Behind the curve. Grading the TSP on new withdrawal rules
We think a grade of a B is about the best we can give. Are we being too hard? Let’s find out.
In September 15th, the TSP rolled out their much-anticipated new distributions rules and regulations required by the TSP Modernization act of 2017. With the approval of this law, it finally brought thousands of retired TSP participants relief from the previous stringent withdrawal restrictions.
However, is this cause for celebration? Did the new regulations go far enough? Did they go too far? As financial planners and educators specializing in guiding federal employees into retirement, we’ve analyzed the new rules inside and out and have given our final assessment.
Our grade: Solid ‘B’
Our teacher’s comments: “A Good start, but missed a few core areas. Still room from improvement”
No doubt about it, the new rules will help retirees hamstrung by the very weird and frankly draconian withdrawal limits placed on them for years. (for a full summary of changes, click here) So why just a ‘B’? Here are 3 things we love about the new rules, and few things we didn’t like.
#1 Improvement: The new ability to take multiple partial withdrawals.
We never understood this one in the first place and are glad this is fixed. Before, you were able to take only one partial withdrawal out of open season for your ENTIRE retirement. (yeah, like 30 years)
Now, in addition to your monthly withdrawals, you can also access your account for any single ad-hoc withdrawals to pay for those unexpected retirement expenses. (e.g., buy a car, take a river cruise, pay for knee replacement, etc.) We’ve always said people don’t spend money in retirement on a routine static basis for years and years. To put it bluntly ‘stuff comes up and stuff costs money.; This new feature helps match withdrawal options with the actual reality of spending money in retirement.
#2 Improvement: The ability to change your monthly (installment) payments at any time.
We rank this improvement as a close second. Before, once you set the dollar amount of your monthly withdrawals, you could only change it once per year, during open season. (who has an open season for retirement withdrawals anyway?) Now that this has been fixed, you can change the amount anytime you want. This is especially crucial for new retirees who are adapting to the true costs of not working and may need to alter their withdrawals early in retirement.
#3 Improvement: The ability to segment where your withdrawals comes from. Roth, Traditional or both.
Accountants around the country are applauding! Now with the ability to choose, you can potentially save yourself thousands of dollars in taxes, especially in the years where you may need to make a large purchase or expenditure. For example, imagine you’d like to buy a condo and want to make a $50,000 down payment. Now, you can have the possibility to choose and withdraw that entire balance from your non-taxable Roth balance and not adversely affect your income taxes for this given year. Income tax rates are progressive and the more you make, the more you pay. Large withdrawals in certain years taken from ‘traditional balances’ would sometimes throw our clients into bigger tax brackets. No one like to pay more taxes.
‘Behind the curve’ Miss #1 : Why can’t I control what investment my distribution money comes from?
This is a BIG whiff. (and why the TSP didn’t get an A)
Financial advisors say the #1 rule of distribution planning is to withdraw your money from the investments with the least volatility. Simply put, you don’t want to take money out of a declining investment. We call this is the ‘Sequence of Returns risk.’
In a nutshell, when you withdraw money from an investment you are actually ‘selling shares.’ When that investment suddenly declines in value and you still need your same annual income, you need to sell MORE shares to accomplish this task than you did the time before it fell in value.
Why is this so damaging? Should it even matter because the fund will eventually go back up? Unfortunately, it matters a great deal. It’s because when the investment goes back up, you have LESS shares than you did before and LESS shares to in which to compound upon. If this happens a few times in the first 10 years of retirement, it could exponentially cut years from your retirement.
‘Behind the curve’ Miss #2: Why didn’t they add any new funds?
The TSP prides itself on its simplicity. But this is an example of a good concept gone way, way too far. It’s wise to keep market losses small in retirement. (see Miss #1) The single biggest weapon people have at their disposal when battling market volatility is diversification. Diversify. Diversify. Diversify. But can you really diversify with only five funds? No, you can’t. If you research the TSP and read the board meeting minutes like we do, you know this has been brought up before and had been repeatedly shot down.
The argument against adding funds is that they will add confusion to participants. We don’t agree. Yes, adding 50 funds into the account does cause confusion, but adding a 4-5 more will only provide better options leading to greater diversification, not more confusion. Asset classes/funds not represented in the TSP but commonly added to other traditional 401Ks include the following:
- High Yield Bonds
- Mid Cap Stock
- World Bonds
- Large Cap Growth
- Large Cap Value
- Real Estate
- Emerging Markets
- Balanced (non-target date)
Adding these funds is not a guaranteed way to earn more return, but added choice does allow for diversification. We know historically that the more diversified a portfolio is, the greater the ability to combat risk. We think the TSP can even choose to implement these funds in the same manner they’ve implemented the others, with low cost index funds.
In the end, we think a grade of a B is about the best we can give. Are we being too hard? Perhaps.
Yes, these regulations do bring relief for TSP participants. But when we remove ourselves from the TSP ‘bubble’, we can honestly say these improvements only bring the TSP functionality up to what every other financial institution has been doing for years. We are happy for the fix but the question does remain: why not sooner?
We’d like to see the TSP get ‘Ahead of the Curve’ and make more improvements that some of the best private 401(k) plans are doing. We think starting with these two suggestions would earn the ‘A’ grade.
- For more thoughts advice and expertise on financial planning for federal employees click here
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- Want to see more of Tony’s federal employee posts? Check out his author page at Fedsmith.com
“The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.”
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