Should I Transfer My TSP?

If you wonder how I pick the topics I write about, often times I decide based upon questions I am getting at the time. And right now I am getting a lot of questions related to moving TSP money into a private IRA, so let’s dig into why you should or should not make this leap.

As a refresher, once you separate from the government, you have the ability (but not the requirement) to transfer some, or all, of your TSP into an IRA. If you’ve gone through a retirement seminar or two, you may have already had this explained to you by a financial advisor. Typical sales pitches revolve around greater opportunity to invest in different products like stocks, bonds, and managed mutual funds. Sometimes the advisor will claim they can get you a better return with less risk. In some instances they may even offer you a product that guarantees NO loss in your investments. Sound good? Read on.

Some of this depends on how exactly you transfer your TSP and who exactly you transfer it to. So I’ll break this up into those categories.

Managed IRA (Better Returns, Better Diversity, Guaranteed Income)

If you have had discussions with a financial advisor that would like you to transfer your TSP to his firm, it is probably meant to be a long-term relationship, typically where he will manage, or at least advise you on, your investments. The implied strategy in this choice is that the advisor will invest your money “better” than you can invest it in your TSP. But what does “better” mean exactly?

Some advisors will emphasize how they can make you more money. These advisors mean they can invest in stocks, bonds, and/or mutual funds, that can potentially earn more money than the simple index funds available in the TSP. In short, they want to beat the overall market.

Other advisors will emphasize how they can diversify your investments better than you can diversify in the TSP yourself. Diversification simply means spreading money out across different investments to lower risk. These guys seek roughly the same returns, but with lower risk.

My least favorite pitch from an advisor is the one that includes an annuity.

A little primer on annuities is in order. You take your money, give it to an insurance company, they invest it, and pay you back a guaranteed amount for the rest of your life. It is very much like a pension. In fact, this is exactly what you have with your FERS retirement annuity. Every pay period over your entire career, you have paid into your FERS annuity. Depending on your job classification, you’ve paid from .8% to 4.9%. This is your “buy-in”, or accumulation phase. Once you retire, you turn on the “pay-out” or distribution faucet. And you start getting a check every month for life. That’s your government annuity.

You can do the same thing in the private sector. You could take $200,000 from your TSP and purchase an annuity that pays you $400 a month for life (or whatever the amount would be). You can do this directly in the TSP (MetLife has the current contract), or you can send this money to an advisor and he can purchase one on his own. I see these being pushed on federal employees fairly often. Personally, I don’t think that’s a good thing. I won’t get into detail in this paper, but feel free to read my (strong and controversial) opinions HERE. The annuity arena is where you will see types of products that guarantee no loss when the market is down, but gains when the market is up. Be very careful of these products.

The Cost?

If you’re thinking that if a professional advisor is involved in your account, you will pay more, then you are correct. “Managed” equals “More costly”. Not necessarily prohibitively costly, but it will certainly cost more than leaving everything in the TSP. What is this cost? That’s one of the best questions you can ask your advisor when you are in the evaluation phase. What it cost will often be based upon what product or service you are obtaining. Some advisors will manage your money for a simple % of the value of the account. For example, you may have to pay .8% a year on your $500,000 account. This would equate to $4,000. This will be the ANNUAL fee, so it will be the cost every year. If the account appreciates up to $1m, that would be $8,000 a year. Some advisors have different percentages depending on the value of the account. Please investigate.

Some advisors will charge hourly rates to manage your account. That’s fairly easy to understand. Just make sure you are clear on how much they bill, and for what.

Perhaps the most confusing (or hidden) costs are those involving commissions and fees for trading. Sometimes these are almost impossible to see, they are so well-hidden. A commission may be paid to the advisor by the company who’s product he sells you. Let’s say you purchase a $500,000 annuity from your trusted advisor. After all, you like the sound of “guaranteed income for life.” He informs you that there is absolutely zero fee for this annuity. He won’t bill you a single dime. Hey, it’s starting to sound even better! However, he may be receiving 7% from the insurance company for placing you into that annuity. Wait, how can the insurance company afford to pay him $35,000 in commission on this product? Well, that’s probably ultimately coming out of the money you gave them. No, they won’t deduct $35k from your account. But their actuaries do a very good job of determining how long you’re going to live so that they don’t pay you more than you paid them. In other words, they can’t pay you everything you gave them plus all of the earnings, or else how will they make their money. Somewhere in that difference is an extra $35k added in.

I know this is a bit confusing. And frankly, I think it’s designed that way. The farther the cost of things can be buried within the investment, the easier the investment can be sold. If this were not true, the investment world would not be coming up with more and more complicated products that perform essentially the same function. The point to all of this is simply to get you to understand you need to be asking this question of your advisor: “What am I getting, and what does it cost me?” And please, make sure you walk away from that conversation with a very clear understanding of everything. If you are sitting in the parking lot after meeting with your advisor, and you can’t call me up and explain exactly how the investment works in plain language, well, shall we just say…that’s not a good thing.

So how do all of these costs compare to the TSP? Great question. You always want to compare costs. Let’s revisit our previous example of having $500,000 in an account and the advisor charging .8%, or $4,000 for the year. If that same $500,000 were invested in the TSP’s C Fund, the annual expense would be just over $210. Multiply that over 20 years and you get $80,000 in fees for the managed account and about $4,200 in fees for the TSP account. You begin to see why Warren Buffett preaches so hard against letting fees erode your account.

Non-Managed IRAs

If you like the thought of moving some money from the TSP to an IRA (like in my Barbell paper), but don’t really want to pay for an advisor, you can simply manage it yourself. For example, you can set up an IRA at a company like Vanguard, Fidelity, Charles Schwab, etc., etc., etc. You can fill out the paperwork to transfer some or part of your TSP to the new IRA and then invest in whatever you would like. You will typically not be receiving any management—you’ll be doing that yourself, although some of the companies now offer some very limited advice services.

In many instances you have the same investment opportunities as in a managed IRA. However, if you are setting up an IRA directly with a mutual fund company (such as Vanguard) as opposed to a brokerage account (such as Schwab), you will be limited in what you can purchase. In a brokerage account, you can buy shares of Amazon, a bond from Coca-Cola, and mutual funds from Fidelity, Vanguard, and American Funds. In essence, the brokerage account is your conduit to market traded investments. Setting up an IRA with a mutual fund company will probably only allow you buy mutual funds that are sold by that company.

The Cost?

Because you’ve taken out the human advisor, these accounts are typically much cheaper. Your expenses would be limited to the commissions on the trades, if any. (Companies like Schwab and Fidelity offer some trades commission free). Almost all mutual funds have an expense fee (often called an expense ratio). The TSP C Fund is .042%, for example. There are index funds available in the private sector that are essentially the C Fund with the same expense or even less. Some mutual funds that are actively managed can have expense ratios as high as 3% or more. But they are required to divulge these fees in their prospectus so make sure you do your homework.

There are generally no annual fees in most of these accounts. But, as always, ask “What am I getting for what I am giving?”

Independent of any IRA you have, you can always hire a fee-only, fiduciary advisor that can help you with a financial/investment plan. I highly recommend this type of advisor.

Other Considerations In Transferring Your TSP

Age

If you are an SCE, you can access your TSP penalty free if you retire in the year you turn 50 or later. Non-SCE’s can access their TSP penalty free if they retire in the year they turn 55 or later. When you transfer your TSP to an IRA, you are now under IRA rules. And the penalty free withdrawal age in an IRA is 59 1/2. So, if you’re an SCE, and retire at age 50, think twice before transferring money into an IRA that you can’t get out before 59 1/2.

There is a special IRS rule that allows you to pull from your IRA penalty free before 59 1/2 but it has some consequences. Read my paper on it HERE.

If you have not closed out your TSP, you can always roll your IRA back into the TSP. (Roth IRAs CANNOT be rolled back into the TSP, however!) This leads us to the next consideration….

Closing the TSP

Do NOT close your TSP. It only takes a two hundred dollars to keep it open. If the IRA and whatever investment you bought goes south, you want to be able to get it back into the TSP. Maybe the relationship with the advisor went sideways, or maybe you just did not understand what you were getting into. If you transfer ALL of your TSP into an IRA, that TSP will be closed and you’ll never be able to open it again.

I was recently contacted by an attorney for some litigation support where a former FERS employee did just what I mentioned. He listened to an advisor who told him to transfer all of his TSP into an IRA. The relationship soured, the investment was poor, and he thought he would just “undo” everything by transferring his IRA back into the TSP. Unfortunately he found out the TSP was closed, and he was stuck. It has resulted in a lot of bad feelings, and now a 6 figure lawsuit. Please avoid this! It’s easy. Just keep the TSP open!

Flexibility

Yes, the TSP has come a long way with increased withdrawal options. We have a lot more flexibility than we ever did before. However, we still don’t have the flexibility of most IRA’s. Multiple withdrawals in the same month are available in the typical IRA. Not so in the TSP, even under the new rules.

One of the biggest drawbacks to the TSP, and I would argue one of the biggest reasons people transfer money out of it, is the fact that you CANNOT designate which fund you want your withdrawal to come from. For example, say the market is doing poorly this year. (And it certainly is). You don’t really feel like selling your C Fund shares to make a withdrawal. You would take a loss. You’d rather just pull from your G Fund and leave your C Fund shares alone. You can’t do that. Any withdrawal will be processed by the TSP as coming out proportionately across ALL funds. Yuck.

Summary/My Opinion

The TSP has some great things going for it. Perhaps the best is the fact that we can access it before 59 1/2. Another, often overlooked benefit is the G Fund. Government bond funds in the private sector do not pay this well. The G Fund is a specially created fund for the government and is not available in the private sector. However, those are about the only two benefits that the TSP has that an IRA does not. Even the long-touted super low expense ratio is no longer a huge selling point for the TSP since so many other mutual funds in the private sector offer the same expense, some even less.

The TSP investment choices are limited to 5 index funds. Period. You want to buy Tesla stock? You’re out of luck. You want to buy a mutual fund that specializes in real estate? Look elsewhere. Have a strong desire to turn your money over to a hot advisor who can make you millions? You won’t satisfy that in the TSP.

To me, it boils down to this: the TSP is a good, simple, cheap, solid investment platform. I don’t think you should ever close it. And if you’re younger than 59 1/2, you might find it to be your primary account to draw from. However, there are some advantages to a private IRA. A wider array of investments is one. The ability to pick and choose where your withdrawal will come from is another. The fact that someone can manage your money for you may be something you are really looking forward to—just be careful.

The TSP becomes less attractive after you reach 59 1/2. Once that age is attained, the early withdrawal rules no longer have any meaning, since you can pull equally from an IRA or the TSP without penalty. Yeah, you still have the G Fund that is not available in the private sector, but that’s really the only advantage left.

Personally, I am a fan of the TSP, but I also appreciate its shortcomings. I don’t plan to ever close it, but I do plan on using private IRAs. In fact, if you read my Barbell strategy paper in May, you know my preferred plan.

It may seem that I am against managed IRA’s. I am not against financial advisors per se. Even those that charge a percentage of your account. In fact, if you’ve followed my papers for long, you’ll know I’m am constantly encouraging people to get professional advice. But I have seen time and time again where retirees are being talked into something they don’t understand, at a fee that is 20 times what they were paying in the TSP, and they end up in essentially the same type of investments. In other words, what’s the point? Other than helping the advisor make his boat payment? There are good advisors out there, but like anything else, do your homework. Is he helping himself more than he’s helping you? Or is his fee worth it because he’s making you WAY more than you would ever make in the TSP?

Hopefully this helps you make a more informed decision about when, or even if, you should transfer money from your TSP to an IRA. Understand everyone’s situation is different and don’t blindly follow what I do (or anyone else for that matter); it may not be applicable to your situation. Please don’t take anything in this paper as advice for your specific circumstances. It’s not meant to be that. If you are unsure about what you should do, pay a couple of hundred bucks to sit down with a financial planner and lay everything out to them. As they build an in-depth profile into your financial picture: debt, risk tolerance, goals, etc., they can help advise you on what is best for YOU. Remember the expert advice from the guy 3 cubicles over from you is probably not what you want to base your entire financial future on.