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Financial Literacy: What To Do with One’s TSP or 401(k) Plan (Part 2)

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 second of two parts that attempts to succinctly address those questions.

In the first part, we discussed the options that one has. In this second part, we review reasons to roll over and also not roll over your 401(k) type plan to an IRA. Note: We generically use the term “401(k) type,” versus the multiple types of retirement plans: TSP, 401(k), 403(b), 457, etc.

Reasons NOT to Roll over your 401(k) type to an IRA

1. The Age 55 Rule
2. Possible to forego taking distributions

For the Age 55 rule, if one separates on or after age 55 years old from your employer and one wants to make a withdrawal, one is not subject to the 10% penalty for any withdrawal from that 401(k) type; one would just have to pay the ordinary income taxes, but one avoids the 10% penalty (unlike for taking withdrawals from IRAs if one’s age is at least 59 years old).

If one is still working at age 72 years old or older (when one would normally then need to start to take Required Minimum Distributions (RMDs) for a traditional IRA), one does not have to take distributions from a 401(k) type plan.

Reasons to Roll over your 401(k) type to an IRA

1. Access to more or better investment options.
2. Fees
3. IRAs tend to be easier to track.
4. Required Minimum Distributions
5. Consolidation

401(k) type plan’s investment options (e.g., mutual funds) are usually very limited in number (e.g., 6 – 40 options). But an institution that one picks to hold your IRA could have thousands to choose from. Also, one may likely be eligible for financial advice to construct a portfolio; manage one’s risk; financial planning.

A 401(k) type plan’s fees, especially those sponsored by smaller companies, can be relatively high. Large corporations can possibly get institutional pricing for fund options, which have lower fees. As always, individual investments for index funds tend to have lower fees than actively managed funds.

Some investment options within 401(k) types are unique to those retirement plans, meaning that a fund’s net asset value (NAV) is not readily available from most news sites. On the other hand, ticker symbols and their NAVs for funds within an IRA would nominally be available at multiple websites and thus their values would be more easily trackable.

More flexibility exists for RMDs if one has multiple IRA accounts versus multiple 401(k) types. For example, if one has five traditional IRA accounts, when one reaches age 72 and needs to execute RMD’s, after calculating the total RMD dollar amount, one can withdraw that RMD dollar amount from just a single IRA account or from multiple accounts; it is your choice on which specific IRA(s) to withdraw from. However, if one has five traditional 401(k) types (presumably from five separate employers during your lifetime), one would need to take at least that RMD percentage from each of the five 401(K) type accounts, not just one or some subset. IRAs and 401(k) type RMDs need to be administered separately. Why the confusing difference in RMDs? Ask the IRS.

Also, one should consider further performing what is known as a Roth IRA conversion, to convert money from a traditional IRA to a Roth IRA, where no RMDs are required and the funds grow tax-free (vs just tax-deferred). But Roth IRA conversions are certainly a large topic worthy of its own discussion in a future article.

If one consolidates, one will have a smaller number of accounts (IRAs) that one has to deal with. An argument can certainly be made that this eases management activities like rebalancing one’s accounts to meet a desired asset allocation.

In summary, one has lots of options when considering what to do with funds in a 401(k) type when one retires/leaves a company. Certainly, discussing these options with a financial planner may be very much worth the cost, but knowledge is always key. Happy investing!