Military Financial Independence

Military families ask a frequent question about financial independence:

“Hey Nords, what stocks should we buy?”

It’s a trick question. Before people start picking investments, the first step is deciding on an asset allocation. Yet the responses quickly devolve into a debate of the merits among commercial real estate, Nvidia, and cryptocurrencies.

 

Logic + math versus emotions

The key is not just picking an asset allocation that will optimize your returns, but also picking one that you’ll be willing to stick with during the volatility of a plunging bear market and a nasty recession. (Nobody complains about the volatility of a rising bull market.) The right asset allocation (right for you!) feels comfortable and helps you sleep better at night– especially if it helps your spouse sleep better at night too.

If that “comfortable sleep” priority isn’t met, then nothing else matters. If it doesn’t “feel” right, then the emotions of behavioral financial psychology will always derail a highly logical asset allocation plan.

Then there’s decision fatigue.

If you have to keep making the same investment decisions over and over again, whether they’re easy or hard choices, then you’ll deplete your cognitive stamina.  Even worse, you’ll abandon the entire decision-making process and end up with minimal retirement savings.

If you’re lucky, your excess cashflow has piled up in a savings account while you dither on your choices.  Or the money could slip through your fingers.

Think about the people you know who haven’t started budgeting, saving, or investing. Maybe they’re not even paying down their credit-card debt or their student loans. Yet they seem like functional adults. Are they really that incompetent with money? (They can do math, right?) Why aren’t they moving their assets?

Or are they just feeling tired and defeated every time they contemplate the numbers, and paralyzed by indecision?

What the heck does this squishy pop psychology have to do with picking an asset allocation?

Understanding your emotions helps you build a plan that you’ll stick with through good markets… and in tough markets.

Better yet, your plan makes it a lot easier to automate your investing and minimize your decision fatigue.

Your chosen allocation has to give you the patience to keep buying shares when the market drops 30%. It has to support your discipline to ignore the hysterics of the financial media and persevere with your plan. It has to give you a written document (or an affirmation on your phone, or a Post-It on your refrigerator) to override short-term panic and to visualize your future financial freedom.

Over the long term (>10 years) you’ll grow more wealth with steady (automated!) dollar-cost-averaging into your asset allocation.

You won’t have to feel (there’s that emotion again) obligated to try to time the market.

 

Stocks or bonds?

Waaaaay back in 2008, Moshe Milevsky’s book “Are You A Stock Or A Bond?” suggested designing your asset allocation to complement your occupation. Over a decade later his thoughts are still relevant to your life stages and investments.

What’s a career look like as a stock?

Well, if you succeed as a professional athlete, or as a big swingin’ Wall Street trader, or as a full-stack developer tech nerd (you know who you are) then your occupation is likely to have high earnings for a few years. The vast majority of rockstars in this category have big payouts, but they tend to be for less than a decade. They might face frequent layoffs or even firings. Their reliability of continued employment is low and their financial uncertainty is high.

Just like picking a stock, their careers might be highly volatile with a risk of a loss of principal.

Take a look at the bankruptcies of NBA basketball players, the movie tropes of Wall Street traders, or the tech industry’s layoff cycles. The income might be awesome while it lasts, and the lifestyle looks exciting from the outside, but the net worth… not so much.

As thrilling as it might be to earn (and spend) those staggering sums of money, there’s no guarantee that your career will end on your terms. You might not even vest in your stock options, let alone in your pension.

Instead, Milevsky suggests offsetting a volatile high-earning career with investments that are high in bonds, Treasuries, and even single-premium immediate annuities.

On the bond-career side there are civil servants, university professors, and military families. The starting salaries are low and the raises are small, but their careers generally have a higher likelihood of continued employment. Persistence is usually rewarded with promotions, and there are retirement investment accounts. Better yet, some of these occupations tend to have untaxed compensation, employer’s matching contributions, annuity income, or even decent pensions to supplement a few decades of saving & investing.

Your bond career won’t get you rich quick, but you’ll have time and compounding on your side. Some of those professions have a much better work/life balance, too.

Milevsky suggests that people in reliable, lower-earning careers should invest in an asset allocation which is high in equities. As long as you expect steady employment, you could even go as high as 90%… if it feels right.

 

The 4% Safe Withdrawal Rate (and the Trinity Study)

These two historical computer simulations ran through many different combinations of stock & bond asset allocations. They’re limited in the scope of their simplistic asset studies: large-cap stocks and government bonds.  They did not include international equities or real estate, and cryptocurrencies didn’t even exist yet.

However this research consistently contrasted volatile assets that are highly likely to beat inflation (stocks) against less-risky assets that reduce volatility without consistently beating inflation (bonds).

None of the withdrawal rate simulations include Social Security, pensions, or annuities. Those benefits were beyond the scope of their research questions. Besides they’re hard to add to a computer model, so both the original 4% SWR study and the Trinity researchers ignored them.

Despite the limits and omissions, these studies answer the most important question of your career: how long do you need to keep trading your life energy (finite yet uncertain) for financial security? When do you have enough?

Even more importantly, when will you reach the point of trading life energy (which you might not have) for money that you won’t need? When does your safety margin become ridiculously excessive?

If the 4% Safe Withdrawal Rate has a very high probability of lasting for at least 30 years with assets of 25 times annual expenses, then why would people keep working for 33x, 40x, or even 50x?!?

Extra assets get back to those emotions of behavioral financial psychology. Words like “security”, “enough”, and “safety” are loaded with feelings. We can be highly logical and do all of the math, but if we don’t feel good about the results then nobody will be happy enough to stop working for paychecks.

Yet nobody is happy about working for paychecks until they die, either.

 

How much of each asset class?

There’s a growing body of research data to support an asset allocation that’s higher in equities (to beat inflation) with some bonds (to reduce volatility).

Most of that research is based on over a century of data for large-cap stocks. The S&P500 is a popular index, and more recent data comes from total stock market indexes that cover a much wider variety of company sizes.

The asset allocations analyzed for the 4% SWR & Trinity studies were at least 50% large-cap stocks and the rest in Treasuries or corporate bonds. Depending on your career, your life stage, and your tolerance for volatility– you could go up to as high as 100% equities.

Bond ratings and durations will affect their yields (and make investors feel sad when those yields drop) but the main reason for bonds is reducing overall volatility of your investments. Once you’ve lowered volatility, there’s no reason to chase yield— especially if a higher yield (from a riskier bond) raises that volatility again. Even if your bonds have a lower yield, your stocks portion of your asset allocation does the real work of beating inflation with higher yields.

It doesn’t matter whether the bond yields match inflation or lag it. Bond duration doesn’t matter, either, especially if they’re in an index mutual fund or exchange-traded fund being held for at least five years. It probably doesn’t even matter whether they’re Treasuries or junk bonds, as long as they reduce overall volatility and don’t default.

Picking the actual asset-allocation number can be tinkering at the margins, but any stock/bond asset allocation between 60/40 and 90/10 has been generally proven to last for at least 30 years.  (Allocations with more stocks are more volatile.) Pick numbers in that range which help you sleep best at night.

Your choices could be as simple as one total stock market fund and one total bond market fund. Both of them should be passively managed and have low expense ratios. If you buy exchange-traded funds then you can hold them at nearly any brokerage instead of paying extra fees. For example the Vanguard total stock market index ETF (ticker symbol VTI) trades commission-free at other brokerages.

If you must pick stocks, then limit your overall asset allocation of individual stocks to no more than 10%. That’s big enough to move the needle on your net worth if you turn out to be a brilliant investor, and small enough to limit the damage when you’re… not.

 

Other asset classes?

“But what about real estate?” Sure, if it makes you feel better (there’s that emotion again), but nobody has shown that real estate is absolutely necessary. There’s more research about stocks & bonds than about real estate, so this is a question of comfort (and volatility) instead of strictly asset allocation.

An investment property probably appreciates at least at the rate of inflation and has a yield of at least a high-quality dividend stock or a corporate bond. The leverage of investing with cheaper mortgage money is the stock-market equivalent of buying shares on margin. You could replace some of the stock asset allocation with an equivalent value of real estate.

We’re just exploring how hard you want to work at managing properties (landlording, REITs, syndications, or anywhere in between) and how well you’re sleeping at night.

“But what about alternatives?” Sure, if you can tolerate the volatility. Again: nobody knows if alternatives (including cryptocurrencies) are absolutely necessary.  There’s not enough history for confidence in the statistics over a 30-year period.

In this case, I’d limit the asset allocation for alternatives to 10%. See the comment above about brilliant investors… or not.

If your asset allocation percentages are measured with increments of less than 10 percentage points then you’re probably overthinking it. Nobody knows that either. At smaller numbers like “6.82%” you’re just tinkering at the margins and giving yourself more busyness to track.

There’s no single perfect asset allocation for anyone, but there are plenty of good-enough asset allocations. You could go with the cake & fruit salad theory, or some variation of your age.  The important part is picking an assert allocation and investing in it instead of being paralyzed by a perpetual quest for the best asset allocation.

Once you’ve started investing in your asset allocation, and put it in autopilot with periodic deductions & share purchases, then you can step back and consider whether it’s worth your time to seek a better asset allocation.

 

What’s next?

Use the 4% Safe Withdrawal Rate as a tripwire for your financial independence.

Once you reach assets of 25x your annual spending (25x is the inverse of 4%), your investments are very highly likely to last for 30 years.

“Tripwire” means that you could decide to keep working if you find your career challenging & fulfilling. You could stop working and go full-throttle FI lifestyle if that’s your plan (and if you’ve been preparing for that new life). If you’re not ready to quit work then you could negotiate part-time hours, work from home, remote work, more paid time off, a sabbatical, or simply an unpaid leave of absence.

You could even start searching for a different job that meets your new standard of work/life balance and your desired quality of life.

If you qualify for Social Security, that income stream drives your portfolio survival to 100%. Social Security was never included in the Bengen SAFEMAX 4% SWR research or the Trinity Study. It’s extra.

For the first decade of financial independence, you can minimize the risk of an adverse sequence of returns by keeping about two years’ expenses in cash.  Replenish the cash stash after years when the stock market is up, and keep spending it after years when the stock market is down.

Two years does the job well enough to minimize this sequence of returns risk, although some bear markets & recessions might last longer. We’re not trying to outlast the bear market or recession– we’re trying to keep just enough cash to avoid portfolio failures.

If the recession lasts longer than two years then you might have to sell bonds or stocks at lower values, but you’ll still probably be able to offset capital gains & losses in a tax-efficient manner. Better yet, your investments avoided worse damage during the first two years and are two years closer to a recovery. You’ve survived the sequence of returns risk.

Is there a better number than “two years”? What about four years of cash? 37.8 months? That answer depends on whether we’re back to sleeping well at night.

How much longer do you want to trade your limited life energy for money that you won’t need?

After a decade of financial independence, while your asset wealth grows faster than your original inflation-adjusted withdrawal rate, the actual withdrawal rate drops.  Economist Karsten Jeske’s research has shown that SORR is negligible when the withdrawal rate drops to around 3.25%… and when there’s no SORR, then that withdrawal rate is sustainable for at least 60 years.  (Parts 38 and 54 at that last link.)

Finally, anyone who’s receiving annuity income (particularly inflation-adjusted annuity income!) can hold an asset allocation that’s lower in bonds (and higher in stocks). That’s because an inflation-fighting annuity (like a military pension or Social Security) is the equivalent of the yield from a fund of low-volatility high-quality TIPS or I bonds. That’s a flawed analogy in some ways (because bonds mature) but it’s acceptable for a discussion about asset allocation.

This analysis has led recent financial researchers to propose asset allocations like Wade Pfau’s review of variable-spending strategies, or Michael Kitces’ “rising equity glidepath.”

None of this discussion addresses rebalancing. Do whatever helps you sleep better at night, but every 2-5 years or +/- 10 percentage points is probably good enough. We don’t have enough research to be confident that rebalancing is necessary.

 

Call To Action:

1. Decide on your asset allocation with a percentage of stocks & bonds between 50/50 to 90/10.
2. Get started by automating it! Use payroll deductions to your 401(k), and deductions from your checking account to your IRA. As your income rises, deduct even more from your checking account to taxable accounts.
3. Make sure that those accounts (your 401(k)s, IRAs, and taxable accounts) are invested in your asset allocation. Pick passively-managed index funds with low expense ratios, and reinvest the distributions.

Once you’ve automated the investments (and the reinvestments), you can dig deeper into this post’s links and consider tinkering with your long-term asset allocation. As your wealth grows, maybe you’ll choose to add other asset classes– but it’s not essential.

The good news is that your investments are quietly compounding away for your financial independence, whether or not you finally find your perfect asset allocation.

 

 

There are no affiliate links or paid ads in this post.  Try your military base library or local public library before you pay money for these books– in any format.

 

 

Related articles:
Jim Dahle’s “150 asset allocations better than yours”
Mike Piper’s asset allocation: fruit salad
“How Should We Plan Our Finances For The Rest Of Our Lives?”
Financial Myths Of Retirement
Ben Carlson:  “A Balanced Portfolio Always Comes With Regrets”
The Bogleheads Wiki on asset allocation

A long-time reader (and good friend!) writes about their financial independence:

“Is there ever an issue to keep money in the federal Thrift Savings Plan instead of moving it to a brokerage firm? I still have my military and civilian accounts at the TSP.”

As you might expect, rolling over has turned into a complicated decision. The TSP used to have the world’s largest passively-managed index funds at the world’s lowest expense ratios, yet in the last decade they haven’t kept up with the rest of the industry.

While you’re in the military, you can’t move your TSP to another account.  But when you leave the military, what should you do with your TSP?  And if you happen to have a civil-service career with a federal TSP account, then when should you move that?

Disclaimer: this is 4600 words of financial and lifestyle advice. (Yeah, long-form posts seem to be turning into my brand.) This analysis is packed with the nuances of your options, and I deliberately chose NOT to include a TL;DR summary of the pros & cons.

I recommend reading the entire post– or at least asking your financial advisor to read it.  But if you must skim, you could skip down to the Call To Action at the end.

I’ve already run a draft past an experienced paraplanner, and if I’ve overlooked an issue then I’m sure my advisor contact network will chime in with their forceful backup.

 

Financial advisors want your TSP account

Before I dig into the advantages and pitfalls that you might care about, I’ll discuss the motivations of other people who are intensely focused on your TSP account: financial advisors.

It’s worth your time to consult financial advisors, especially if you’re feeling paralyzed by analysis or a lack of confidence. However the advisor’s incentives should align with yours.

Advisors (even the fiduciaries with your best interests in mind) have built their own industry around TSP rollovers. That’s a very good thing because (as we’ll describe in this post) the TSP’s features and infrastructure make it ridiculously complex to roll over “your” money.

The danger from financial advisors is that TSP accounts are still part of the nation’s largest collection of retirement assets. (As bank robber Willie Sutton might have said: “That’s where the money is.”)  Advisors can always offer more options for your assets than the TSP funds can give you, but moving a TSP account to a brokerage firm gives the advisory profession a personal motive: boosting their assets under management.

Traditional advisors who are paid for assets under management can immediately raise their income (you’re paying them!) simply by rolling over your TSP account(s) to their platform. Even worse, if they’re earning commissions or using a sketchy “fee-based” revenue model, they can grow their income ever-higher by piling on more products and services.

Advisors are supposed to base their recommendations on all of your assets (whether or not they manage them) and after considering your life priorities. Unfortunately (for them) they only get paid AUM fees for your TSP investments if you roll those assets over to their control.

The world’s best fiduciary fee-only advisors still have an ulterior motive to roll over your TSP assets. They’re not charging you for AUM or earning other commissions, but your assets on their platforms make their business look bigger. The size of their company helps them scale to a higher level of services and could enable them to negotiate better terms with service providers. Someday (possibly decades later) if your advisor decides to sell their firm (or partner with other advisors), then one of the valuation metrics is their assets under management.

Advisors may suggest a TSP rollover as “consolidation, convenience, and customer service.” It’s easier for them to track your assets and focus on tactics to boost your wealth while cutting your expenses. That’s generally a good strategy as long as it’s still in your best interests.

One way or another, advisors benefit when you roll your TSP over to your IRA. Just make sure that you get your share of the win too.

 

The TSP is falling behind the fund industry

In the last millennium there were few ways for military families to invest for financial independence. My spouse and I joined the military in the late 1970s, and and the TSP was opened to civil servants in 1987. (But not to the military!) Servicemembers finally got TSP accounts in January 2002. (I retired a few months later.) Yet my spouse and I still managed to invest for financial independence with our IRAs and taxable accounts.

Although civilian 401(k)s had employer contributions and matches way back in the late 1970s, the TSP didn’t offer matching for military families until 2018 (with the Blended Retirement System). That discussion only started in 2015 when military families campaigned the Dept of Defense (in surveys and at all-hands calls) about employer matches. I’m pretty sure DoD only got interested when retention became even more of a challenge.

The TSP’s employer match is essential… for workers. Once you leave military and civil-service employment, the matching stops and you have more options for your retirement accounts.

Roth 401(k)s were created in 2006, yet the Roth TSP didn’t roll out until 2012. (National Guard & Reserve families had to wait many more months for their Roth TSP accounts.) The TSP has had nearly a decade to implement the federal law for in-service conversions of retirement accounts. Yet I doubt the TSP will ever offer to handle converting traditional TSP accounts into the Roth TSP, so rolling a TSP account to an IRA is (still) the only choice for Roth IRA conversions.

The TSP was America’s greatest investment during the 1990s-2000s era of mutual funds with front-loaded sales charges and 1.5%(!) expense ratios. Unfortunately since those bad ol’ days the TSP hasn’t kept up with the industry, especially compared to Vanguard & Fidelity expense ratios.

Then there’s the TSP’s 2022 software “update” with its ensuing chaos. In my opinion, the TSP’s program management (and contractor execution) demonstrated inexperience and incompetence bordering on criminal negligence.

After you’ve separated from the military or the federal civil service, nobody needs that “upgrade risk” hovering over their TSP accounts— let alone inadvertently deleting their beneficiary designations.

Before we abandon the TSP, let’s review a few reasons to keep a TSP account.

 

Federal protection with the TSP

Legally, the TSP offers more federal protections than most states for bankruptcy, liability, litigation, and divorce. Your assets might be safer from those risks in the TSP than in your IRA. Surgeons, architects, and civil engineers can appreciate the potential shield from malpractice or civil lawsuits. If you’re sued as a landlord (especially by a tenant’s health insurer) over injuries from falling tree limbs, then the TSP could offer more federal litigation protections than a state’s IRA laws.

Of course there’s liability insurance for landlords, too, and you might not need to care about the TSP’s federal protection. Check your state law (and consult a lawyer or a financial advisor) to confirm how the risks affect you, your occupation, and your family.

Next let’s look at the money.

 

Five financial benefits of the TSP

First there’s the G fund.

Long-term government securities might seem like a great place to park your cash that you’ll spend in the next year or two.  (There’s zero risk of principal loss.)   The G fund also seems a lot easier to manage than a TreasuryDirect account or Treasuries in your brokerage account. (The G fund was especially popular during the last two decades of record-low interest rates.) However CDs and high-yield savings accounts are currently paying… higher yields.

For your first decade of financial independence, the G fund can help new retirees avoid sequence of returns risk as they draw down their assets.

Keeping an asset allocation of two years’ expenses in the G fund might be all the reassurance you need for coping with bear markets or recessions. After a decade of retirement, though, almost everyone is past the sequence of returns risk for at least the following 20 years (probably longer).

Once your pension or Social Security deposits begin, then the G fund’s cash stash is no longer financially necessary. Emotionally (as documented by behavioral financial psychology) you might still care about the G fund for sleeping comfortably at night.

Your asset allocation preferences can change during your decades of retirement, and you could hedge your choice to use the G fund. Even if you decide to roll your TSP over to your IRA, you might still want to keep a few hundred bucks in the TSP (for their minimum-balance requirements) in the G fund.

Second, there’s the I fund.

Continuing the discussion of asset allocation: if yours includes international equities then the TSP’s I fund may still have a lower expense ratio than most other international index funds. Unfortunately the expense ratios of the TSP’s other funds are no longer competitive with Fidelity, Vanguard, or Schwab, but the I fund still has an edge… for now.

If you decide to buy the I fund, be aware that holding international equities in a retirement account means you can’t take the foreign income tax credit. My spouse and I are still lugging forward a $998 credit from seven years ago (when we shed our last international equity fund in a taxable account) and that credit is only good for 10 years.

A third financial benefit is a TSP annuity.

This might be a great idea for vets who didn’t stay long enough to vest in a military pension or to pay the price for VA disability compensation. Every retiree needs a little annuity income to hedge against longevity risk, even if it’s “just” Social Security.

Perhaps the TSP contract managers (Blackrock and State Street Global Advisors) get a better price on buying annuities in bulk, although I’ve not yet been able to confirm this. If you think a single-premium immediate annuity is a good idea for your retirement asset allocation, then check the TSP’s pricing along with the giants of Berkshire Hathaway, Vanguard, Fidelity, and Schwab.

Fourth, there’s the backdoor Roth IRA tactic.

An employer’s traditional retirement account sets up a backdoor Roth IRA. (If your eyeballs are glazing over, please stick with me for a few paragraphs and I’ll link a video.) Military vets with high civilian incomes (from bridge careers after active duty) can blow through the earned-income limits and get locked out of contributing directly to a Roth IRA. Their traditional TSP account lets them work around the limits.

It’s not just the employee, but also their spouse. “High earned income” in 2024 starts phasing out Roth IRA contributions at $161K/year for single filers and $228K/year for married filing jointly.

If you’re the spouse of a high earner, this could also affect your contributions to your spouse Roth IRA.

The first step for a backdoor Roth IRA contribution is emptying out your traditional IRA account by rolling over its assets to an employer retirement account. Your traditional TSP (or just about any ol’ traditional 401(k)) can take a rollover from your traditional IRA. Emptying your traditional IRA means that you’ll no longer have any tax-deferred contributions (let alone taxable gains) in it.

Traditional IRAs don’t have earned-income limits on contribution eligibility. Once your traditional IRA is empty then you make that year’s lump-sum non-deductible contribution from your high earned income. Shortly after the contribution has settled in the account, you do a Roth IRA conversion from that account. The contribution wasn’t deductible (it’s already been taxed before the contribution and is not taxed by the conversion) and the traditional IRA probably didn’t have any gains in that short period, so the Roth IRA conversion costs minimal (or zero) income taxes.

Caution:
I’ve glossed over a few esoteric details of backdoor Roth IRAs, and timing is critical. If you expect to reach those earned income limits then check your plans with your financial advisor or a CPA. They might be a tad twitchy about the IRS’s step transaction doctrine, although it seems to be rarely inflicted on backdoor Roth IRAs.  For us mortal humans, Michael Kitces has translated this reference into plain English.

Of course when your corporate salary is that high, then a backdoor Roth IRA tactic is tinkering at the margins. Maybe it’s just simpler to contribute to a taxable investment account. My friend Rob Berger can talk you through the process in this video and help you decide if it’s worth the hassle.

Fifth and finally, there’s the Rule of 55.

This benefit is only offered to those who separate from the military, or retire from active duty, or retire awaiting pay (from the Guard/Reserves) “during or after the year at which you reach age 55 or later.”

Yeah, you have to still be in uniform during the year in which you reach age 55.  Very few servicemembers will be sticking around for this benefit, but it’s in the tax code.  This is far more common in the Guard/Reserves, or with people who joined the military later in life, or for servicemembers with broken service.

It’s an IRS exception to the early-withdrawal penalty of retirement accounts for

“Distributions made to you after you separated from service with your employer after attainment of age 55.”

Keep in mind that the Rule of 55 withdrawals can only be made from a TSP account, not from an IRA.  Withdrawals are penalty-free, however withdrawals from a traditional TSP account might also be subject to a 20% withholding rate for income taxes.  If this 20% is withheld then you might get some or all of it back when you file your next income-tax return.

We’re finally finished with the reasons you might want to keep your TSP account.

 

Why you might want to ditch the TSP

Still with me? None of those considerations are keeping you in the TSP? Then let’s roll… over to an IRA.

Here’s the first and most important reason to leave the TSP as soon as you separate from the military and the civil service: your beneficiary designation.

As my spouse and I get older, our life planning has shifted from financial independence to legacy, estate taxes, and beneficiaries.

I’m alarmed by what I’ve read about the treatment of TSP beneficiaries. Frankly, the TSP makes life hard on your beneficiaries— and it’s hardest during the most vulnerable days after your death.

WARNING: Before you read any further, please check that the TSP’s 2022 software update has not “accidentally” deleted your previous beneficiary designations. Make doubly sure that these beneficiaries are the people you want to receive your money!

Here’s the TSP’s policy: your surviving spouse is probably not eligible to have a TSP account, let alone any of your other beneficiaries. The TSP has dealt with their eligibility problem by making it your beneficiary’s problem.

If your beneficiary designation is 100% to your spouse, the TSP sets up a Beneficiary Participant Account.  Right in that link, on a red background, is this text:

“You cannot make contributions to, borrow from, or roll over money to your beneficiary participant account.”

On another part of the TSP’s website:

“Spouse beneficiaries can keep their balance in their TSP beneficiary participant account.”

If your spouse has read the first 1800 words of this post, they probably already share those concerns. With the TSP’s additional restrictions on beneficiaries, would they still want a TSP beneficiary account? Here’s a handy 20-page PDF for them to consider their options.

The TSP is even worse for non-spouse beneficiaries. Here’s the verbiage from the TSP’s site:

“Non-spouse Beneficiary. A beneficiary who is not a surviving spouse cannot retain a TSP account. We will establish a temporary TSP account for the non-spouse beneficiary. Payment from this account will be made directly to a non-spouse beneficiary or to an inherited IRA.”

Your non-spouse beneficiary has to move quickly, too… along with everything else that your loved ones have to accomplish after your death:

“Non-spouse beneficiaries have 90 days to request payment from their temporary TSP account. If a non-spouse beneficiary does not initiate payment within 90 days, we will automatically send the payment on the 90th day or the next business day.
Beneficiaries must first be identified and located, their Social Security numbers (or Employer Identification Numbers for estates or trusts) must be obtained and verified, and their addresses and dates of birth must be confirmed.”

All of the beneficiaries of your TSP account (spouse or others) have a second beneficiary’s clock that starts ticking as soon as you pass away:

“If a beneficiary participant dies, the new beneficiary(ies) cannot continue to maintain the account in the TSP. Also, the death benefit payment cannot be rolled over into any type of IRA or plan.”

If your beneficiaries won’t want a TSP account after you’re gone, then maybe it makes sense to roll out of the TSP now (before you die) and save your heirs the additional financial bureaucratic hassle.

Bottom line for beneficiaries:
The TSP’s beneficiary rules make IRA beneficiary requirements look a lot easier. If the TSP is inflicting their malicious compliance with inheritance law to drive your beneficiaries out of the TSP, then maybe you want to roll the TSP over to your IRA now. You can designate your beneficiaries with your IRA custodian and save everyone even more (literal) financial grief from the TSP.

Let’s move on to other reasons to leave the TSP– while you’re still alive.

The second reason to roll over your TSP account: Roth IRA conversions.

If you’ve decided to do a Roth IRA conversion (a topic for an entirely separate post, just as soon as I write more than this comment response) then eventually you’re going to move money from your traditional TSP through your traditional IRA and into your Roth IRA.

The big question is whether you roll from your traditional TSP to your traditional IRA all in one transaction (and then do smaller annual Roth IRA conversions) or whether you roll over your traditional TSP to your traditional IRA in a series of smaller annual transactions.

How many times do you want to use the TSP’s website to request your rollovers?

Fortunately the TSP has greatly streamlined their bureaucracy of the rollover process. You can even obtain your spouse’s rollover permission through Docusign (instead of using a human notary). Since you’re rolling over your traditional TSP to your traditional IRA without any of the funds actually touching your hands, you do not have to withhold income taxes from the rollover.

Let me re-emphasize two points from earlier in this post:
– The TSP does not offer a conversion directly from a traditional TSP to a Roth TSP, not even after leaving the military.
– If you’re a high-earning veteran who wants to do a backdoor Roth IRA contribution, this is best done with an empty traditional IRA account. That could be emptied by rolling it back into the traditional TSP.

Personally, unless you think you’ll want to do a backdoor Roth IRA or otherwise leave some money in the TSP’s G or I funds, I’d roll over your entire TSP to your IRA in one transaction. Once you’re free of the TSP (and free of any “upgrade” risks to the TSP’s software or website), you can continue with your Roth IRA conversion plans on your own schedule.

By the way, if you’ve contributed to your military TSP (traditional or Roth) from Combat Zone Tax-Exempt pay, then keep reading for more advice on handling this edge case.

The third reason to roll over your TSP account: tapping your TSP funds early.  These are much more than Roth IRA conversion ladders.  These are methods to access your TSP contributions from Combat Zone Tax-Exempt pay, or to tap your Roth TSP contributions with no taxes or penalties.

I’d only withdraw your funds before age 59.5 if you urgently need the money. If you yank these contributions early from your TSP (or your IRA) then you’re cannibalizing the compounding for your retirement. If you’re facing a large expense (or a long layoff) then you’ll also need to wait for a few weeks for the TSP or your IRA custodian to accomplish this financial engineering.

Maybe there’s a better way to cover your unexpected expenses: consider withdrawing some of your Roth IRA contributions (tax-free and penalty-free) before you touch your TSP funds.

Caution:  These TSP-tapping techniques are advanced tactics, and they’re not for everyone. If you have any questions or concerns about the best way to handle this then consult a CFP, ChFC, CPA, or AFC. I strongly recommend one of the members of the Military Financial Advisors Association.  They’ll probably answer your questions for free, and they’ll help you do the transaction on a fee-only basis.

Tapping your traditional TSP contributions from your CZTE pay is relatively straightforward: (1) roll your traditional TSP over to your traditional IRA, while (2) specifying on the request to the TSP and to your IRA custodian that you do NOT want the tax-exempt balances to be accepted in your traditional IRA. Instead you want to receive the CZTE pay contributions directly, either as a paper check or by an online transfer into your personal checking account.

Finally, you’ll send that paper check (or transfer the money from your checking account) straight over to your Roth IRA custodian with instructions to deposit it as a rollover into your Roth IRA (not as a contribution). You have up to 60 days to complete this transaction, but do it right away in case your Roth IRA custodian has more questions.

Of course you could choose to spend the CZTE contributions. (They’re tax-exempt, so there’s no penalties or taxes.) Unless you urgently need the money (medical debt or high-interest loans) then I recommend depositing it into your Roth IRA to compound for your retirement.

The TSP knows how much CZTE pay you’ve contributed (it’s on your TSP account statements), and they might even pass those numbers to your IRA custodian. (Please save copies of all your LESs with CZTE pay… for the rest of your life… and for your heirs.) You’re still on your own for making sure that the IRA custodian uses the correct IRS Form 1099-R withdrawal codes for your tax returns. Refer to my earlier recommendation to consult a financial advisor.

Tapping your Roth TSP contributions is slightly more complicated. In this maneuver you roll your Roth TSP over to your Roth IRA. (That’s the easy part.) If you have already had a Roth IRA (any ol’ Roth IRA) for at least five tax years, then after you roll over your Roth TSP you can withdraw the amount of the contributions you made to the Roth TSP (but not the Roth TSP’s gains!) from your Roth IRA, tax-free and penalty-free.

Again, you’re responsible for making sure that your Roth IRA custodian understands what you’re doing and uses the correct 1099-R codes. In addition, they’re probably going to tell you that they’re withdrawing your other Roth IRA contributions first, not your Roth TSP contributions. That’s the default assumption the IRS uses for Roth IRA withdrawals.

Here’s the fourth (and last) reason to roll over a TSP to your IRA: Qualified Charitable Distributions.

This is totally a first-world problem of philanthropy planning for wealthy retirees.

Briefly, if you’re required to take Required Minimum Distributions from a traditional IRA, you can designate up to $100K of the RMD as a QCD. (The IRS raises the annual QCD limit with inflation, just like they do with IRA contributions.) Instead of paying taxes on that $100K (at your personal income-tax rates) you send the money straight to the charity. You “lose” $100K– but if you were planning to give away that much money in the first place, then you’ve at least avoided some income taxes.

Here’s a pro tip that I’ve learned from the Millionaire Money Mentors forum:  QCDs are especially important if you (or your spouse) have high earned income after you leave the military. Roth IRA conversions only make sense when you have an opportunity to do smaller annual conversions in years of lower income-tax brackets. If you leave the military with a large traditional TSP (perhaps with DoD’s matching contributions from the Blended Retirement System) or a large traditional IRA balance, and move on to a high-paying bridge career, then good for you! You’re winning at financial independence, but those tax time bombs will keep ticking while you’re earning even more income.

Exponential compounding in traditional retirement accounts can work its magic for years without you noticing.  Compounding looks linear until it turns the corner and goes hyperbolic. If that happens in your 60s or even your 50s then you’ll have less time to accomplish a substantial Roth IRA conversion.

When you save & invest for financial independence then you’ll almost certainly have more than enough money for the rest of your life. You can spend it, gift it, bequeath it, or donate it to charity– but if you don’t think ahead then you’ll surrender some of it to the U.S. Treasury on your income-tax returns.

Do the math, learn the rules, and plan ahead.

 

Call To Action: “What Would Nords Do?”

As Charles Barkley said, “I’m not paid to be a role model”— but I have a lot of experience.
When my spouse and I separated from the military, the following year we started converting our TSP accounts (and our traditional IRAs) to Roth IRAs.

We did this primarily because we could see that our pensions and our investment compounding would drive us into higher income-tax brackets in our 60s. It took us 16 years of small annual incremental conversions to accomplish this task in a tax-efficient manner.

In my personal opinion, the TSP is a great military plan for matching contributions.

However the TSP is much less useful after the military. Like almost all 401(k) plans, there’s rarely a reason to keep it after you leave your employer– and lots of reasons to roll it over to your IRA.

Personally, I would only keep a TSP account after the military or civil service if I was:

• • in an occupation or a lifestyle with high risks of liability, litigation, bankruptcy, or divorce– and if my state’s IRA laws had weaker protections than the TSP’s federal law, or
  • earning a very high civilian salary and wanted to do a backdoor Roth IRA contribution, or
  • highly enamored of the TSP’s G or I funds, or
  • strongly attracted to the idea of a TSP annuity, or
  • expecting to separate or retire from the military at age 55.

I’d also review each of those choices with a fiduciary fee-only financial advisor, while keeping in mind that their incentives need to be aligned with yours while they’re boosting their assets under management.

Can you think of another edge case? Post a comment, or use the “Contact me” form, or e-mail NordsNords at Gmail.

 

(There are no affiliate links or paid ads in this post.  Try your military base library or local public library before you pay money for these books– in any format.)

 

 

Related articles:
What To Do With TSP When You Leave The Military
“Should I Invest In The Thrift Savings Plan Or In Taxable Accounts?”
Understanding Tax Exempt Contributions and Withdrawals to the TSP
Early Withdrawals From Your TSP and IRA After The Military
Should You Rollover Your TSP Account Into an IRA? Pros and Cons of Transferring Your TSP
Podcast:  “Should I Rollover My TSP Account For Slightly Lower Expense Ratios?”
(scroll to ~4:15 for the TSP question.)
Maximizing Your TSP Contributions In A Combat Zone
TSP News Release:  Updating The I Fund Benchmark Index