Rolling Out of the Military: Do I Have to Roll Out of the TSP?

Getting out of the military whether at the end of your service, because you are retiring, or for any other reason, comes with a lot of decisions and moving parts.  For those with a Thrift Savings Plan (TSP) balance, one of the most common questions among those getting out of the service is if they should roll their TSP account into something else such as another employer plan or an Individual Retirement Arrangement (IRA).  While this article isn’t going to tell you what to do, it will give you a few considerations as you ponder your decision. 

Keep your TSP account: It’s The Easy Button!

While you might be getting out of the service, your TSP doesn’t have to.  You may not be able to contribute to it anymore, but you can certainly continue to adjust the allocation and watch your account balance continue to do what it always has – grow or decline in line with your allocation and market swings.  If anything, in the landscape of decisions you “have to” make when exiting the service, this one does not need to be one of them.  You can leave it for later.

Keep your TSP account: It’s Inexpensive

Another reason to keep your TSP is that the TSP net expense ratios for the various core funds are relatively inexpensive compared to other employer plans and some other investments such as mutual funds and actively traded accounts.  This is becoming more of a “push” with many Exchange Traded Funds having similar fees to TSP, but all in all, TSP is still low cost.  When thinking about how much investment growth remains in your pocket, the net operating cost of any given investment is important to keep in mind. When the fees get too high, they chip away at your earnings. 

Keep your TSP account: It’s Protected

Don’t forget about some of the legal protections to keeping your investments in an employer plan.  Unfortunately, bankruptcy is a reality for some and if you ever have to file for, with some rare exceptions, your TSP balance is protected from bankruptcy.  This includes money that you roll into your TSP balance.  Assuming the rollover was done correctly, money you roll into the TSP is now also protected, which brings us to a final reason to keep your TSP account balance. 

Keep your TSP account: A Backdoor Roth’s Best Friend

Keeping your TSP account open allows you to keep the option open to roll other pre-tax account balances into the TSP.  Wait, into?  Yes, into.   Let’s assume you’ve been saving pre-tax dollars in your personal IRA.  One day, you reach the income level where you can no longer do that so your financial advisor says to you, “we should look into a backdoor Roth conversion,” and you should!  However, you have an IRA with pre-tax dollars that you are about to mix with after-tax dollars.  While you can, the IRS has something to say about that.  You’ll be subject to the pro-rata rule which states that you can’t cherry-pick just the after-tax contributions to convert into your Roth IRA.  The pro-rata rule will determine the ratio of pre-tax and after-tax dollars and subject whatever amount you convert to Roth to that ratio.  Pro-rata, although manageable, can make your Roth conversions and tax efficiency unnecessarily complex.  Fortunately, the TSP allows IRA rollovers into the TSP.  This means that before you begin contributing after-tax dollars to your Traditional IRA, you can clear your pre-tax contributions out by rolling the balances into your TSP, thus giving you a clean Traditional IRA account without subjection to pro-rata. 

Rollover your TSP account: It’s Not Very Flexible

There are some decent reasons to roll your TSP contributions out into another employer plan or IRA, the first of which is control.  No, you aren’t losing control of your money, but you do give up quite a bit of flexibility control.  For example, let’s say you’ve got an allocation either within one of the many Lifecycle funds or even your own mix of C, S, I, G, and F core funds.  You decide that you are ready to begin your regular distributions or have even reached the point of requirement minimum distributions (RMD).  Ideally, you would distribute from fixed income allocations leaving equity to continue to grow. You won’t be able to do that in the TSP.  The TSP will take a pro-rata (there’s that word again!) distribution across your entire allocation.  

Rollover your TSP account: It’s Not Friendly To Contingent Beneficiaries

Another area where you lose control is after you’re gone.  If you have a spousal beneficiary who outlives you, your spouse will inherit your TSP through what is known as a Beneficiary Participant Account.  However, if your spouse passes or if you don’t have a spouse, your next beneficiary, a non-spouse, is not allowed to have a TSP account. They will instead have 90 days to make an election to have their TSP benefit rolled into an inherited IRA or else a check be written for the full balance which cannot then be rolled into an inherited IRA.  This could be significant tax problem in the year of receipt, depending on the balance received.  In the government, 90 days is not a lot of time to get anything done and this could turn into a complete tax disaster.    

Rollover your TSP account: Limited Investment Options

One more area of control has to do with the TSP fund options.  While the TSPs core five funds have done well historically, they are limited to those five options.  For instance, if you wanted to be a little more specific about value, growth, or blended equities, you can’t do that in the TSP. To find additional investment options, you would have to roll your TSP into an IRA where the whole wide world of investments is open to you. 

Rollover your TSP account: You Might Forget It!

Lastly, and a reason less to do with control, is simply forgetting about the TSP.  You might think to yourself that that could never happen, but weirder things have happened.  Think about it.  You get out of the military and go to work for someone else with a 401(k) employer plan.  You also open a Roth and Traditional IRA.  You’re married and your spouse has employer plan and their two IRAs.  You have 4 kids and you open 529 accounts for them all.  You also decide to open a taxable brokerage account.  Before you know it, you have a dozen investment and bank accounts, it’s been 20 years since your military days, and you suddenly remember, “I’ve got a TSP!”  While you likely haven’t lost any money, it probably also wasn’t optimized for growth and taxes over the last 20 years.  Rolling your TSP, or any employer plan “forward” into your current employer plan if they allow it, or your IRA, helps consolidate your accounts and simplify where possible 

A Little Bit Of Both

There is a middle ground you might consider.  TSP requires that you maintain an account balance of at least $200 or else they will close your account and send you a check.  A strategy often used is to keep a $500 - $1,000 TSP balance to account for any market declines and roll the rest out into your employer plan or IRA.  This allows you to take advantage of some of the key benefits of both.  Just remember that by rolling money out of the TSP into an IRA, you then could lose some of the bankruptcy protections you would have by keeping your money in an employer plan.  Also, be sure to set yourself a reminder for when you turn 65 to distribute or rollover whatever is left in your TSP account.

Do What Works For You

You don’t have to be in a rush making a decision about what to do with your TSP account.  You can transition from the military and then come back to your TSP decision.  You have options which include keeping your TSP right where it is.  Just be aware that eventually, when you pass and if married, your spouse passes, your non-spouse beneficiaries will be forced to exit TSP.  So, the real question is not if you roll your TSP balance out, but when will you do it? Stay in control and roll it out when it works best for you.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation.  Read the full disclosure.