The Thrift Savings Plan on Monday took a major step toward allowing federal employees and military personnel to put retirement savings in investment funds other than those the TSP offers.

The TSP’s governing board gave the agency the go-ahead to study what would be needed to create an investment “window,” an authority that has been on the plan’s back burner for five years.

The study, projected to last until mid-2015, is to examine issues such as the potential fees for participants who would use it, how it could be integrated into existing TSP systems, and whether there should be limits on the amount a person could direct to outside investments. If a proposal is ultimately approved, implementation would take another 18-24 projected months.

TSP is considering new investment options for federal employees. (Image buy istock)

The TSP offers five funds linked to stock, bond and government securities indexes, as well as five “lifecycle” funds that mix investments in those funds in ratios that differ according to the projected withdrawal dates.

Following criticisms from Capitol Hill and elsewhere of those offerings as too sparse, a 2009 change in law authorized, but did not require, the TSP to create an investment window, a feature available in many comparable savings plans such as private-sector 401(k)s. The TSP afterward focused on other changes required by that law, including introduction of after-tax “Roth” investing.

However, in the spring the TSP conducted a preliminary study of the investment window idea and more recently collected information that TSP Executive Director Greg Long called an “eye-opener.”

In particular, he said, the TSP discovered that of participants who retired or separated from the government for other reasons in 2012, 45 percent withdrew their account balances, in many cases to roll them over into IRAs, within a year. That amounted to $10 billion in withdrawals from a program that as of October held $431 billion of investments. Another $2 billion was withdrawn as lump-sum payments allowed for those still employed but who have passed age 59 ½.

“There’s a good chunk of our participants that are firing us and one of the reasons for it is a desire for more investment flexibility,” Long told the board at its monthly meeting in Washington.

He said that while life events such as wanting to pay off a mortgage were the main reason for the withdrawals in both cases, 23 percent of each group cited a desire for more investment options, such as funds specializing in emerging markets, real estate or other specific market sectors.

Several board members commented that such findings have moved their opinions of the investment window idea from negative or neutral to positive.

Board members and Long noted that both groups of investors surveyed also expressed a desire for more flexibility in withdrawals. IRAs, for example, allow a greater choice in the amounts an account holder can pull out and how often, while the TSP offers only lump-sum withdrawals, equal monthly payments, the purchase of an annuity, or a combination.

The officials also noted that outside investment funds tend to charge higher administrative fees than the TSP, stressing that participants would have to be well educated about the effects on their investment returns.

“Yes, we’re interested in proceeding but in a holistic manner” that addresses the demand for more investment and withdrawal choices and for more help with managing an account, said board chairman Michael Kennedy, a managing director in the Atlanta office of the Korn/Ferry International financial services company.

The $6 million to $10 million cost of developing an investment window would be shared among all 4.7 million account holders but those who actually use it would be charged a fee, potentially around $100 a year, and could be limited to investing 25 percent of their account balances in outside funds. Long said that in 401(k)s, relatively few investors use such windows.

He added that the TSP investigated limiting the outside funds to those that charge no more than 1 percent annually but found that such a limit would be difficult to administer and would eliminate a substantial number of the outside fund options.

While opening the window and beefing up help to investors are within the TSP’s control, expanding the withdrawal options would require a change in law.

The TSP last week got a similar endorsement of the investment window idea from an advisory group of employee organizations.