“Leakage” from retirement savings plans such at the TSP is unfortunately common and even small drains can have major long-term impacts, according to a the Center for Retirement Research.
It said that the typical 401(k) plan now has about $110,000 on investment, about the same as the average TSP account, reflecting the growth of the importance of defined contribution plans. However, it adds that such plans, unlike defined benefit plans, offer several opportunities for participants to draw out money before retirement—specifically, through loans and in-service withdrawals.
In-service withdrawals based on financial hardship generally are subject to income tax and a 10 percent tax penalty, while age-based withdrawals, allowed after age 59 ½, are generally taxed but not subject to the penalty (any tax-free withdrawals would come from balances in Roth status).
Withdrawals are not paid back into the account. Loans are, but taking one also depletes the account and if they are not paid in full by the time of separation, the loan is treated as a taxable distribution that further is subject to tax penalties.
The study put together a hypothetical outcome based on a plan design similar to the TSP formula for FERS employees, with employer contributions, and an employee starting investing at age 30, with an assumption of a 6 percent of pay investment and annual after-inflation earnings of 4.5 percent. If such an employee suffered just a 1.5 percent leakage of assets each year, the result would be a 25 percent decrease in the account size at age 60.
It said that to protect investors, plans could limit situations in which hardship withdrawals are allowed, while possibly eliminating the tax penalty for those with truly severe financial problems. The study added that there is only a relatively small problem with defaulting on loans and that policies likely should remain the same, given that the opportunity to borrow against an account is one incentive for investing in it in the first place.