If you’re a federal retiree or an employee relatively late in your career, the TSP is ready to do everything short of giving you a toaster if you would just keep your money with them after retirement.
Their concern is the high numbers of participants who ditch the TSP as soon as they can. For active employees, of course, if you’re dissatisfied with the program there’s not much you can do other than refuse to invest in it. But that would be a cut off your nose to spite your face response, since you’ll be giving up tax-advantaged retirement savings—including, for higher-income people, the only opportunity to save on a Roth after-tax basis—and, for FERS employees, matching contributions of up to 4 percent of salary above the 1 percent they get automatically.
It’s a different story after retirement, though, when you can leave your money in the TSP or transfer it into another tax-advantaged program such as an IRA (or simply take a withdrawal, although with potentially heavy tax consequences).
The TSP sees that as a growing problem. Of those who separate from government service more than half now move their money out of the TSP just within the first year.
While some of those were taxable distributions, that tended to be the practice of investors with smaller than average accounts—averaging less than $19,000. Among investors who transferred money to an IRA or similar plan, the average was nearly $127,000; 75 percent of all funds drawn out went to other financial institutions.
In doing so, they are giving up the almost comically low investment fees the TSP charges and accepting fees from the IRA provider that can be much higher—sometimes on the order of 20-30 times higher.
Why would anyone do that? In a few words, the range of choice—more accurately, the lack of it—in the TSP.
A mutual fund company might offer scores of funds for its IRA investors. The TSP offers only five core funds and five lifecycle funds that blend investments only of the core funds. A poll of TSP investors in 2008 found that 39 percent believed the program would be improved with the addition of more funds; a poll in 2013 found just about the same thing, 36 percent. And there is what the report calls a “vocal minority” strongly in favor.
The TSP traditionally had resisted calls to create specialized funds, and indeed sat for years on an authority to create an investment window. That was based on a view that investors would have a hard time making up for the added costs of outside investing, and that by chasing returns would raise their risk of losses.
And the TSP effectively allows only two post-separation withdrawal actions. One is a partial withdrawal—and even that is not allowed if you took an age-based withdrawal while still employed—and the other must be for the entire account balance. This could include, of course, a decision to spread out the distribution through monthly payments or an annuity, but once the decision is made, it is set.
In contrast, IRA providers again offer far more flexibility, allowing investors to tailor their choices according to life events, within certain distributions required by the tax code.
The TSP wants to hang onto those investors by creating a mutual fund window, through which they could direct part of their TSP accounts (remember, after retirement, while you can no longer make new investments you can move money among investment funds). This essentially will mirror what would be available by transferring the money to an IRA provider, since in both cases investors would have the full range of funds available through a financial firm. The TSP is preparing to solicit and issue a contract for that, which probably will go to one of the big mutual fund companies.
While the TSP is going ahead with that under existing authority, it will need Congress to agree to its planned improvements to withdrawal options. That would include removing the limit on the number of partial withdrawals (along with allowing more than just one in-service age-based withdrawal); allowing quarterly or annual periodic payments rather than only monthly ones; and permitting the payment amounts to be changed at any time, including stopped.
It likely would be 2017 at the soonest before either set of changes could be put in place.
They have potential downsides. That’s especially true of the widened investment options, under which some investors might make poor decisions.
But the TSP has come to the conclusion that the benefits to the many from staying in the program will outweigh the risks to the few who, after all, ultimately are responsible for managing their own money.