The recently enacted 2006 Pension Protection Act is a diverse collection of new legal provisions affecting pension and retirement accounts, including the Thrift Savings Plan.
One of the most beneficial provisions for TSP participants will allow children and other non-spouse beneficiaries to roll the balance of an inherited TSP account into their own traditional IRA account. The most obvious benefit of this provision is that it will permit younger beneficiaries to extend the TSP’s tax-deferral advantage over an additional generation.
A less obvious but, I believe, more important benefit is that the new provision eliminates one of the weakest, but most frequent, arguments used to convince TSP participants to roll their TSP accounts into IRAs after retirement. Now it will no longer be necessary to roll TSP funds over during a participant’s lifetime for the sole interest of his beneficiaries.
TSP, the government’s defined contribution retirement savings plan, provides, among other benefits, the ability to defer income taxes during the life of the participant and the life of his or her spouse following the participant’s death.
Before the new law, TSP accounts could be rolled into an IRA by a surviving spouse named as the beneficiary of the account. This allowed the spouse-beneficiary to avoid having to pay taxes on the entire account balance during a single year following the participant’s death. But, a non-spouse beneficiary could not enjoy the same privilege. If a son or daughter were named as beneficiary, for example, the account balance would have to be distributed and all taxes paid.
Under the new law, beginning in January, non-spouse TSP beneficiaries may elect to roll an inherited balance into a traditional IRA and continue deferring taxes into later years. This will benefit the beneficiary by allowing the inherited balance to enjoy additional tax deferral, which is nice — for the beneficiary.
But what about the TSP participant? The TSP is becoming an increasingly important source of retirement income for federal employees. The implementation of the Federal Employees Retirement System, with TSP as one of its three bases, certainly emphasized this fact, and it is possible that future erosion of various other sources of income after retirement will do the same. While providing financial benefits to heirs is of interest to many federal workers, those who will rely on their accumulated assets to meet their living expenses in retirement will be best served by putting their own interests ahead of those of their heirs when managing their TSP accounts.
It is these participants — those relying on their accounts for retirement income — who will reap a less obvious but far more important benefit from the new law. Those of you who read my column regularly know that I think the TSP is the best retirement savings vehicle of its kind available anywhere. Unfortunately, in spite of this, many financial services providers aggressively encourage TSP participants to move their account balances out of the TSP and into an IRA account after retirement.
These investment advisers and management companies often make their money by deducting fees from your account. They can only do this if your investment assets are in an account that is under their management — not the TSP.
So the primary objective of these advisers is often to convince you to move your money into an IRA under their control as soon as possible. Mutual funds, brokerage firms, insurance companies and others routinely make this their first order of business in approaching new clients.
Unfortunately, this maneuver is often in direct conflict with the interests of TSP participants. Why? Because it is virtually certain that you’ll be moving your money from a more favorable investment environment to one that is less so.
TSP’s combination of ultra-low cost, efficient and broad investment diversification, convenience, visibility and simplicity are unmatched in any widely available alternative.
Contrary to much of the marketing hype, the TSP, if properly used, will deliver better expected
performance than higher-cost or higher-risk alternatives like managed mutual funds or separately managed brokerage accounts. For this reason, I emphatically recommend that TSP participants leave their accounts intact as long as possible unless it can be clearly demonstrated that moving the money is in their best interests.
With the new law in effect, TSP participants can rest assured their beneficiaries will have tax-deferral options and they will have one less reason to sacrifice their retirement benefits for the benefit of their investment advisers. This may prove to be the new law’s most important benefit of all.
Written by Mike Miles
For the Federal Times
Publication September 4, 2006