So you’ve been in the military for a few years and you’ve been dutifully putting part of your paycheck into the Thrift Savings Plan. (If you haven’t been contributing to the TSP then go read this post and get hot.) Maybe you’re even maxing out your contributions. But if you’re like me, you’ve been so focused on the “saving” and “investing” parts of your financial planning that you haven’t really thought about the eventual “after the military” and “withdrawal” parts.
Now that the long-awaited “Roth TSP” option is finally coming in 2012, the withdrawal phase of TSP investing is going to get a lot more interesting. Let’s look at today’s options and consider how they could affect your savings & investing plans. And, yes, believe it or not, a future post will dig into the details of the Roth TSP.
I was a little surprised to discover these TSP statistics: half of the active-duty military still aren’t using the program! As of February 2011, only 49.5% of active-duty service members participated in the TSP. Reserve participation was even more miserable: only 15.4 percent. The difference could be mandatory enrollment (with optional disenrollment), which takes place in the rest of the federal government but not among military members. The overall participation rate for federal employees is nearly 85%. Maybe the Roth TSP feature will improve military TSP enrollment.
TSP contributions are made from before-tax pay. (Every dollar that goes into the TSP reduces your taxable income by a dollar.) Contributions grow tax-deferred until they’re withdrawn. Contributions made while serving in a combat zone are tax-free even when withdrawn. The earnings are taxed, but the contributions are not. (It’s a great deal, but keep in mind that eligibility requires serving in a combat zone.) Contributions to the military TSP can only be made from military pay, so when you stop receiving military pay then you’re no longer able to make contributions to your military TSP account.
After your military pay stops, you have several options for your TSP account. Later in life you’re able to start making withdrawals from your TSP account without penalty (as early as age 59.5) and eventually you’re required to make withdrawals (soon after age 70). If you’re already age 59.5 or older then you can skip down to the break to start reading about withdrawals, but for everyone else let’s discuss the “after the military” options:
Your first option is to leave your contributions in the TSP. This is a good idea because the expense ratios of the TSP’s funds are among the world’s lowest (0.03%, less than half of even Vanguard’s lowest-expense funds). Not only can you leave your contributions in the TSP, but you can also roll your pre-tax conventional IRA contributions over to the TSP to take advantage of the TSP’s low expense ratios.
Even if you don’t plan to take advantage of rolling over your deductible conventional IRA contributions to the TSP, it’s worth hanging on to your TSP account for the Roth TSP program. You may then be able to roll over all of your conventional IRA (and Roth IRA) funds to the TSP. I’ve been retired for nearly a decade and I still plan to exploit this option if it’s implemented.
Your second option is to roll your contributions out of the TSP to a conventional IRA. You may have plans for your IRA funds that the TSP can’t handle (like real estate or individual stocks). Or it may just be too darn confusing to keep track of another account and another asset class. Unfortunately if you had any tax-free contributions to the TSP, rolling your TSP to an IRA will eliminate the tax-exempt withdrawal of those contributions.
Here’s another important reason to consider rolling some of your TSP over to an IRA: penalty-free early withdrawals. One of the main reasons that military are reluctant to max out their TSP contributions is because they don’t want to “lock it up” in the TSP until age 59.5. Luckily there’s a loophole: the IRS provision for “substantially equal periodic payments”, part of the tax code section 72(t) which allows these withdrawals. The rules are quite detailed and a 72(t) withdrawal can only be done from a conventional IRA– not the TSP. However, you don’t have to make this decision when you leave the military. You can roll over a portion of your TSP to an IRA anytime, and you’d be able to do so just before starting a 72(t) withdrawal plan.
A third option would be to roll your TSP contributions over to your employer’s 401(k). The only advantage to this option is that you’d be able to borrow against your 401(k). However, borrowing against a 401(k) has a number of its own significant drawbacks, so moving the TSP to a 401(k) is generally not to your benefit. Most veterans in bridge careers probably wish they could roll their 401(k)s over to their TSP accounts. If you had any tax-free contributions to the TSP, rolling your TSP to a 401(k) will eliminate the tax-exempt withdrawal of those contributions.
A fourth option would be to cash out: take the money and run. Bad idea. You’d immediately be subject to income tax on the amount you withdrew, plus a 10% penalty for an early withdrawal. Maybe you think you “need” the money to pay off debt or to start a business, but there are other ways to accomplish those goals without cannibalizing your retirement.
—– Break to the “withdrawal options” —–
Let’s say that you decide to leave your TSP money where it is, perhaps adding to it from your IRA, until you’re ready to start withdrawals. What’s next? Your traditional penalty-free withdrawal options start at age 59.5:
You can withdraw as much as you want (over $1000) whenever you want without penalty. You can do this one time as a lump-sum withdrawal. You’ll still pay income taxes on the withdrawal (except for tax-free contributions made from a combat zone) but there’s no penalty.
You can set up a series of monthly payments. You can choose a fixed dollar amount or you can have the TSP calculate your withdrawals from the IRS life expectancy tables. Pay attention to how you set up the size of your withdrawals. You don’t want to accidentally bump yourself into a higher tax bracket, but at the same time you might not want to be making large withdrawals later in life when you’re receiving a Reserve/Guard pension (starting at age 60) or Social Security (starting at age 62-70).
Finally, you can purchase an annuity. TSP annuity rules are a complicated subject and not necessarily a good idea when interest rates are low, so we’ll dig into TSP annuities in the next post.
Where to put your savings while you’re in the military
Simple ways to start saving
Start saving early
Retiring on multiple streams of income
How many years does it take to become financially independent?
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