Cheap or choice. That about sums up your options as you consider whether to take your money out of the Thrift Savings Plan, the 401(k) for Federal employees and armed forces members. If you're mustering out or simply getting your first private-sector job, know this: You'll be hard-pressed to find a plan outside the TSP with lower fees -- or fewer investment possibilities. But if you head for a plan with more investment choices, pay attention to IRS guidelines to avoid an unwanted tax bite.
The $200 Rule
If your balance exceeds $5 but not $200, your account will be closed in one payment. If you don't want to pay tax -- plus a 10 percent early-withdrawal penalty -- you have 60 days to deposit the money in a qualified tax-deferred account, such as an IRA or employer-sponsored retirement plan. Amounts less than $5 simply are forfeited to the TSP.
When you're no longer one of Uncle Sam's employees, you can't contribute to the TSP, but as long as the account stays above $200, you can leave it for as long as you want -- at least until you start taking required distributions the year you turn 70 1/2. But as soon as you take out the money, you have 60 days to choose your new plan or the whole pile gets taxed as ordinary income, plus a 10 percent penalty if you're not yet 59 1/2. It's best to have your new account ready before you initiate the pullout. You probably can avoid 20 percent withholding by having the withdrawal check made to "new plan account name FBO -- for benefit of -- your name."
Individual Retirement Accounts provide the greatest investment variety. Depending on your IRA custodian, you should be able to invest in commodities and real estate as well as stocks, bonds, mutual funds, savings accounts and certificates of deposit. Keep your TSP rollover IRA separate from other IRA accounts you might have or begin later. That will allow you flexibility to pursue other options later with fewer tax complications. One IRA disadvantage: in some states, IRA assets don't have the same protection from judgments or creditors as the TSP.
Workplace Retirement Account
A 401(k) or 403(b) retirement plan at your new job carries the same protection from creditors and judgments as the TSP, and most also include loan options. Although you'll have fewer investment choices than in an IRA, workplace plans have boosted the attractiveness of their investment offerings, and many now offer helpful investment advice. However, employer-sponsored plans typically carry higher custodial fees than an IRA and certainly higher than the TSP.
Buying a tax-qualified deferred annuity avoids any immediate tax liability and allows you to create a path to a monthly retirement income payment that will last as long as you do. Sounds great, but annuities normally carry higher fees than the other options. Although you can't outlive the income payments, annuities often end when you die with nothing left for heirs. Choosing an annuity may be irreversible. At the least, getting out of an annuity contract would be extremely costly.
You can split your money among various options, including leaving part of it in your TSP account.
Combat pay or other earnings from a tax-free zone deferred into your TSP are never subject to federal taxes, even when you withdraw them -- similar to after-tax deposits to a Roth IRA. However, tax-exempt contributions limit your options because 403(b) plans as well as most 401(k) plans and tax-qualified annuities won't accept rollovers that include tax-free contributions.
Check your TSP statement for the tax-exempt balance. If it's a large portion of your assets, consider rolling your TSP into a Roth IRA. You immediately will pay taxes on assets that are not tax-exempt, but you'll escape the early-withdrawal penalty and when you reach 59 1/2, all withdrawals will be tax-free with no required minimum distributions. Although you avoid taxes on the proportional amount of a traditional IRA withdrawal made up by tax-exempt contributions, the portion from nonexempt contributions and any investment growth will be taxed in retirement as ordinary income.
Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.