Costly Thrift Savings Plan Mistakes to Avoid

Aug 21, 2017

accountThe Thrift Savings Plan is one part of the Federal Employees Retirement System, so it’s an important part of your retirement income. The following are Thrift Savings Plan mistakes you should avoid.

Not Updating Beneficiary Forms

This Thrift Savings Plan mistake can have surprisingly large consequences. These beneficiary forms override any beneficiary designation stated in your will. If you haven’t updated these forms and you pass away, TSP pays out in the following order:

  • Spouse
  • Child/children equally, and descendants of deceased children
  • Parents equally or surviving parent
  • Appointed executor or administrator of your estate
  • Next of kin entitled to your estate under state laws in which you resided at the time of your death

If you haven’t selected a beneficiary but want to change who it is, submit a new form (TSP-3) and that one supersedes any previous forms.

Contribution Mistakes

If you want to change your existing TSP allocation, do an Inter-Fund Transfer. To change how your contributions are going into your TSP, do a Contribution Election change. And to change your existing TSP allocation and your contribution election, do both. The mistake here is most people who want to change how their money is allocated only do a contribution election.

Not Taking Responsibility of your TSP

The TSP is unlike your CSRS/FERS annuity in that there isn’t a magic formula for knowing what your benefit will be at retirement. You determine how much you contribute (up to the IRS limits), what’s best; a Traditional TSP, Roth TSO, or a combination, and how your TSP funds should be allocated based on your comfort level.

Having an Outstanding Loan at Retirement

If you leave federal service with an outstanding loan balance, you have the option to pay it back within 90 days of the date of your separation. If not paid back within those 90 days, the IRS will declare it as a taxable distribution. You also may be subject to the IRS 10 percent early withdrawal penalty unless you’ve separated from service in the calendar in which you turn 55 or older.

Not Keeping Money in Your TSP After Retirement

If you rollover all your TSP funds to an IRS and later decide you want to roll them back to the TSP, you won’t be able to. Be sure to leave some money (minimum of $200) in your TSP if you do a rollover to an IRA, just in case you ever decide to roll them back to the TSP.

Transferring to an IRS Before Age 59 ½

If you retire at age 55 or later and need to access your TSP, there will not be an early 10 percent withdrawal penalty. However, withdrawals taken from an IRA prior to age 59 ½ will be subject to the 10 percent penalty. If you are transferring to an IRA, make sure to leave enough in your TSP to cover any withdrawals needed prior to age 59 ½.

Not Contributing to the Roth TSP

Be proactive in the tax planning and take advantage of the Roth TSP. If you are a federal employee eligible to contribute to TSP, you’re also eligible to contribute to the Roth TSP. A Roth allows you to pay tax on the starting investment.

Also, keep the following in mind when choosing a Roth TSP:

  • You pay tax now in today’s known tax environment
  • Most people have fewer deductions in retirement
  • Most other retirement income sources are taxable

Not Understanding Options for TSP Penalty Free Access Prior to Age 55

If you separate from service prior to age 55, you can take life expectancy withdrawals and avoid the 10 percent early withdrawal penalty. This payment is locked for the longer of 5 years or reaching age 59 ½.

So, what are life expectancy payments?

  • Your age and TSP balance determine the payments
  • Payment is made in all 12 months and recalculated each year based on your age and TSP year end account balance from the previous year. To see a table of this, click here.

Many fall into this trap: you begin taking life expectancy distributions at age 50. Once you turn 55, you contact TSP and stop the distributions. Five years have gone by so you mistakenly think you’ve satisfied the 5-year rule. The problem is it’s the longer of 5 years or reaching age 59 ½. In this case, the longer would be reaching 59 ½. Because of this, you would owe the IRS 10 percent of the total amount you withdrew from your TSP during those 5 years.

Not Understanding a Beneficiary Participant Account (BPA)

The rules are:

  • A BPA account is only available to a surviving spouse
  • No other beneficiary may leave funds in TSP
  • The BPA owner may take partial withdrawals (even if the deceased spouse had already taken a partial withdrawal) and then a full withdrawal, as follows:
    • Single payment
    • Series of monthly payments
    • Life annuity
    • Combination of all 3

Some federal employees suggest to their spouse that they leave finds in the TSP if they pass before. The benefits of the TSP will still be available; low fees and monthly withdrawals. However, be aware of these complications that could occur:

  • At the spouses’ death, funds can’t remain in TSP. Instead, the BPA owners’ beneficiaries receive a direct payout. They can’t roll this over into an Inheritance IRA, which they would be able to do if the money was already in an IRA. This means funds are taxed at the beneficiaries’ ordinary tax rate and added to their other income, which may increase taxes. If the surviving spouse had rolled over the TSP into an IRA, any balance left at their death could be rolled over to the designated beneficiaries, via an Inherited IRA, avoiding a significant tax reduction.
  • Another issue is the BPA owner must use the Single Life Expectancy Table for Required Minimum Distributions (RMD’s). This table requires a larger distribution than the Uniform Table, which a TSP or IRA owner would use to calculate RMD’s. If the surviving spouse rolls over the TSP into an IRA, they could calculate the RMD using the friendlier Uniform Table.

Planning for retirement takes just that; planning. The TSP plays a vital part in your retirement years. It’s important to do your research and fully understand the rules and regulations regarding your TSP. Doing so will help you avoid most, if not all, of these thrift savings plan mistakes and maximize your investment.

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