[VIDEO] TSP Modernization Act
If you are a federal employee, you should be smiling. The TSP took its rather archaic and rigid withdrawal options, which had been around for 30 years, and brought it to the modern era. As of Sept 15th 2019, the TSP Modernization Act is in effect and withdrawing money from your TSP account is now much easier, and comes with more options and flexibility.
With all the changes that came down regarding the TSP Modernization Act, I decided to put together a brief video breaking down the most prevalent changes of the Act. Since the main changes have to do with how you access and withdraw money, that’s where I will focus.
While this video is not intended to go line by line as to all of the fine print, I did want to touch on what I consider to be the most important aspects of the act.
Okay, so here’s the good news…nothing is being taken away. While it’s certainly been a long time coming to upgrade the current withdrawal options, the modernization act is definitely giving federal employees much more control and flexibility with their TSP. The move to “reboot” the TSP was more out of necessity and bringing it into modern times. The limitations on the TSP withdrawal options pushed many Federal employees, usually out of frustration, to transfer their money into an IRA where they typically have more investment options, control and greater withdrawal flexibility.
Okay, so let’s start with age-based In-service withdrawals. Age-based In-service withdrawals means you’re still an active employee with the federal government but you are at least 59 ½ and you wish to take a withdrawal from the TSP. This type of withdrawal is done through form TSP 75. As it stood before the modernization act, federal employees who hit 59 ½ were only allowed 1 age-based withdrawal during their entire career. Taking an age-based withdrawal also prevented the participant from taking a partial withdrawal when separated.
With the Modernization act, federal employees who have attained the age 59 ½ and are still working for the government are now able to take up to 4 age-based withdrawals per year, and taking an age-based withdrawal will no longer preclude the federal employee from taking a partial withdrawal when separated. In my opinion, this definitely provides more access to your retirement savings while you’re still employed. An important side note, when you do any type of withdrawal from your tsp while working, you still continue to contribute to the TSP through payroll deductions as you are now.
Next, let’s look at changes to partial withdrawals when you ultimately separate from federal service. Before the modernization act went into effect, if a separated federal employee had not taken an age-based withdrawal while working, they were allowed to take only 1 partial withdrawal after they separated. After a partial withdrawal had been taken, only 1 full and final withdrawal was allowed. As you can imagine, this is extremely limiting, especially if you need access to your money for any reason.
With the modernization act, partial withdrawals when separated will be treated very differently. Whether or not a separated participant has taken an age based in-service withdrawal, or multiple withdrawals for that matter, there is no limit to the number of partial withdrawals that can be taken, as long as they are not taken more often that every 30 days. This is certainly an upgrade since the old way was so antiquated and provided minimal flexibility in retirement. That being said, I do see a potential issue with this new-found flexibility. One concern is that TSP participants can now tap into their TSP too often and treat it like an ATM, per se, vs letting their money sit and grow.
Next, I’d like to discuss how proportional withdrawals are handled for those who have both traditional and Roth balances in their TSP. As you know, if under the old rules you had both the traditional and Roth accounts with the TSP, when making a withdrawal, all withdrawals had to be taken proportionally between the two balances. Going forward, proportional withdrawals are no longer required. Federal employees will have the option of choosing from which account balance – traditional or Roth – they want their withdrawals to come.
So, let’s spend a little time discussing your main withdrawal options of your TSP at retirement. Obviously, upon separation, you’re able to do a full or partial withdrawal of your tsp via form tsp 99. Before the passing of the Modernization act, you were only able to do that one time at retirement. Now, you’ll be able to do up to 1 withdrawal every 30 days if you wanted to. Since those distributions can come a variety of ways, I wanted to make sure I went over those ways and how they’ve changed going forward.
First, is a single payment. This is where separated participants have the ability to take a lump sum withdrawal on all, or a portion, of their TSP account balance. The new rules now allow you to take a withdrawal every 30 days if desired and there’s no lifetime limit on the number of withdrawals, however the minimum withdrawal has to be $1,000. You also have a couple of options with this scenario…one option, you can take the distribution yourself and deposit it in your checking or savings account. Please keep in mind that this could potentially make it a taxable event. Further, when you choose this option, the TSP is required to automatically withhold 20% of the amount you are requesting for federal withholding.
Another option you have with single payment, which remains unchanged from the old rule, is you can take the lump sum withdrawal as a non-taxable transfer or rollover to either a new employer’s retirement plan, like a 401k, or an IRA. By doing that, the 20% federal withholding does not apply since the money is going from a qualified retirement account to an IRA.
Next, let’s look at installment payments. With the old TSP options, once a separated employee began taking monthly payments, they could not stop unless they cashed out. They did have the option to change the amount of the payment but that could only be done on an annual basis and they were not allowed to take a partial withdrawal once they began taking monthly payments. Once again….very limiting.
TSP has certainly improved this option and now your installments can be on all or a portion of your account balance over time. Installment payments provide flexibility by taking the installments that you want and the amount and frequency of installment payments can be changed at any time. With the new rules, these installments can be taken monthly, quarterly or annually. You can start, stop, or change the payment amount at any time and taking installment payments will not preclude you from taking partial withdrawals either.
Now when it comes to installments, you actually have a choice of either a fixed dollar amount or payments based on life expectancy. According to the TSP, once you go down the fixed dollar path you do not have the flexibility to change this to the life expectancy path….and if you go down the life expectancy path and switch to the fixed path, you cannot switch back.
With the fixed dollar side, you are in charge. you pick the payment and self-manage your money, but you also bare all of the responsibility. Ultimately, by taking too much money out you run the risk of spending the TSP balance down to zero and running out of money.
There is one more thing to think about….inflation. Let’s say you are taking $2,000 a month out as equal monthly payments to help fill the income gap and cover monthly expenses, but due to the cost of goods and services increasing every year, you may wind up needing to take out more from your TSP to cover these increases, or what if a major expense pops up out of nowhere? Now, the odds are increased that you will likely run out of money even sooner than first expected. I’m sure you can see the risk this poses from a planning perspective.
With the life expectancy option, the TSP automatically calculates your balance and spreads those payments out for you, essentially making adjustments every year to ensure your money lasts for your life expectancy. As you can imagine, that comes with its own set of potential problems down the road as well. For example, what if you live past your own life expectancy.
Now, let’s look at the life annuity withdrawal option. This option is actually unchanged from the old rule. So, with this option, you would transfer over all or a portion of your TSP balance to the TSP annuity provider – which is currently MetLife. MetLife will purchase what is often referred to as a Single Premium Immediate Annuity, or SPIA. Your monthly benefit amount is calculated by MetLife based on the dollar amount you are wishing to purchase the annuity with, your age, the state you live in, and which payout option you choose.
There are many options to choose from like single life or life only, joint life with spouse, and joint life with other survivor, and then there is level payments, increasing payments, cash refund or 10-year period certain. I know, that can get a bit confusing and these choices will change the amount that is paid out to you. Each of these options do different things and it’s critical that you analyze each option with regards to your personal financial situation. I say that because this is a one-way street and once the payout amount is locked in and the request is processed. there is no turning back or changing a thing.
With any of these withdrawal options, if you are unsure about the tax implications on taking money from your TSP, visit tsp.gov and search for Tax Notice TSP-536 which covers tax information on the different types of withdrawals. I highly recommend that you speak with your tax advisor as well.
I’d like to take a moment now and talk about Required Minimum Distributions, or RMDs. RMDs are mandatory withdrawals you must make from your retirement funds by April 1st following the year you turn 70 1/2. Under the old TSP withdrawal rules, one huge limitation leaving your money in the thrift was that if you did not withdrawal your account by your RMD deadline, your account balance would be moved to the G fund and subsequently forfeited to the TSP. Then, you could reclaim your account, but you would not receive any earnings on your account from the time it was forfeited.
The good news is…you are no longer required to make a full tsp withdrawal after age 70 1/2, however you will still need to take an RMD if required. TSP has made changes that do away with that outdated rule and now automatically sends you your RMD payment every year when due. This is a huge convenience and helps ensure you don’t miss your RMD payment for any particular year, invoking the huge IRS penalty of 50% for not meeting your RMD requirement.
However, here is a potential problem I see…while this sounds like a convenience, and probably is for most people, what if you have other qualified tax accounts or IRA accounts that you can take your RMD from? What if you have a retirement income annuity which you are taking payments on which satisfy your RMDs for that year? Unfortunately, with IRS rules, you need to take out your RMD from this account regardless of whether you are separated or not.
IRS rules state that you must satisfy your RMDs from employer plans like the TSP. They don’t cover each other as they can with individual IRAs. This may be a reason to consider rolling your TSP over to an IRA upon separation. I personally believe decisions like these should be looked at from all angles to ensure you are doing the right thing for your circumstances.
Regarding fund selection, just a quick note…the new rules are not changing anything with the investment options you have available to you. You’ll continue to have the 5 main funds to invest your money in – the G, F, C, S and I. The Modernization Act is improving the accessibility of your tsp funds but not increasing or expanding upon the investment choices available to you to invest in. The funds are still going to be very low cost, which is a huge plus, especially when you are trying to accumulate money for retirement.
If you have further questions regarding the changes to the tsp, the tsp has published a fact sheet under the forms and publications section of tsp.gov entitled PL 115-84. Obviously, when it comes to retirement, there are many things to consider with regards to how and when you tap into your TSP. For most Federal employees, the TSP is their largest asset and we believe that these decisions shouldn’t be left to chance. If you are unsure which option is right for your particular financial situation or you want to better understand the impact that these decisions can have on your retirement, I invite you to contact us anytime.