I hear a lot of complaints about the Thrift Saving Plan’s various limitations. One partial lump-sum distribution per lifetime and too few investment choices are probably the most common. But coming in third I’d guess would be that the TSP does not allow participants to select the exact source of funds used to fulfill a distribution request. TSP requires that any money distributed from your account come, proportionately, from each of the funds in which you are invested at the time the distribution is made. In other words, the asset allocation that will make up your distribution will always match the asset allocation of your account at the time the distribution is processed. If, at the time of a distribution, the asset allocation of your account at the time of the distribution is 30 percent C Fund, 10 percent S Fund, 5 percent I Fund, 20 Percent G Fund and 35 percent F Fund, for example, the distribution will be taken from these funds in those same percentages.
This upsets participants who are sensitive, and rightly so, to the risk of taking a withdrawal from an investment position that has lost significant value from its former high. I frequently hear from TSP participants that they are concerned about having part, or all, of their withdrawal taken from one of the stock funds after a market crash. Some have even complained that it does no good to allocate money to the G Fund in anticipation of needing income from their account if they can’t specify that any distributed money come from that fund.
Fortunately, there is a way around this mandate. I can’t tell you how to specify the source of a distribution, but I can tell you how to achieve the same result as if you had.
All you need to do to “synthesize” a selective distribution is to rebalance your account to the allocation that would have the result of a selective distribution after the usual distribution is complete. I have suggested this to individual participants many times over the years, and have seen a mixed response. Some get it right away, and others take a little convincing, so here is a simple example to prove that it works.
Assume that your account at the time of the distribution contains $50,000 worth of G Fund shares and $50,000 worth of C Fund shares. That’s an allocation of 50 percent G Fund and 50 percent C Fund. You’d like to take a distribution of $10,000 and have all of it taken from your position in the G Fund. If you could do this, after the distribution your account would contain $40,000 worth of G Fund and $50,000 worth of C Fund shares. That is an allocation of about 44 percent G Fund and about 56 percent C Fund.
But, under the TSP’s rules, $5,000 of your distribution will be taken from the G Fund and the other $5,000 from the C Fund. This will leave your account invested equally in the two funds, as it was before the distribution, albeit with only $45,000 in each. It should be fairly easy to see that if you rebalance your account, after the distribution, from 50 percent G Fund and 50 percent C Fund, to 44 percent G Fund and 56 percent C Fund, you’ll be in exactly the same position as if you had been able to specify the source of the distribution as entirely G Fund.
Since all money coming out of the TSP (with the exception of combat pay contributions) is taxable as ordinary income, at your marginal tax rate, and capital gains and losses are irrelevant, the exact source of the distribution isn’t really important. What matters is the total account value relative to the distributed amount, and the asset allocation that you proceed to use after the distribution has been completed.
Like many things in the world of investing, your intuition or emotional response this issue is not reliable. While it may seem to be problematic to have to take money from a fund after it has suffered a loss, this is not the case if the total value of the account has not suffered a comparable rate of loss. In this case, the thing to be concerned about is whether, or not, the post withdrawal asset allocation scheme is right one to use from that point forward.