Business is booming for investment brokerage firms that are convincing Federal employees and members of the armed forces to roll their Federal defined contribution retirement plans – Thrift Savings Plans – into more traditional plans, like self-directed IRA's.
But is it the right choice?
Often, but certainly not always. Mostly it depends on what type of investor you are.
What is the Thrift Savings Plan?
The Thrift Savings Plan – or TSP – is the government equivalent of a 401(k) plan. It is a retirement savings and investment plan for federal employees and members of the military, including the ready reserve.
It was established under the Federal Employees’ Retirement System Act of 1986. Like other retirement plans, it provides savings and tax benefits, such as tax deferral of contributions and investment earnings within the plan.
A TSP is a defined contribution plan, which is to say that how much you put get out of it – and how much will be available upon retirement – will depend upon the contributions that you have made during your working years, as well as the success of the investments you held in the account.
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What are your investment options in a TSP?
TSPs offer a more limited investment selection than IRA plans, and many 401(k) plans as well.
There are five basic choices:
G Fund. This is a fixed income fund that invests in a non-marketable US Treasury security. Because of this, the value of the investment is guaranteed, and will never lose principal. (We can presume that the “G” designation for this fund means “government”.)
F Fund. This is a bond fund held through Barclays Capital US Aggregate Bond Index, which is an index fund tied to the US bond market. The fund invests primarily for interest income, as well as potential capital appreciation should some of the bonds in a portfolio increase in value. Naturally, with the potential for capital appreciation also comes some risk that you can also lose money.
C Fund. This is the stock fund, and it’s invested to match the performance of the S&P 500 Index.
S Fund. This is another stock fund, except that it’s invested to match the performance of the Dow Jones US Completion Total Stock Market Index. That is an index covering the broader stock market, but not including companies that make up the S&P 500 Index.
I Fund. This is the international fund that matches the performance of the Morgan Stanley Capital International EAFE Index. EAFE stands for Europe, Australasia and the Far East.
There is also the L Fund, which is a life cycle fund based on a mix of the five funds above. That fund however was closed to new plan participants in 2010.
How do TSP withdrawals work?
TSPs come with a wide assortment of withdrawal options. If you are leaving Federal government service, you can take withdrawals by any of the following methods:
Partial withdrawals – you can make this on a one time basis, and leave the balance in your TSP.
Full withdrawal as a single payment – this is a lump sum distribution of the entire account balance.
Full withdrawals as a series of monthly payments – you can choose to take the withdrawals based on a specific dollar amount, spread over your life expectancy, as a life annuity, or as a combination of methods.
There is also a special allowance for participants in the uniformed services who have served in a combat zone. TSPs offer Tax-Exempt Balances for the Uniformed Services in which the participants contributions are exempt from Federal income taxes when they are distributed. The earnings on those contributions will accumulate on a tax deferred basis, and be taxable upon withdrawal.
Advantages and Disadvantages of a TSP
Probably the biggest advantage of a TSP for a participant in the plan is the fact that it has virtually the lowest expense ratios in the retirement universe. Expense ratios have ranged between a low of .015% and a high of .102% over the past 13 years, with .029% being the average.
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Largely because of those low fees, the five funds in the TSP have outperformed the average of other investment funds for at least the past decade. Though the improvements over comparable funds is small on a year-to-year basis, the difference in returns can be significant over a period of decades.
And since TSP’s offer only limited fund options, there’s virtually no trading, and no management fees to be paid by members.
That doesn’t mean TSP’s are without downsides. In today’s investment environment, having to choose between just five funds seems incredibly limiting, even if those funds outperform their competitors. The participant is unable to invest outside those funds, or even to purchase individual stocks within the plan.
In addition, there is no management per se, no broker to call to get advice on certain investments or even on setting up or adjusting your portfolio allocation.
It’s these last two factors that are causing people to want to exit TSP plans in favor of IRAs.
Why you should rollover your TSP to a self-directed IRA
If you’re a hands-off investor, who simply wants to pay the lowest fees possible, your TSP is exactly where your money needs to be. However, just understand that the world may not cooperate with your decision to stay put and be a passive investor.
There are factors that make TSPs more risky than surface factors would lead us to believe.
Consider the following:
- Despite the five investment funds, the success (or failure) of a TSP is based entirely on the stock market – there are no alternative investments, such as real estate investment trusts, precious metals investments, sector funds or even individual stocks.
- Except for the G Fund, the entire plan is based on just four index funds, and as discussed above, there are no alternative investments. When the market begins to collapse, those alternative investments will be exactly where you’ll want your money to be.
- Both the G Fund and the stock index investments are heavily dependent on the strength of the dollar. A devaluation could collapse both the G Fund and the index funds.
- The same government that has control of the TSP is also the world’s largest debtor. Sacking the plan to cover out of control deficits may become an option in the future.
- TSPs are completely under the control of the government – at some point they could conceivably pass a law making it impossible to withdraw your funds from the plan.
- Unlike IRAs, there is no investment advice availability with TSPs – and that’s something you may suddenly want when market fortunes shift in a major way.
TSPs have been steady performers over the past few decades precisely because of the high level of predictability that has come from the equity markets and the steady decline of interest rates – both courtesy of the Federal Reserve.
But when that dynamic shifts, and it will at some point in the not too distant future, having the bulk of your retirement assets in the TSP could render you incapable of protecting your portfolio.
IRAs may have more fees than TSPs, but they also have far more options. And when volatility returns to the financial markets, you’ll have a much better chance of defending your assets in a truly self-directed investment account.
Learn about Donny's story on why he choose to rollover his retirement savings to a self-directed IRA in order to diversify his investments… Read More