Federal retirement expert, Chris Kowalik, discusses the new guidance just released by the Thrift Savings Plan (TSP) with respect to the withdrawals and the loan options for participants affected by COVID-19. Is taking money out of your TSP account under these rules advantageous for you? Or, are there some hang-ups that you haven’t considered?
- Who qualifies to take money from TSP under these special rules
- TSP distribution or withdrawal rules and how they have been affected by the CARES Act
- TSP loans and how these changes affect borrowing from the TSP
- Potential problems and considerations you should think through before making a decision
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Hello and welcome to this episode of FedImpact, candid insights on your federal retirement. I’m Chris Kowalik of ProFeds, home of the federal retirement impact workshop. Today, we’re going to be talking about the new guidance just released by the TSP with respect to the withdrawals and the loan options for participants affected by COVID. Just last week, the TSP released its guidance on how it will make TSP monies available under these special rules that were spawned from the CARES Act that passed earlier this year. This act allows for enhanced access to various types of funds, including the TSP again, for those participants affected by COVID. More details are expected from the TSP in the coming weeks, but I couldn’t let this news pass by without offering some thoughts to our listeners about what the real impact is of taking one of these options.
Now, our team here at ProFeds provides retirement workshops for federal employees all over the country, and we’ve been doing so in a virtual environment for a couple of months now. We have fielded so many questions from employees that are curious if taking money out of the TSP under these rules will be advantageous, or if there are some hang-ups that they hadn’t considered. So we’re listening to the concerns that federal employees have on issues like this. So we knew that this was a perfect topic to talk about today before we get too far down this road of employees deciding to take this option.
Four main things we’re going to cover today
Now, here are the four main things that we’re going to talk about today. The first is who qualifies. Next, the distribution or withdrawal rules and how those have been affected by the CARES Act, same thing with loans and then fourth, some potential problems and maybe points of consideration that I hope you’ll really think through before deciding to move forward.
So let’s start with who qualifies. Now I’m not going to get into all of the specifics of reading the legislation to you. So if you think based on my basic description here, you think you might qualify, I would encourage you to go read further to get all the nitty-gritty details. But essentially the legislation requires that either you, your spouse or your dependents have had COVID, or that you have experienced a financial consequence or loss as a result of a COVID-related matter. Things like being quarantined, the loss of child care, you’re out of work, your hours have been reduced, those types of things. So that’s the basic qualification. Again, if you’d like some additional details, I would encourage you to go read that legislation.
All right. So let’s talk about the distribution or what we’ll refer to as the withdrawal rules. Typically, when we refer to a withdrawal out of the Thrift Savings Plan, it means that the money is permanently leaving the account. It’s not intended to be paid back like a loan. So with a withdrawal under these circumstances for the CARES Act rules that we’re talking about today, you can take up to $100,000 out of your TSP, but know that if you have other qualifying accounts, it’s a total of $100,000. So you can’t take $100,000 from the TSP and go out to an old 401(k) and take $100,000 from there. It’s a max of $100,000. Now the window of time that you can do this would be mid-July when the TSP opens up this opportunity, and then you must have taken the money by December of this year. So there’s a relatively small window that you can take this money and be under these rules.
Now, why would you do this versus taking money out of the TSP, just based on normal rules? Well, for some of you, you’ll be able to use the “old rules” for taking money out of TSP. And it’s no big deal. If you don’t need that much money, even if you do, if you’re already retired, of course, you have access to that. And if you’re over 59½, you have access to that money right now. But where this comes in most handy is for those who are under the age of 59½ who are still working. You have an opportunity to take this money out of the Thrift Savings Plan that you otherwise would not have had the opportunity to do so because of your age. So more on that here in just a moment, but to give you an idea of why this legislation would be important in the event that this is an appropriate amount to take.
Favorable tax treatment with respect to the CARES act
Here’s something interesting about the withdrawal options. You’re allowed to repay the whole amount within the next three years. This is unusual for a withdrawal because typically once that money comes out, it cannot go back in because of IRS contribution limits. So there are some special ways that they’re going to allow people to have access to this money. And if you think it will be for a relatively short period of time, and that you’ll have the capacity to pay it back, you can get all that money back into your account. Now, it might not make you whole because of the loss that you might’ve experienced by not being in the market and taking that money out. But it’s an interesting adjustment to the normal withdrawal rules.
Now, when this money is paid to you, when you take it out of the TSP, there will not be the typical mandatory 20% withholding. That is normal for any kind of distribution or withdrawal that comes out of TSP is that they slap a 20% mandatory withholding on it, because eventually you’re going to have to file your taxes for that year and you’re going to owe tax on the vast majority of that money. Of course, if you’ve got some Roth money, you won’t owe tax on that, but for all the traditional money, that is all going to be taxable to you. But in these special rules, they will not issue a 20% mandatory tax withholding, but you can ask for one.
Word of caution
Now, a little word of caution here is that if you do not anticipate paying the money back, don’t put yourself in a bind by not withholding anything from this money being paid to you, and then come tax time, have a really difficult time wrestling with that tax obligation. So don’t put yourself in a bigger bind than perhaps you already are by taking out this much money from the TSP. Now, if you are under the age of 59½, and you decide to take money out of the TSP under the CARES provision, you will not suffer a 10% early withdrawal penalty. This is a penalty typically assessed to federal employees who are under the age of 59½ and who access their money. And this happens not just to federal employees, but anybody taking money out of qualified accounts under the age of 59½. So this is a special exception that they’ve made under the CARES provision.
All right, so those are the basic withdrawal rules of how this program works under the CARES provision. Let’s talk about loans for a moment. The maximum loan normally available is the lesser of either $50,000 or half of your account. It’s one or the other. Whichever’s less. But that number, that $50,000 has been raised to $100,000 and the 50% of your account rule has been raised to 100% of your account. So they’re having pretty open access to this money if you wish for it to come out in a loan versus a withdrawal. Now the window for being able to do this, this will begin June 22nd is the scheduled start time that TSP will be prepared to be able to take these loan applications. And you must take that loan by September.
So don’t wait all the way until the end of the year. This is a pretty narrow window. Looks to be about three months, depending on when in September they do that cutoff. That hasn’t quite been announced yet, but we should probably expect it to be the earlier part of September, just to be safe. Now for the loan, normally these loans are repaid within five years and that’s still true for this loan. However, you’re allowed to suspend the payments for 12 months. So you still have a five-month loan. It’s just, you’re not going to start paying on it for a year from now.
And keep in mind this is true for existing loans, too. So if you already have a loan within the TSP, you can request to suspend those payments once they open up that document, that request form. Again, there will be a special request form for that extension of the suspension of payments, and we expect that to be released shortly by the TSP. But keep in mind, even when you suspend those payments, there’s still interest that accrues during that time. So this isn’t a free suspension, you’re still going to be paying interest.
Some concerns for employees taking one of these options
All right, so let’s move to my favorite part of this, which is to talk about some points of consideration and some concerns that I would have for an employee taking one of these options. The first is maybe not the most important, but one that I’ll just get out of the way. And that is you need to be ready for more complicated tax filings. If you take this money out of these special provisions under the CARES Act and want this favorable tax treatment, we have to be prepared for just that more complicated situation come tax time. So that’s an easy one. If you already work with a CPA, they’ll be able to figure all that out. But if you’re used to doing your own taxes, that might get a little bit complicated. Okay?
Next, I want to make sure that employees are using this option as a very last resort. The reason is that when you take this amount of money from the Thrift Savings Plan, you are spending that money and you can’t get it back. So if you’re going to take that and spend it on something, maybe you have a bright idea of paying off your house or doing something else like that. You no longer have access to that money in retirement. So you want to be very careful. And I like the old adage, just because you can do something doesn’t mean you should. And we should think really carefully about taking this amount of money from a retirement account.
What we don’t want to see happen is that through this, for your access to the TSP money, that you end up eroding the long-term savings vehicle that you’re trying to build and preserve for retirement. You’re going to need that money. And if we use it too loosely now, then it may have a greater impact on your ability to make that money last as long as you do in retirement.
All right. The last piece that I’ll mention is this idea of locking in losses. And this is, is a pretty big point, couple of things that I want to share with you. Many of you have heard of what we in the financial services industry refer to as the “Retirement Red Zone.” It is the five years immediately prior to retirement. And it’s your first five years of retirement. This is a time that you, as an investor must be very careful. The reason being is that you do not have the opportunity to wait for a market to recover. You likely need that money to be in place ready for withdrawal and hopefully a strategy, not just willy-nilly taking the money out, but that you have a strategy on how to get the money out and do it in an efficient way.
So if you’re in that Retirement Red Zone, again, the five years immediately prior to retirement, or within the first five years of retirement, we want you to be very careful before you take a large chunk out of the TSP, especially when the market is down and you’ve locked in a loss and we have a lower account value to be able to pull on over the remainder of your lifetime. So if your account has suffered a hit, if you’re in the C, S and I Funds and your account has not recovered, doing one of these options, either the withdrawal or the loan option is going to lock in your loss. It’s not just a loss on paper anymore. It’s a real loss because you have sold those shares.
See folks, we know that we’re supposed to buy low and sell high. We know that that’s what the rule that we’re supposed to follow. But in this case, if you take a withdrawal or a loan, or frankly transfer your account let’s say from the C Fund over to the G Fund, you are effectively locking in your loss today. And so if you decide to pay that money back, let’s say you take a withdrawal and over the next three years, you’re going to go ahead and pay that money back, you very well might be buying back at higher share values. In fact, I hope you do because that’s indicative that the market has recovered and we’re back up to nice high share prices. So keep that in mind.
And I know I covered this in the last podcast that we had, but I got so many questions on it that I want to review it again. And that is the weakness that these market conditions have exposed in the Thrift Savings Plan. So we know that last year at the end of 2019, the TSP finally enacted the new withdrawal rules under the TSP Modernization Act. And it gave much freer access to be able to get to your money in retirement. And they really modernize that to look more like what the private sector has offered for decades. But here’s the deal. The TSP did not fix a critical part of their withdrawal options. And that is they do not allow participants to pick and choose which funds to pull from. Let me repeat that. The TSP does not allow participants to pick and choose which fund to pull from.
Let me give you an example. Let’s say just for argument’s sake, you have half of your money in the G Fund and half of your money in the C Fund. So golf and Charlie. The money that’s in the G Fund has not suffered a loss at this point, right? That G Fund doesn’t suffer losses. They only have gains, which is great. You also don’t get those big gains over in the G Fund. So there’s some downside there, but it’s maybe not as obvious. But the C Fund, of course, this is where you can get massive gains and massive losses. Just depends on what the market conditions are. So if we’re in a situation where the market is doing really well, and we had a choice, if we wanted to take money from the G Fund or the C Fund, we would prefer to take it from the C. The reason being that the value of those shares is high because it’s performing very well. Buy low, sell high.
So if we had a choice, that’s what we would want to do. But the TSP doesn’t allow you to say for the withdrawal that I’m going to take this month, or the lump sum withdrawal that I’m going to receive, let me just take it from the C Fund. Conversely, they don’t allow you to do it the other way either. So if the market is down like it is now, and it has been for a couple of months, you don’t have the choice to say, well leave my C Fund alone because I don’t want to sell low. Just give me my money out of the G Fund. It doesn’t work that way. The TSP does not allow participants to pick and choose which fund to pull from.
So when we’re thinking about this idea of taking money from the TSP in undesirable market conditions, if you have any of your money in the C, S and I Funds, when you take money out, you are locking in the loss that you have already had, but haven’t felt yet. Because again, you haven’t sold the shares yet. But once you do by taking this withdrawal option or the loan option, you have now locked in the loss. So something that I really want to stress to everybody, just because you can do this doesn’t mean you should. So if you meet the basic requirements that I mentioned at the beginning, and you say, well, I mean, maybe this would be a great time to access that TSP and pay off debt or pay off the mortgage, or whatever idea you have out there where you’re actually spending the money. This is a big concern, a really big concern. We don’t want to see you deplete assets that are designed to be there for the remainder of your lifetime.
So hopefully today’s session was helpful. This is a relatively short podcast, but I could not let this time go by without addressing the concerns that I have when I see legislation like this that’s passed and then now we’re implementing it with the Thrift Savings Plan, because sometimes it looks too good to be true. And if we don’t always understand the financial impact of what we’re doing, we can make bad decisions without realizing it.
So here at ProFeds, we provide benefits and retirement training workshops to federal employees and agencies throughout the country. We bring this candid, no-nonsense approach and we offer this lively session that helps to inspire feds to take action, to go get the retirement that they want. And better yet we’re on the GSA schedule, which makes it even easier for feds to get their hands on this training. So if you want to see if one of our open workshops is available in your area, visit FedImpact.com, click on that green “Find a Workshop” button, and you’ll see all of the available training.
As always, it’s wonderful to be able to dig into hot topics like this so that we can help federal employees better understand the consequences of important decisions like this. I’m Chris Kowalik of ProFeds, stay tuned to the FedImpact Podcast to get straight answers and candid insights on your federal retirement.