FEDweek

Report Details Proposed Changes to TSP Withdrawals

Following is the text of the House report on a recently passed bill expanding withdrawal options for TSP investors.

 

H.R. 3031, the TSP Modernization Act of 2017, expands withdrawal options for Thrift Savings Plan (TSP) participants. The TSP is a 401(k)-equivalent retirement account for Federal employees.

H.R. 3031 increases the flexibility and control Federal employees have over their accounts to bring the TSP in line with private sector rules. It allows participants to make multiple partial withdrawals from their TSP accounts after separation from Federal service and permits participants, who are current employees, to make multiple age-based partial withdrawals. H.R. 3031 also enables separated participants who previously elected to withdraw their money using periodic payments to change that election as long as they do not return any payments already made. Finally, the bill eliminates the withdrawal election deadline and the default election of an annuity purchase if a participant does not make a withdrawal election by the deadline.

BACKGROUND AND NEED FOR LEGISLATION

The Federal Employees’ Retirement System Act of 1986 established the TSP.1 The TSP is administered by the Federal Retirement Thrift Investment Board (FRTIB). For employees covered by the Federal Employees Retirement System (FERS), the TSP is the defined contribution portion of the tripartite retirement system that also includes a defined benefit pension and Social Security.

Participation in the TSP brings advantages over private sector defined contribution systems. The design of the system is simple and allows for passive investment management. Investors may purchase shares in any of the five core investment funds, including the Government Securities Investment Fund (G Fund), the Fixed Income Index Investment Fund (F Fund), the Common Stock Index Investment Fund (C Fund), the U.S. Small Capitalization Stock Index Investment Fund (S Fund), and the International Stock Index Investment Fund (I Fund). Investors may also purchase ‘‘lifecycle’’ funds that are comprised of a mix of the core investment funds, allowing the FRTIB to select an appropriate mix of shares depending on when the investor is expected to begin withdrawing funds. Another advantage of utilizing the TSP is its low administrative costs. In 2016, the expense ratio for the TSP was 3.8 basis points, one of the lowest in the industry. The reason for these low costs is the simple plan structure and passive investment management that result from using low-cost index funds such as the C and S Funds, which are designed to track market indices. Economies of scale also enable the TSP to minimize costs. As of June 2017, approximately 90 percent of FERS employees participated in the TSP, with over $500 billion invested. Although the TSP offers many advantages, the current withdrawal rules for TSP accounts can be restrictive. In-service TSP participants may make only one age-based partial or full withdrawal after they reach the age of 591⁄2. Separated participants are also limited to only one partial withdrawal. After, only a full-withdrawal option is available to separated employees. A TSP participant is not allowed to take a partial withdrawal once separated from federal service if he or she took an in-service age-based withdrawal.

Finally, if a separated employee elects to withdraw his or her full balance via periodic payments, the payments cannot be stopped unless a participant withdraws his or her entire remaining balance. The separated employee cannot elect to switch to a partial withdrawal or annuity purchase. The law also requires TSP participants to make a post-separation withdrawal election by April 1 of the year following the year in which a participant turn 701⁄2 and are separated from federal service. This withdrawal election deadline is independent of the Internal Revenue Service requirement to begin annual minimum distributions by April 1 of the year following the year in which the participant is 701⁄2 years old and separated from federal service. The law requires that the FRTIB purchase an annuity for a TSP participant if he or she fails to make an election by the TSP withdrawal election deadline9 In 2014 and 2015, the FRTIB examined TSP data and discovered many participants were transferring their plan balances from the TSP to other financial institutions at age 591⁄2 and upon separation from federal employment. In 2013 alone, separated participants transferred $9 billion out of the TSP to other financial institutions, most of which have higher expenses than the TSP, thereby ‘‘reduc[ing] a participant’s net returns and negatively impact[ing] his/her retirement readiness.’’  Of these participants, 27 percent cited a desire for additional withdrawal flexibility as a motivating factor behind these transactions, and 36 percent cited the need for funds to address life events. Among those who took age-based withdrawals, 30 percent desired additional withdrawal flexibility, and 52 percent needed the funds to address life events. Agents for the TSP’s customer service phone line also report significant dissatisfaction with what participants consider are overly restrictive withdrawal options. As part of its study, the FRTIB looked at the reasons for the current restrictive withdrawal options. According to the Board, defined contribution systems were still relatively new at the time of the TSP’s creation. A decision was made to model the withdrawal options based on the defined benefit pension administered by the U.S. Office of Personnel Management (OPM).

The TSP initially had a withdrawal scheme that was designed to mimic a participant’s eligibility for the OPM defined benefit annuity. Effectively, only participants that reached the age and service requirements that qualified them for a defined benefit payout could execute a TSP withdrawal that would result in a direct payment to the participant.

All other separated participants were required to transfer their accounts to an [individual retirement account] or another qualified plan. This structure proved confusing to participants and was modified several times through legislative changes. . . . Each change brought the TSP’s withdrawal options more in-line with those commonly found in ERISA [Employee Retirement Income Security Act] governed 401(k) plans. Despite these past changes, the FRTIB study found the TSP’s current withdrawal options continue to vary from plans found in the private sector. To bridge this gap, the study recommended allowing participants to take multiple partial distributions once separated and allowing participants who take in-service, age-based withdrawals to take partial distributions once separated, both of which are options found in many private sector plans. The FRTIB also reviewed a Vanguard 2013 study of private sector defined contribution plans that looked at the effects of allowing multiple partial withdrawals as one nears retirement and after separating from service. The study found increased withdrawal flexibilities for participants produced a 50 percent increase in plan retention of participants and assets. H.R. 3031 addresses these problems by providing additional withdrawal flexibility to TSP participants. The bill allows TSP participants to make multiple partial withdrawals post-separation, and it eliminates the prohibition on making a post-separation partial withdrawal if a participant has taken an in-service, age-based withdrawal. It allows separated employees to stop periodic payments of their account balance as long as they do not return any money that was already dispensed. The participants may then elect for a partial withdrawal or purchase an annuity. The bill removes the requirement that TSP participants make a withdrawal election by the withdrawal election deadline—the year following the year in which they turn 701⁄2—and removes the requirement that the FRTIB purchase an annuity for any employee who has not made an election by the withdrawal deadline. Finally, the bill allows inservice employees to make multiple age-based withdrawals.

SECTION-BY-SECTION

Section 1. Short title The short title is the ‘‘TSP Modernization Act of 2017’’.

Sec. 2. Thrift Savings Plan Account Withdrawal Flexibility This section amends section 8433 of title 5, United States Code, and includes related stand-alone provisions and conforming changes. The amendments include removing a prohibition on Thrift Savings Plan (TSP) participants who have separated from government service making a partial post-separation withdrawal from their TSP account if they made a partial withdrawal during their in-service period. It also allows separated TSP participants to make more than one partial withdrawal.

This section would prohibit a TSP participant who has elected to withdraw money from the participant’s TSP account by purchasing an annuity, from changing that election on or after the date on which such annuity contract is purchased. A TSP participant who has separated from service may not return a payment that was made pursuant to a withdrawal election. The revised section will allow separated employees to change their withdrawal elections, even after receiving periodic payments from their TSP account, as long as they do not return any money already dispensed from their TSP accounts. Separated employees will be allowed to change from periodic payments to partial withdrawals or annuity contracts.

Section 2 also removes a withdrawal election deadline and the requirement for FRTIB to purchase an annuity for a TSP participant if a participant has not made a withdrawal election by April 1 of the year after the participant reaches the age of 701⁄2. This gives TSP participants additional time to consider their withdrawal options, while not changing the Internal Revenue Service required minimum distribution rules.

Finally, the section removes a limitation allowing a TSP participant who is still employed by the federal government to make a withdrawal after reaching the age of 591⁄2 only one time while still employed by the Federal Government.