Thrift Savings Plan investors have the option of rolling their balances into individual retirement accounts (IRAs) after they separate from service and are no longer contributing to their accounts. With the large number of federal employees expected to retire during the coming years, financial services firms are gearing up to try to capture these soon-to become-available sources of commissions and fees.
I suggest that participants be extremely cautious about making the decision to roll a TSP account over and, if in doubt, leave the balance where it is until a competent and unbiased analysis has been done to fully inform the decision.
Potential disadvantages of moving your TSP balance to an IRA
- Higher costs. In his 1999 book, “Common Sense on Mutual Funds,” Vanguard Funds founder and index fund pioneer Jack Bogel provides convincing evidence that the most accurate predictor of the long-term performance of an investment is cost. The lower an investment portfolio’s costs — which include operating, marketing and other expenses — the more likely it is to outperform its peers. The TSP’s five investment funds — four index funds and one stable value fund — have annual expenses of 0.10 percent. This is far lower than the cost of the typical managed equity mutual fund and lower than any other widely available index fund, according to data compiled by investment research firm Morningstar. So, moving your TSP balance to an IRA will likely result in higher investing costs, and these higher costs will directly and negatively affect the prospective performance of your portfolio.
- Confusing choices. The TSP’s carefully selected array of index funds easily enables participants to implement an effectively diversified portfolio. An IRA brings with it an incredible range of choices — where to establish the account, whom to trust to provide any investment advice, and which of the tens of thousands of securities available to include in your portfolio. And, you must make these choices against the backdrop of aggressive and sometimes misleading marketing efforts designed to further the interests of investment companies at the expense of the investors they propose to serve.
- Loss of early withdrawal privileges. For those participants who separate from federal service during or after the year they reach age 55, the TSP offers a unique opportunity to make withdrawals before age 59½, without the 10 percent penalty for early withdrawal that might apply to similar distributions from an IRA.
Potential advantages of moving your TSP balance to an IRA:
- Convenience. IRAs can offer a great deal of convenience, particularly when the time comes to begin taking withdrawals. Some custodians now allow you to write checks, with tax deposits automatically withheld, directly from your IRA. It may also be attractive to have all of your tax-deferred retirement savings — such as TSP, IRA and 401(k) — consolidated, managed and monitored in one IRA account.
- Access to competent advice. In certain circumstances, you may be required to move your TSP to an IRA in order to obtain the services of an investment adviser. Diligence is required to make sure such a move is in your best interests.
- Greater freedom to make withdrawals. The TSP is rather restrictive in its rules regarding withdrawals following separation from service. IRA custodians, on the other hand, usually allow virtually unrestricted access to your money — you can withdraw as much as you want, whenever you want it, subject to penalties for early withdrawal. They also offer regular automatic distributions, direct deposit and check-writing privileges.
- Greater choice. In certain cases, investors may see a need to invest in securities or use management strategies not available in the TSP. In these cases, an IRA may allow access to such investments. Again, it is important to be cautious in making this type of decision.
- Tax deferral for your heirs. Rolling your TSP balance into a traditional IRA may allow your heirs to continue deferring taxes on the balance after your death — a benefit not available from the TSP. The rules applicable to this strategy are complex, however, and there are risks. The decision should be based on careful consideration of your individual circumstances.
Poor reasons to move your TSP balance:
- To improve returns. It is not possible to reliably predict market returns, and it is generally counterproductive to pay an investment manager to try to beat the markets. Your objective should be to allocate your investment into the appropriate markets — stocks, bonds, etc. — according to your circumstances, and then capture as much of the return from those markets as possible. This is typically best accomplished through the use of a properly diversified and allocated combination of index funds with the lowest possible cost — like those offered in the TSP.
- To reduce risk. The TSP’s fund selection offers the opportunity to design and implement extremely riskefficient portfolios. The TSP’s G Fund is a unique investment vehicle, offering an attractive risk-return combination not available anywhere else. Without careful and competent management, it is highly unlikely that an IRA portfolio will deliver superior risk-adjusted returns to its TSP counterpart.
- To diversify your portfolio. The TSP’s fund selection offers everything needed to implement a fully diversified portfolio.
Written by Mike Miles
For the Federal Times
Publication April 11, 2005