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Financial Literacy: What To Do with One’s TSP or 401(k) Plan (Part 1)

By CAPT Arnold Lim, USN (Ret)

The Intercom’s Financial Literacy column of May, 2021, contained a survey on areas of interest to members. One topic submitted to us was the options that one has on Thrift Savings Plan (TSP) withdrawals. Specific questions were what options exist for withdrawing money or rolling over money to an Individual Retirement Account (IRA) for more flexibility. This article is the first of two parts that attempts to succinctly address those questions.

The TSP is of course the federal government’s retirement savings and investment plan offered to federal employees; it is very similar to 401(k), 403(b), 457, etc. that are offered to employees at civilian employers. Upon retirement or leaving an employer, one has many options with these retirement plan(s) that one has contributed to. Here, we will discuss those options, focusing on some pros and cons to the conventional wisdom option of rolling over one’s retirement plan [generically referred to as “401(k) type” below, versus “TSP,” 401(k),” “403(b),” “457”, etc.] to an IRA.

Options

1. Leave the 401(k) type’s funds where it is at.
2. Roll over the funds to a plan at a new employer. (Of course, this option only exists if one is still working, and your new employer offers such a plan.)
3. Cash the funds out.
4. Roll the funds over to an IRA.

For option one, one should consider the fees. For 401(k) type plans, a plan’s administrative fees that one has to pay can vary quite a bit; some are low, which is good, while some can be quite high (e.g., > 1% per year), which is costly and will detract from your overall balance. [One important note for the TSP in particular is that the TSP generally is considered to have amongst the lowest fees if not the lowest nationwide, which is obviously ideal for the member.] The cons are that one cannot make contributions to it anymore, and one will no longer get a matching of funds from the employer. But the funds will continue to be able to grow tax-deferred.

For option two, if one is still working and has a new employer, then rolling the funds from the 401(k) type to your new employer’s retirement plan will allow one to consolidate your funds, which may simplify your accounting. However, a con is that those funds from your old 401(k) type are now subject to the rules/options of the new employer’s plan, which may have been originally good, but can change at any time. General wisdom is that performing this option two is not worth the risk of change that one cannot control.

For option three, cashing out the funds is a pro perhaps only if one needs access to the money immediately. A significant con is the mandatory 20% withholding fee sent to the IRS, plus a 10% penalty if one’s age at the time of the cashing out is less than 59 ½ years old. The funds will also be subject to taxes at one’s tax bracket, as ordinary income. From all of these taxes and penalties, this option three is not the best, especially because the funds will not be allowed to continue to grow.

Performing a “direct rollover,” as option four is called, is generally the best option for many individuals because it offers flexibility to you, but it has many discussion points. First, if one has a pre-tax, traditional component to your retirement plan, these funds must roll to a traditional IRA; if one has a post-tax, Roth component, these funds must roll to a Roth IRA. (One really cannot mix the two components without purposeful actions, including paying taxes.) As part of the rollover, a check(s) is sent by your old employer’s sponsored plan to the financial institution that you selected to manage your new IRA account; the check will have a For Benefit Of (FBO) your name on it, and thus no tax withholding will be taken out of your retirement fund balance.

Next month, we will continue in this two-part discussion by reviewing reasons to roll over and also not roll over your 401(k) type plan to an IRA.