP Distribution. Of course, you would potentially have investment earnings along the way…this is a simplified example.
Receive payments based on your IRS Life Expectancy
For this option, your initial payment amount is determined by a combination of your account balance and age on your age upon receipt of your first payment. Each January thereafter, the TSP recalculates your monthly payment, again based on your age and account balance at the end of the preceding year. Of note, investment gains or losses will factor into the payouts. Taxability of the distributions is again determined via proportionality.
Who should do this: If you are entering your "retired years" and need income for the remainder of your life, this option may be for you. IRS Life Expectancy Tables are geared to have your money last well past age 100, thus while you could theoretically run out of money, though in practice, that is usually not the case. Of note, you are still exposed to market risks with this option, which can work for or against you. If you need GUARANTEED payments, this is not the option for you.
Full Withdrawal as Life Annuity
With this option, the TSP will purchase an annuity for you from the Metropolitan Life Insurance Company, the TSP’s annuity provider. You must annuitize at least $3,500 of either or both of your Traditional or Roth Funds. Annuity options will be the subject of a separate article. For now, please know your choices ranges from an Annuity based solely on your life to Annuities with other guarantees for your Survivors when you pass away. In general, the more guarantees, the lower the payout. Taxability is also a separate issue to consider before deciding an annuity is for you. Finally, once you commit to an annuity, the choice cannot be undone, so it is critical to have a robust entrance strategy.
Who should do this: For those who need lifetime income not subject to market risk, an annuity may be for you. An annuity is one of the few investment products specifically designed so you do not outlive your money. That said, annuities are not without shortcomings, though that is true of nearly all investment products. So who might want do this? If you know in advance you will have a lifetime expense - perhaps for a special needs child or in-home health care not otherwise covered by insurance - an annuity may be for you. There are many potentialities where a lifetime income stream makes sense.
A combination of the above options
The flexibility of distribution options provides the prudent planner a formidable tool set to address various planning needs. For those who enter military service at or around 20, maximize their TSP Contributions, and then leave the funds in the plan until age 70, it is conceivable you may amass an ending account balance approaching $1 Million. At those asset levels, you can combine withdrawal with annuities and specified payouts to craft the ideal plan for you. True, it can be a daunting endeavor, though that is why it is a good idea to consult a financial professional when you are kicking ideas around.