TSP

Originally published at Kiplinger.com

What NOT to Do with Your TSP: 8 Thrift Savings Plan Mistakes to Avoid

 

Many federal workers saving for retirement in TSPs get tripped up by these common pitfalls. To help maximize your own savings, make sure you steer clear of these eight mistakes.

by: Scott Tucker, Investment Adviser Representative
April 14, 2021

For federal employees, participation in the TSP (Thrift Savings Plan) can greatly increase your chances of financial security in retirement, yet some of the folks you work with aren’t making the most of their TSP.

By participating in your TSP, you can save part of your income for retirement through automated payroll deductions. You can also receive matching contributions from your agency, perform some forward-looking tax planning for retirement by considering using the Roth option, and potentially grow your money for the future tax-free. But to help maximize your TSP, you should avoid these eight TSP pitfalls:

If you aren’t putting at least 5% of your income into your TSP, to maximize the matching contributions from your agency, you’re turning down free money.

You may already be at 5% and not know it. On Oct. 1, 2020, the automatic enrollment percentage for TSPs increased from 3% to 5% of basic pay. So, if you enrolled with the default option, on or after that date, you’re at 5%.

But, if you’re enrolled at a lower percentage (either by choice, or by default because you enrolled earlier), you might want to increase your contribution back to 5%. And you don’t have to stop at 5% either. Most financial advisers, including me, recommend saving far more than just 5% of your income (depending on your financial situation).

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Lots of federal employees like the Government Securities Investment (G) Fund because it feels safe. The fund is invested in short-term U.S. Treasury securities that are specially issued to the TSP, so principal and interest payments are guaranteed by the federal government. When the stock market is volatile (and isn’t it always?), the G Fund appears to be a safe choice.

Unfortunately, if you put all your money into the G Fund, you’re exposing your retirement savings to a different challenge: inflation risk. Instead, splitting your money between two or more funds (there are five to choose from) could offer both increased diversification and a greater growth potential, which you’re very likely to need to combat the corrosive effects of inflation and help protect your purchasing power in retirement.

Lifecycle funds take a retirement “target date” approach to investing. They’re based on the idea that younger federal employees can handle more risk than federal employees who are closer to retirement.

TSP Lifecycle funds are made up of a combination of all five TSP funds, and they automatically shift to a more conservative asset allocation as you approach your planned retirement date.

Many federal employees have chosen a Lifecycle fund because it sounded like “autopilot.” When you fly on an airplane, the middle of your flight is set to autopilot. But you still need a pilot for a safe landing. Autopilot without a pilot is dangerous, not safe.

Lifecycle funds make the assumption that all federal employees who plan to retire in the same year have the same risk tolerance. Of course that’s not the case.

If you’re using TSP Lifecycle funds, please “seek professional help,” and meet with a financial adviser to make sure you’re on course. Most financial advisers will offer you a complimentary appointment.

You’ve probably heard it before, but it bears repeating: “Past performance is no guarantee of future results.” Research the funds available to you in your TSP and you’ll find past performance for each fund. But you’re investing for the future, not the past, and none of those funds can guarantee to repeat what they’ve done in the past. Instead: Focus on your risk tolerance, and your goals, to find the TSP funds that will best suit your needs for retirement.

Taking a loan from your TSP is a bad idea. The money you’re putting into your TSP is for retirement, not for buying a new car. If you leave federal employment with an outstanding TSP loan you have to pay back the full loan balance within 90 days. If you don’t, the IRS will consider the entire outstanding loan amount as a taxable distribution, taxing the sum as earned income. In addition, TSP borrowers who are younger than 59½ can also get hit with an additional 10% early-withdrawal penalty.

If you pass away without a Designation of Beneficiary form (TSP-3) on-file, your TSP will be distributed in the “statutory order of precedence,” which starts with your spouse and goes through a variety of other “potential beneficiaries.” If that’s OK with you, you don’t have to bother with this form. But if you’ve already filed a beneficiary form, and something has changed (maybe a divorce, a new marriage or maybe new grandkids), or the statutory order of precedence just doesn’t give you a warm fuzzy, file an updated Designation of Beneficiary form.

When you leave federal employment, you have a few choices for how to take the money from your retirement account. You can:

  • Withdraw all of the money as a taxable lump sum.
  • Withdraw the money in equal monthly payments based on the dollar amount or actuarial tables.
  • Have the TSP purchase a life annuity for you.
  • Work with a financial adviser to perform a rollover to a Traditional IRA and/or Roth IRA, and for advanced income planning, asset allocation, investment management, forward-looking tax planning, health care planning and legacy planning.

The first option listed above — withdrawing all your money as a lump sum — exposes 100% of your Traditional TSP balance to federal income taxes (and possibly state income taxes) in one tax year.

The second option is likely too simplistic for most separated federal employees, and likely won’t work as well as other retirement income options. Consider meeting with an independent retirement financial planner so that you can at least consider other income options that may work better for you. It’s always best to have choices.

The third option gives the TSP the job of purchasing a life annuity for you. This is kind of like when I was in Navy boot camp and they told me the exact underwear I was going to wear for the next two months. No choices. No argument. Do as you’re told. Yes, sir.

If you’re going to consider a life annuity for retirement income, I recommend you meet with an independent retirement financial planner and have them see if the TSP’s life annuity is your best option. It may not be.

The fourth option may be a good choice for you if you’d like broader — and possibly better — options than just the five funds that are available to you in your TSP, and if advanced income planning, asset allocation, investment management, forward-looking tax planning, health care planning and legacy planning are important to you.

Often, when federal employees enroll in the TSP, it’s done without thinking about how the TSP will complement (or complicate) other retirement accounts and retirement income sources, such as Social Security benefits, pensions, IRAs, 401(k)s, 403(b)s, Deferred Comp, non-qualified accounts, bank accounts, etc.

Enrolling in the TSP is great, but don’t just enroll in it and settle for the “default settings.” Meet with a retirement financial planner and qualified tax professional to see what forward-looking tax planning and advanced retirement income planning options might be in your best interests.

Rather than just enrolling in the TSP and turning off your brain, find qualified professionals — even if it's just for one meeting, because you don’t know what you don’t know.

They can help you evaluate your TSP choices within the context of a holistic, tailored retirement plan. How much will you need to have saved for a comfortable retirement? Will your TSP fund choices, and your contribution percentage, get you to that goal?

Look for independent financial professionals who are knowledgeable in TSPs, and work together to build a retirement financial plan that’s based upon your specific needs, wants, and goals.

Kim Franke-Folstad contributed to this article.

Appearances on Kiplinger.com were obtained through a paid PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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