Measuring The Health of Your Spending

/ Patrick Facey / Leave a comment

The old saying, “what matters is what’s measured”, is certainly a truism in personal finance. In order to improve on your circumstances, you have to objectively analyze what is going on so that the problems areas can be identified. The most common use-case for this rationale is a budget. I have mixed feelings on when and why a budget should be used. On the one hand, everyone needs to itemize all expenses at least once to fully see where exactly money goes. That can be a very sobering experience. On the other hand, it can be a bit tedious and unnecessary to concern yourself with where every dollar is going. Spending freely on reasonable purchases is a liberating feeling that should be enjoyed if you are still saving and progressing towards your goals. However, if you are a chronic over spender, this may not be the best mindset to embrace.

A more straightforward and quick way to examine your financial health is to use financial ratios. Ratios are an effective method in comparing your financial habits against a pre-determined benchmark in order to target any potentially category of your finances that may contain an overextension of money. There are numerous different ratios out there, but here I have chosen to highlight those that cover some of the most important areas of your finances.

Savings Ratio= Savings/Net income; .20 minimum

If you care about improving your personal financial situation, your savings rate is the most important ratio nail down. No matter what type of financial goal you have, you will have to be able to save money in order to reach it. Therefore you simply must know the amount of income that is left over after paying taxes and living expenses.  Saving 5-10% of net income is certainly better than nothing, and can be a good start, however we should all really be striving to hit at least a 20% savings rate. Contributing at least 5% into the TSP is mandatory, so working towards stashing away an additional 15% should be a primary goal, bringing your total AFTER tax saving ratio to 20%.

Housing Expense Ratio= Housing Expenses/Net income; .30 maximum

Housing is the number one largest expense for most. Whether renting or paying a mortgage, the cost of a place to live is the usually the most expensive line item in all of our budgets. The good news is that because this expense is disproportionately large to the rest of our budget, it also provides the biggest opportunity to free up cash. The housing expenses ratio takes the monthly total of all housing related expenses and divides it by monthly net income. Housing expenses not only include the amount of rent or mortgage, but also utilities, property taxes and home insurance, as these are all part of the living situation. We should aim to spend no more than 30% of net income on a place to live, which would equal a ratio of .30 here.

Liquidity Ratio= Liquid Assets/Monthly Expenses; 3-6 minimum

You simply can’t get ahead when minor setbacks easily knock you down. That’s why establishing an emergency fund is one of the first orders of business in building financial stability.  Having a readily accessible stash of cash is necessary for dealing with the inevitable ebbs and flows of life. The liquidity ratio serves to show how long your current lifestyle could be sustained solely off of your liquid savings (meaning investments do not count). The resulting number from the ratio is in months, so 3-6 is a solid target to shoot for. In the event of something like a job loss or any unexpected expense, this provides an adequate financial cushion to help absorb the impact, without having to immediately scramble over the bills.

 

Credit Utilization Ratio= Credit Amount Currently In Use/Total Credit Amount; .30 Maximum

Good credit can be a useful financial tool to have. It helps you obtain the best financing arrangements when needed, and provides an additional source of funds to be used strategically. This matters most on large purchases, like a house or a car. Credit utilization is simply the amount of credit that you are currently using out of the total amount of credit that you’ve been given. Scoring agencies like FICO typically consider you responsible in this category if you are using less than 30% of the total credit that you’ve been extended, so your score will reflect positively in that range. The lesson in responsible credit utilization applies to all areas of personal finance. Buying a fraction of what you can actually afford is typically a smart move. The smaller the loan, the less the interest that will paid over its life. Applying this approach to the largest purchases, such as houses, cars and education, can yield nice savings over the years.

 

Vehicle Expense Ratio= Vehicle Expenses (purchase price of car + .6 *( annual miles))/Net Income; .20 Maximum

After housing, vehicle costs are next on the list of the three largest recurring expenses for individuals. Minimizing how much you spend on a car and how much it is driven is crucial to your finances. The vehicle expense ratio accounts for exactly these two costs: how much is spent on the purchase of a vehicle, as well as the average cost per mile driven. The cost per mile is derived from an average provided by AAA that takes into account depreciation, insurance, gas and maintenance. Ideally, we would want this ratio number between .15 and .20. To achieve this, you will likely need to adhere to the cardinal financial rules of vehicle ownership. To sum up these rules: spend no more than 1/8th of your net income on vehicles and live within a 10 mile roundtrip commute of work. As long as you aren’t racking up hundreds of miles on weekends, these two points will drive your vehicle expenses way down.

Financial ratios exist to serve as a reasonable guideline in evaluating the condition of our financial standing. They should not be treated as steadfast rules, but should certainly be given reasonable consideration. If you find yourself outside of any of the recommended ranges, simply consider bringing some attention to that area of your finances. Spending more in a certain area of life that brings more value to you is perfectly fine. Just understand that it may be taking away from other financial opportunities, such as retirement. Being genuinely content with those types of tradeoffs is a big part of feeling successful with managing your money.

Using IRAs With the TSP

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Saving and investing for a well-funded retirement can often seem like an insurmountable task. Between paying taxes, putting food on the table and a roof over our heads, saving for retirement can easily slip to a distant afterthought. Federal employees are fortunately equipped with a robust three tiered retirement package, which helps to ease some of this burden. When maximized effectively over the course of a career, these benefits of Federal service can evolve into an enviable retirement. However, we can all agree that no matter how much progress we’ve made toward our retirement goals, a little extra money never hurts. The government offers three main financial vehicles to help and encourage citizens to save for their later years: 401ks, pensions and IRAs. Federal employees are automatically opted into a 401k (TSP) and a pension, but it’s up to the individual to set up an IRA if desired. IRAs, or Individual Retirement Accounts, are simply investment accounts that exist for the public to utilize in saving for retirement. For all intents and purposes, IRAs function like the TSP. They come in two flavors–Traditional and ROTH—which are simply the way in which the contributions are taxed (Traditional, before tax; ROTH, after-tax). They also come with their own annual contribution limit– $5,500 for individuals under the age of 50 and $6,500 for those over the age of 50 in 2018. IRAs simply function as another tax advantaged account, with a few of their own perks, and offer a great opportunity to add extra financial padding to retirement.

Why Contribute to an IRA?

If you’re already maxing out your TSP, contributing to IRA is a way to add even more fuel to your retirement planning. The common maxim in saving for retirement is to start as soon as possible and invest as much you can. This is because of compound interest, which harnesses all of its power from time and amount. It’s easy to assume that because of the contribution limits ($5,500), IRAs won’t make a meaningful difference in retirement. The power of compound interest shouldn’t be underestimated, though. Over 20 years, contributing $5,500 to an IRA each year could result in an increase of $250,000 to your portfolio. That’s a quarter of a million dollars added to your balance sheet, all for a $460 monthly investment over time. Furthermore, as with the TSP, funds in an IRA retain tax advantages. This characteristic makes them more valuable than funds held in a standard brokerage or savings account. For example, if you had been making ROTH contributions for all of those 20 years, everything that you withdraw from the account in retirement will be exempt from any taxes. You could withdraw the entire $250,000 at age 59 ½ and pay nothing in taxes. These tax advantages can be powerful asset to have in retirement.

Some people may feel that if they aren’t maxing out the TSP, any extra retirement savings should be going towards that goal. That’s certainly not a bad strategy. The TSP is a premier retirement account for practically everyone, and diverting extra funds to it is rarely a bad move. For certain reasons, I feel that the best strategy for investing in retirement accounts involves a mix of 401ks and IRAs. One big reason for that is diversification; diversification of withdrawals as well as investments.

As long as you are contributing at least 5% (that’s important) to the TSP, contributing to an IRA can be useful. The TSP offers a limited, albeit very effective, menu of investments. Within the TSP, an investor can get great exposure to large, mid and small cap US stocks, international stocks, and bonds. Using the L-funds also makes the proper diversification among these assets a breeze. In truth, L-funds are perfectly sufficient for the bulk of retirement investing. Despite the broad exposure of the TSP, there is a wide range of investments out there that become accessible with an IRA. This of course can be a blessing or a curse, depending on the acumen of the investor. One should always tread carefully into attempting to select any type of individual investment such as company stocks. There’s a reason why the TSP only offers index funds, and why they are the most commonly touted investments for retail investors. Selecting individual investments is without a doubt a very risky endeavor for the under informed. When approached intelligently however, the expansive investment selection within an IRA can be used to tactically improve a portfolio.

One of my favorite uses of an IRA is to gain exposure to real estate. Real estate is an important asset class, yet unless you’ve purchased a primary or rental home, you probably have no exposure to it. If you own a house and a large percentage of your net worth is tied up in that house, there’s probably not added value to your portfolio in investing further into real estate within an IRA. For an individual that rents and doesn’t own any property, their entire portfolio might only consist of stocks and bonds (i.e. the TSP). In that case, using an IRA to invest in a real estate investment trust (REIT) like the Vanguard REIT ETF (VNQ) may add real value to the overall portfolio. Doing so provides exposure to another major asset class, while also capitalizing on some of the tax advantages of not only IRAs, but the special tax treatment of REITs as well. This is just one example of how an individual might benefit from accessing investments that are available in an IRA, but not the TSP.

Diversification of withdrawal options is another reason that having some exposure to IRAs is valuable. This mostly applies to ROTH IRAs, but is valuable nevertheless. With a ROTH IRA, since you have already paid taxes on the funds that you are contributing, the rules permit you to withdraw those funds from the account at any time, free of any penalties. With TSP contributions and traditional IRAs, there is a 10% penalty on funds withdrawn before age 59 ½ that are not used for a qualified hardship. Additionally, traditional (pre-tax) contributions will also be subject to taxes upon withdrawal. This accessibility of funds in a ROTH IRA builds a huge buffer of safety into a portfolio. If managed responsibly, it can even act as an extension of emergency savings. That may make all the difference if facing withdrawal penalties and taxes on a 401k during hard times.

IRAs are just another tool in the retirement toolbox that should be considered. When approached responsibly, for example not using the IRA to day trade stocks, they have potential to add real value to a portfolio. Flexible options for accessing funds and exposure to assets not available in the TSP make IRAs a useful medium in building a more diversified and resilient portfolio.

 

The Advantage of TSP’s G Fund

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The Government Securities Fund, known as the “G Fund”, is one of the select investment options found within the Thrift Savings Plan. It is the most secure investment available in the TSP, as it is guaranteed to never decline in value, while also (historically) outpacing inflation. The fund consists solely of special short-term U.S treasuries that are issued exclusively to the TSP. In the public market, long term treasuries provide a higher return than short term treasuries due to the longer time horizon of risk. The beauty of the G Fund is that its securities are short term in nature, but with long term interest rates. This makes for a uniquely secure investment, which also has an above average rate of return given its risk class. The G Fund is also unique in that, unlike all of the other TSP’s investment funds, there is no equivalent available to the public. The only access the public has to the G Fund, or anything like it, is through the “myRA” government sponsored retirement plan, which is now being phased out. The G fund offers a unique opportunity for Federal employees, and especially Federal retirees, to capitalize on.

The Yield Advantage

g fund yield advantageG fund inflation
Source: http://www.tsp.gov

Since its inception, the G Fund has consistently outperformed the 90-day (short term) Treasury bill, its only publicly available comparison. It has also handily beaten inflation during this time. Meaning that retirement assets within the TSP have been insulated from the eroding effects of inflation, without any risk, through the use of the G Fund. During a few periods, its rate of return has even been 2-3% higher than that of the T-Bill. Keep in mind, this is with an equal amount of risk. Imagine if the government created a special savings account that paid 3% interest versus the virtually 0% interest currently paid by most banks, but you could only use this account as a Federal employee. Of course, most would opt to keep their savings in the account yielding 3%. It’s the same product, with a much more favorable result. This is the essential advantage that Federal employees have over the general public by having access to the G Fund.

Using the G-Fund

The G Fund is clearly a valuable asset to Federal employees, but as with every investment vehicle, its benefits are optimized under specific circumstances. On the risk-reward spectrum, the G Fund is a very low risk, low reward investment. That alone lets you know that it is best suited to an older individual or better yet, a retiree. The older we get, the less risk we should be taking with our portfolio due to the less time available to recover from losses. This idea governs how you should be invested in the TSP. As an employee nears their retirement date (5 years out), their TSP should be begin shifting more heavily into the G Fund. Bear in mind, this doesn’t mean that you go 100% G Fund for retirement so that you don’t risk losing any money. It’s still important to maintain some level of stocks and bonds for growth, just to a much lesser extent than it is in our younger years. Utilizing the “L” funds is immensely valuable in achieving the proper balance. These funds are setup to automatically optimize and adjust the appropriate allocation of the G Fund in your TSP over time, based on when you will begin withdrawing the funds for retirement. I am a big proponent of the L-funds due to their simplicity and effectiveness. For example, if you are currently retired or will be within a year, you may decide to put your entire TSP balance into the L-Income fund. The G Fund makes up 74% of the L-Income Fund, with the other 26% spread across stocks and bonds. Contrast this with the L-2050 Fund, an allocation tailored to younger individuals who plan to retire in the year 2050. The G Fund only makes up 12% of L-2050, with stocks and bonds allocated heavily towards the other 88%. As you can see, due to its stable and low risk nature, the G Fund becomes increasingly valuable (and appropriate) for your portfolio with age.

L2050Lincome

Figure 1: L-2050 Fund Allocation                              Figure 2: L-Income Fund Allocation

As a Federal employee, the G Fund is an excellent tool to have in constructing a healthy retirement portfolio. With its return that typically beats inflation, and also never loses money, the G Fund makes for a uniquely advantageous investment that all Federal employees can benefit from. However, the closer that an individual gets to retirement age, the more important the G Fund becomes within the TSP.

 

How Much is the FERS Pension Worth?

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The FERS pension is one of The Three Components of FERS Retirement. For Federal employees, the FERS annuity and social security benefits serve as the fixed sources of retirement income, with the TSP being the variable source. It is one of the rare pensions that is still in existence, which is why it’s coveted by many. There’s no doubt that the FERS annuity is a big factor for those who have chosen, or are considering, a career with the government. Knowing how much the annuity is worth can help provide clarity on retirement and also help with making an informed decision about the value of working for the government.

The real value of the FERS pension lies in that it is a no risk, fixed stream of income, that is secured for life.

Guaranteed Income

Guarantees are hard to come by in life, especially with money. The fact that an annuity provides a guaranteed stream of income for a set period of time is what makes it so attractive as an investment asset. Planning for retirement becomes much easier and less stressful when you know that regardless of what the stock market or economy does, you’ll still have a reliable source of income. This can also be thought of as an essentially risk-free return—the only risk being that the company (or the government in this case) goes bankrupt and can no longer pay you. The only sources of similar risk-free returns available to the public are in private annuities, treasury bills, money market accounts and savings accounts. Since risk equals reward in investing, the rate of return on those low risk assets is extremely low, typically hovering around 1%. Let’s say you worked a 20 year career with the government and the average of your highest three salaries was $70,000. At age 60, you would be looking at collecting an annuity of $14,000 for life. If you wanted to achieve that same level of risk-free payment from T-Bills or a money market account, you would need to have $1,400,000 to invest. You would be able to adjust that number downwards if you planned on burning through all of the principal before death, but for illustrative purposes, receiving a risk-free income of $14,000 per year requires astronomical initial investment.

The 401(k) Equivalent of the Annuity

Aside from the government, few other employers offer any form of a pension to their employees for retirement. The bulk of private sector employees have to rely heavily on a 401(k) to fund their retirement above and beyond what social security provides. It’s known that a lot of the value in a government job is embedded in the benefits, and the FERS annuity is no small part of that equation. Let’s look at how the annuity can be quantified into a dollar value equivalent for a government employee.

*Note: The formula for calculating your annuity at the time of retirement is: (Number of years worked X Average of highest three salaries X 1%) = Annual payment

*Employee: 40 years old; Plans to retire at age 60; salary $70,000*

Each year that the employee works they will accrue 1% of their salary as a lifelong income stream, to begin at a minimum age of 60. In this case, each year of work will earn this employee an annual retirement payment of $700 (1 X $70,000 X 1%), provided by the annuity. Assuming the unlikely scenario that this employee’s salary never increases, , they will have accrued 20 years of service and an annual retirement income of $14,000 (20 X $70,000 X 1%) by the time they reach age 60.

To translate $14,000 per year of retirement income to an equivalent dollar amount in a 401(k), we can apply the standard investment withdrawal rates. At the age of 60, an individual can expect on average to live about another 20 years. Using a 5% withdrawal rate (approximate safe withdrawal rate for 20 year time horizon), a 401(k) would need to have a value of about $280,000 in order to provide the retiree with $14,000 per year until death. To build up $280,000 in a traditional 401(k) over 20 years, the employee would need to invest ~$6,120 each year and earn 8% annually on those investments. So in effect, this employee is actually earning a salary equivalent of $76,120 ($70,000 + $6,120) because of the annuity value. Keep in mind that this doesn’t account for qualitative factors like the unpredictable returns of the stock market (401(k)), or the guarantee of the annuity. It’s up to the individual to determine how much that safety is worth. Another distinction to make is that with a 401(k), you have to be able to actively exercise the discipline to make the contributions. The annuity simply accrues in the background while you work your career and live your life. Removing that behavior requirement from the equation is invaluable while saving and investing for retirement.

The FERS annuity offers a unique value proposition to federal employees in that it lowers the nominal value of their government salaries in comparison to the private sector, but in turn provides a secure, no risk stream of income for retirement. It is a key asset to have for federal employees in building wealth for retirement, as it provides fixed income for life and eliminates chances of detrimentally emotional behavior. Knowing how to value the annuity ultimately helps you understand your total compensation as a federal employee, but it also helps to determine if a federal career is the right decision for your future.

 

Fundamental Stages of Building Wealth

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Unlike making the Forbes rich list, building a comfortable level of wealth into one’s life can be accomplished in a fairly systematic manner. The attainment of financial stability is a precursor to financial security, which can then pave the way for the common end goal for most, complete financial independence–meaning that all of your income is being derived from investments or other sources that don’t require your active effort. This is what ultimately needs to be accomplished for retirement. By progressively achieving certain financial milestones, the foundation can be laid for a secure financial future.

  1. Avoid Bad Debt: From day one, avoiding any and all debt should be a priority. For most, debt won’t be entirely avoidable in the early stages of life. If and when debts have been incurred, extinguishing them needs to become an urgent priority. You simply cannot afford the headwinds of paying interest to others while trying to secure your own financial footing. One important distinction to be made is between good and bad debt. Consumer debt (credit cards/ auto loan) is the clear bad, and should be avoided at all costs. Investment debt (school loans/mortgages) can be considered good debt. I emphasize “can” because it completely depends on the terms upon which this debt was obtained. Egregious amounts and/or unfavorable terms can easily sour these “investment” loans. If any bad debt has managed to nestle itself into your financial house, it’s imperative to banish it ASAP. Getting your future self ahead financially is unnecessarily difficult when you’re still stuck paying for the consumption of your past.
  2. Acquire Knowledge/Skills/Experience: In our early, lower earning years, we might not be saving much and perhaps even going into debt to stay afloat and progress forward. Since younger people simply haven’t had the time to build the skills and experience, it’s common to earn less the younger you are in life or a career. Skills, knowledge and experience are the three things that really fuel our earning potential going forward through life. The downsides of making a low income or even going into debt are lessened IF they are being leveraged into a much more valuable long term outcome. The best part about not having had the time to gain experience is that you likely have a lot of time to gain experience. It’s not so much where you are, but where you are going that ultimately matters.
  3. Develop a Savings Habit: Developing the habit of spending less than you earn is the fuel that pushes you forward on your wealth building journey. Just as eating fewer calories than you burn each day snowballs over time into a healthy body weight, spending a little less than you earn eventually builds into a meaningful sum. It doesn’t matter if you’re only saving 5% of your paycheck at first, saving anything will get you into the positive habit that pays off handsomely over time. The more you save, the harder you push on the accelerator towards financial independence. Once you have saved 3-6 months of your living expenses, you will feel more financial secure knowing that life’s inevitable curve balls will no longer immediately derail you. This relieves a great deal of stress and opens up mental capacity for the next stages, thinking about investments and creating your vision. It’s also important to acknowledge and deal with the forces that will work against our saving efforts as we grow and progress through life. Typically, the more we earn, the more we are tempted to spend. Developing the discipline to safeguard you from this destructive lifestyle inflation is an invaluable trait to possess while building wealth through life.
  4. Think About Investments: The word “investment” should be used loosely here. Investments can be thought of as anything that requires an outlay of resources to produce a more valuable outcome than would have otherwise been attained. Often times, we’re quick to associate the thought of investments with the stock market or real estate. Those assets certainly have their place in a portfolio, but they should by no means be the default for your investment dollars. Some investments that might have a much greater return are: a professional education, a family vacation, time off work, a backyard remodel, a home gym, a side business, or debt repayment. Once a decent emergency fund has been established and the savings habit is firmly in place, it’s time to start thinking about investing. As the CEO of your life, it’s your job to determine where money should be allocated in order to derive the maximum benefit to your personal situation.
  5. Create a Vision: Money is a means to an end–its only value lies in its ability to purchase the outcomes in life that you desire. Once you have enough savings in the bank, and you are making investments to improve the quality of your life, the bigger picture should be more seriously considered. This doesn’t mean that you should expect to have your whole life mapped out. Life is fluid and unpredictable, and the dots rarely connect going forward. Creating a vision is simply thinking about the possible additions (or subtractions) to your life that would collectively create your most ideal state of living. When you begin to realize your desired life through a conscious effort with money, you will begin to experience true wealth.

Progressing through each of these stages of building wealth will put you on a solid track to becoming financially secure, while also setting up the lifestyle that you desire. The best part is the positive compounding effects that these create in your life. The longer the time frame that you can persist in their application, the more powerful the wealth generation in your life will become.

 

 

 

Everything You Need to Know About TSP Loans

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As we know, the TSP is a top tier retirement account. When it comes to putting away money for retirement, it is second to none. For that reason, feds should be stashing as much excess money into the TSP as manageable. Doing so is a key part of any long term strategy for Feds building the funds needed later in life. However, due to the restrictions on taking a withdrawal from the TSP while still in government service, it can be problematic if a short term need for extra cash happens to arise. There are only three ways to withdraw money from your TSP while still working your federal job: an in-service withdrawal, a hardship withdrawal or a TSP loan. In general, taking an in-service withdrawal from the TSP should be avoided, and hardship withdrawals can only be made under specific circumstances. That leaves TSP loans as the most reasonable method of removing funds from your TSP. Keep in mind this is the lesser of three evils, if you will. Funds should only be removed from the TSP before retirement if absolutely necessary. TSP loans come with more favorable terms than an in-service withdrawal and may actually be useful in certain situations. Of course, it’s vital to consider your situation to determine whether or not removing money from the TSP is warranted by a true need.

Should You Take Out a TSP Loan?

Before worrying about anything else, the most important question involving a TSP loan needs be addressed: do you really need one? The decision to take a loan from the TSP should be based on two key factors: the use of the money and the ability to pay it back. The TSP should not be viewed as a credit line for personal consumption purposes. Although I do maintain the opinion that your money (in a 401K or not) should always be used to maximize your personal utility throughout the entirety of life, it’s equally as important to keep your financial perspective in check. The problem is that actual desires become blurred with fictitious wants when larger sums of money suddenly become available. If you start to view your TSP as funds that can be used for current wants, rather than for future needs, financial trouble will be inevitable. The criteria for what constitutes a useful withdrawal is of course highly personal, but it should generally be for productive, not consumptive, purposes. Additionally, you must be sure of your ability to make the repayments on the loan. If for any reason you cannot repay the loan, the loan will then be treated as a distribution from your TSP, triggering taxes and potential penalties.

How TSP Loans Work

Taking a loan from the TSP is not much different than taking a loan from a bank. Except with the TSP, you are also the bank. Fortunately, since you are borrowing the money from yourself, the interest on the loan is also being paid back into your account. This is what makes it so advantageous in comparison to other methods of financing—repaying yourself is clearly a more favorable move than paying a bank. It’s important to remember that although you’re being paid interest, rather than paying interest with a TSP loan, you may miss out on the investment gains that would have accrued in your account if the money had stayed invested. In a bull market like the one we’ve experienced over the last 8 years, taking money out of your TSP could have proven very costly.

The Two Types of TSP Loans

There are two types of TSP loans: General Purpose and Residential.

  • General Purpose: As the name implies, this loan is for any general purpose. This is basically a no questions asked loan from your TSP. It doesn’t matter if it’s for a weekend in Vegas or a lifesaving surgery, you can borrow from the TSP for any reason with this loan.
  • Residential: A residential loan is required to be used towards the acquisition or construction of your primary residence. The term “residence” is defined fairly loosely by the TSP as: “a house, condominium, shares in a cooperative housing corporation, a townhouse, boat, mobile home, or recreational vehicle.” Residential loans cannot be used to refinance or pay down an existing mortgage, renovations or repairs, or for buying land.

The Rules for Borrowing

When it comes to any financing arrangement, rules and restrictions always apply. Here are the key rules that govern loans from the TSP:

  • Currently Employed: First and foremost, you must be actively employed by the government as a Federal civilian or military member. Since the payments on the loan are deducted from your future paychecks, you must be in a pay status.
  • Minimum Loan Amount: $1,000 is the lowest amount that may be borrowed from your TSP. Therefore, you must have at least $1,000 of your own contributions and earnings in the account. This means that the match provided by the government cannot be included to arrive at this minimum.
  • Maximum Loan Amount: Typically, the most you’ll be able to borrow from the TSP is $50,000. However, your personal maximum may be smaller than this due to the restrictions the TSP puts on the calculation of an individual’s maximum. The restrictions require that the smallest of three calculations is what will be used: the total of your own contributions and earnings, 50% of your total vested account balance or $10,000 (whichever is greater), or $50,000 minus your highest outstanding loan balance (including those paid off in the last 12 months). If you have any outstanding loans, these play a factor in those calculations in various ways. In that case, it’s best to consult the specifics on the TSP’s website.
  • Repaid Loans: You must not have repaid a TSP loan of the same type (general or residential) within the previous 60 days.
  • Taxable Distributions: You must not have withdrawn money in a taxable manner (not in a loan or eligible age requirement) within the last 12 months.

Borrowing funds from a retirement account such as the TSP is typically frowned upon, but that’s not to say it can never be a useful move. Although, among the other risks, there is a limit on the amount of funds that can be placed into tax-advantaged accounts each year to help fund your retirement. It’s important to make an informed, rational decision, and to consult a professional if needed before taking funds out of your TSP.

TSP Withdrawals: In-Service

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There comes a time when we’re all faced with the temptation of withdrawing money from the TSP before reaching retirement age. Be it life’s unexpected expenses, or desires, there always seems to be something that comes up to test our dedication to those coveted retirement funds. Seeing as how the bulk of assets tend to be tied up in a house or a retirement account, it’s a logical place to turn in search for money. The unfortunate twist is that these two assets are also a couple of the most inaccessible. Taking an In-Service withdrawal, a withdrawal made from the TSP while still actively employed by the government, is understandably tempting, but it should be approached with caution. The TSP is a retirement account, and is therefore designed with barriers in place to discourage such withdrawals before reaching retirement. After all, draining the resources needed to fund retirement does in fact come with varying results. Nevertheless, your TSP is still your money. It can be tapped for its value at any time, but understand that it may not be as pain free as selling off some stocks or visiting an ATM.

Two Types of In-Service Withdrawals

  1. Financial Hardship: If a “genuine financial need” exists, a financial hardship withdrawal is permitted. For a genuine financial need to be established, one or more of the following four conditions must be met:

    Negative Monthly Cash Flow: Negative monthly cash flow is what we aim to avoid at all costs in our personal finances—spending more than is being earned. This can be determined by tracking expenses on a monthly basis and comparing it to your income for the month. If you need assistance in doing so, the TSP provides a worksheet on their website that provides guidance.
    Eligible Medical Expenses: Generally, the medical expenses that the IRS considers eligible for deduction on your tax return are considered eligible for a financial hardship withdrawal. The IRS describes medical expenses in publication 502 as, “the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.” Expenses can be incurred by you, a spouse or dependents, and must not have been paid yet.
    Personal Casualty Loss: Casualty losses are pretty much a fancier way of saying damage, destruction or theft to personal property. Typically, these losses are the result of events such as natural disasters, vandalism or accidents wherein your actions weren’t negligent.
    Legal Expenses: The TSP limits the definition of legal expenses to those involving unpaid attorney’s fees and court costs that are in relation to a divorce or separation from a spouse. Alimony and child support are not eligible legal expenses, but can be included in the calculation of negative monthly cash flow.

  2. Age-Based: If you are at least 59 ½ years old and still employed by the government, you are permitted a one-time withdrawal from the TSP. This is referred to as an age-based in-service withdrawal. This withdrawal is treated essentially the same as making an eligible withdrawal in retirement. There will not be a penalty, and the withdrawal will be taxable unless eligibly rolled over into an IRA or other employer plan. The biggest caveat with an age-based withdrawal is that once completed, the option to perform the partial withdrawal upon separating from the government is forfeited.

Consequences of In-Service Withdrawals

Removing funds from an employer sponsored retirement plan such as the TSP rarely comes without some sort of adverse effect. Age-based withdrawals function like an eligible retirement withdrawal though, so there aren’t many negative consequences with those. As with any TSP withdrawal that isn’t an eligible transfer, applicable taxes must be paid on an age-based withdrawal, but there are no extraneous penalties. Additionally, both types of in-service withdrawals remove the option for a partial withdrawal upon separation from service at a later date. Financial hardship withdrawals on the other hand, come with their own set of unfavorable repercussions:

  • You may have to pay the 10% early withdrawal penalty. Losing an automatic 10% of your withdrawal is never ideal.
  • You won’t be able to make contributions or receive matching contributions for 6 months, but 1% agency contributions will still be made. Contributions to your TSP will essentially stall for half of a year. This could lead to lower contributions for the year, and if markets are doing well, missed growth of the funds that would have been otherwise invested.
  • The withdrawal amount is permanently removed from the TSP. Similar to the above situation, when funds are removed from an investment account, they can no longer work and grow for you. If the markets happen to be in an upswing when the funds are removed, the gains that could have been had will be forever gone.

As long as the TSP remains one of our largest personal assets, in-service withdrawals will always be a temptation facing federal employees. To avoid potentially crippling one of the most important three legs of your FERS retirement, it’s usually best to find alternatives. Keeping sufficient cash on hand whenever possible is always a great buffer in dealing with the unexpectedness of life. However, if no other viable options exist and the TSP must be tapped, taking a TSP loan is almost always more advantageous than taking an in-service withdrawal.

TSP Withdrawals: After Leaving Federal Service

/ Patrick Facey / Leave a comment

The Thrift Savings Plan is a critical element of a federal employee’s financial life. For most, it serves as the primary investment account that holds stocks and bonds for retirement. Putting money into the account is very straightforward: contribute as much as you can, as often as you can. If the decision of selecting investments within the TSP poses a challenge, there is one allocation that I believe trumps all others. When it comes time to withdraw money from the TSP on the other hand, the options are more varied. There are two times in which funds will be withdrawn from the TSP: after leaving federal service or while currently employed in federal service. In this article, we’ll discuss the methods of withdrawal after leaving service.

Withdrawals After Leaving Federal Service

First and foremost, if you are leaving federal service before the year in which you turn 55, withdrawing any funds from your TSP account will result in an early withdrawal penalty tax of 10% in addition to possible federal/state income taxes. If you leave before turning 55 and wish to withdraw the funds without being penalized, you will need to either leave the money in the TSP until age 59 ½ or have a direct rollover performed from the TSP into another employer sponsored plan or IRA. Keep in mind that this simply changes the account wherein the funds are held. You still won’t be able to use the funds without facing taxation and a possible penalty. That being said, when you wish to withdraw funds from the TSP there are 3 methods of payment to choose from.

1) Partial Withdrawal: As long as you never made an age based in-service withdrawal while employed by the federal government, you are permitted a one-time partial withdrawal from your TSP upon leaving federal service. This can be useful in providing a lump sum of money when funding post-employment objectives. Partial withdrawals should always be performed in a cognizant manner towards taxes. Depending on the amount withdrawn and your personal income tax rates for the year, a sizable tax bill could be incurred.

2) Full Withdrawal: By age 70 ½, the time that IRS required minimum distributions take effect, a full withdrawal method must be selected for the entire balance in a TSP account. There are a few options to select from with the full withdrawal:

  • Lump Sum Payment: The lump sum payment simply pays out the entire balance of the account in a single payment. Again, caution should be exercised in electing a lump sum payment due to the potential income tax consequences. One way to avoid taxes, and also broaden your withdrawal (and investment) options, is to perform a direct rollover into an IRA after separating. As long as the rollover is direct, meaning sent directly from the TSP to the IRA within, it is not considered a taxable event. Once the money is in the IRA you will be able to withdraw as much as you wish, at any time. The disadvantages of this action are that the IRA offers less creditor protection and higher cost investment funds than the TSP. A distinct disadvantage that I see in abandoning the TSP is the loss of access to the G fund. The G fund is an extremely valuable no-risk investment for retirees to use in structuring a portfolio for security and income, and it is available exclusively in the TSP.
  • Monthly Payments: You may elect to receive your account balance paid out in a series of monthly payments. You’ll have the option of choosing 1 of 2 ways to have these monthly payments computed: Based on the IRS life expectancy tables or your own desired dollar amount. If the life expectancy tables are used, the monthly payment amount will be recalculated each year based on your account balance and age. If you choose your own monthly payment amount, the desired amount will be paid out monthly until the account balances reaches $0. 
  • Life Annuity: For a minimum of $3,500, a lifetime annuity can be purchased through the TSP. In exchange for your lump sum payment, the TSP will provide a level monthly payment that is guaranteed for as long as you or a joint annuitant (if selected) are alive. Annuities can be great for those looking for guaranteed income. They relieve the annuitant of ever having to stress about markets or investments by simply guaranteeing the same check shows up each month, for life. The downside with annuities is that this guarantee comes with a cost. Since the annuity provider is assuming all of the risk and you are assuming none, they build their margin of safety into the payment. This means that by opting to receive their guaranteed income, you are likely earning less off your investment than could otherwise be possible by managing it on your own. Nevertheless, this price can be well justified by those wishing to receive stress free income for life.

3) Partial/Full Combination: If more than one of these options sounds appealing, you can split distributions among any combination of the partial and full withdrawal methods. The same individual rules and restrictions apply to each type withdrawal, such as the $3,500 minimum for an annuity. Opting for a variety of withdrawal methods can be useful in diversifying the ways in which income is extracted from the TSP.

One of the few pitfalls of the TSP is that it is considered to offer a limited amount of withdrawal options once it comes time to access your money. While this is arguably true, the withdrawal methods that are available do provide a decent mix of ways in which a participant can receive payout of their account. Between the one time partial withdrawal and the various full payment options, funds can be withdrawn from a TSP account strategically, so as to provide adequate income with minimum income tax liability. For those desiring more control over their account, the TSP balance can also be directly transferred into an IRA. Doing so provides much more control over withdrawals, but forfeits the valuable benefits of the TSP, such as creditor protection, low cost investments and the exclusive G fund.

Make More Money by Increasing Your Value

/ Patrick Facey / Leave a comment

When it comes to building wealth, a lot of focus is placed on the saving and investing side of the equation. Seeing as how investing is arguably the most attractive aspect of personal finance, it makes sense. However, this results in a disproportionate amount of attention being directed towards the accumulation rather than generation of money. At the end of the day, the money available to be saved and subsequently invested depends on two factors: the amount of money coming in and the amount of money going out. It all begins at the top, with how much is coming in. So naturally, increasing that amount will have a trickledown effect on the rest of our finances.

Most people would like to earn more money. It’s an understandable desire, as more money generally equates to more options in life. In an employment scenario such as a federal career, this is generally accomplished by increasing value which leads to promotions over time. Value, in the context of the workplace, is an overarching concept that is comprised of many facets. We can, and should continually strive to increase our value by working on its driving factors.

  • Increase Knowledge: There may be no cliché more universally true than “Knowledge is power”. Knowledge is what ultimately shapes our ability to problem solve, critically think and work effectively. It also broadens our perspectives and shapes our worldview—two things that help us find meaning and happiness, in and outside of work. Through formal study and self-study, we can effectively build the knowledge base that will propel us forward in our careers. In many career fields, college degrees are now simply the cost of admission. Seeking out professional certifications and designations in your career field not only gives you the few extra letters after your name, but should also provide the specialized knowledge that is required to become an outlier in your field. If it doesn’t, you shouldn’t be investing time and money into it. For most of us, it’s difficult to find the time and mental energy for self-study on top of the life’s other demands. It is crucial, nevertheless. One efficient way to implement this into a busy life is through the use of audiobooks. Audiobooks are particularly useful for commutes and can provide a lot of value.  
  • Manage Time: Time management is the crux of accomplishing anything in a day, week, month, year and ultimately, a lifetime. Effectively managing time isn’t so much about planning every minute of life as it is about understanding how your tasks adhere to your personal energy cycles. Everyone functions optimally at different times of the day, and even at different times of the year. It’s useful to learn your energy, and schedule your tasks (and relaxation) accordingly. It’s impossible to operate at max capacity all day every day. Productivity will plateau, and burnout will quickly ensue. It actually may lead to less effectiveness over time. On that note, constantly switching attention between tasks and checking your phone all day is also ineffective. Focus is everything, and it’s becoming increasingly difficult to harness in this age of endless distraction. The practice of focusing on one thing at a time will certainly give you an edge in getting things done. Planning what and when we are going to work on something is key to dialing in and making meaningful accomplishments.   
  • Practice Entrepreneurship: You don’t have to start a business to practice entrepreneurship. And we should all be practicing entrepreneurship on some level. Employees may operate in a completely different work and incentive structure than entrepreneurs, but they can benefit greatly by applying some of the more entrepreneurial practices. Employees are like entrepreneurs, just on a less consequential playing field. An employee has certain tasks and functional areas that they are responsible for executing, a kind of mini business that they are in charge of. If they fail to do so effectively, they risk losing promotion opportunities, a demotion or maybe even losing their job. The natural progression through the ranks of a system, such as a federal career field, is to gradually become responsible for greater tasks and larger functional areas. Typically, the more breadth or depth of responsibility equates to a higher position. Learning to view your current tasks and responsibilities as your own “business” that you are in charge of running successfully helps in producing great work. Business owners also usually look to expand their operation over time. An employee may do so by exposing themselves to new learning opportunities after mastering their current responsibilities.
  • Take Initiative: The stagnation of most careers comes down to one central theme—complacency. Matter of fact, most issues in life arise out of complacency. Be it a career, relationship, health or what have you, when we stop putting the effort forward is when things begin to decline. If we are to make progress and feel fulfilled, we have to continuously fight mediocrity. It’s not enough to do the bare minimum, we need to always push ourselves into new limits in order to grow. Simply put: if you’re not growing, you’re decaying. More often than not, others don’t have the time or inclination to hold our hands and guide us towards progression that we desire. They’re busy with their own life. It’s up to the individual to take initiative and actively pursue the path forward.  
  • Gain Experience: Learning plays an important role in bettering our abilities, but it has its limits. Eventually, we must be able to apply the knowledge in practice for it to be of any use. Gaining real life experience is ultimately what matters most in any field. Reading every book on building a house won’t make you a better house builder than the guy who has successfully built 100 houses. Putting ourselves out there to experience trial and error in real time exposes us to the best learning opportunities. It equips us with the necessary practical experience to become a master of the craft.  
  • Update Resume: Resumes are an often overlooked and undervalued aspect of our financial lives. Being able to market yourself in a clear and concise manner is what ties opportunities together. Nothing is more concise than the resume. Everything that you know, have done and are capable of doing has to be effectively synthesized into a couple of pages. Unless the hiring manager knows you personally, this is often the ticket towards receiving any kind of consideration for a position. It’s likely what will land you the interview, only at which point you can (and should) elaborate more effectively on your abilities.

Money is the byproduct of value. In federal employment you will receive small “step” increases based on time, but it’s not reasonable to expect substantial increases in pay just because you’ve been doing something for a long period of time. If we desire to meaningfully increase our income, it is only logical to increase the value that we provide. The more value that we can create for others, the more we will be compensated. Increasing your value can be accomplished by building knowledge and sharpening skills, but also through managing time and organization. Taking the initiative to gain experience and pursue opportunity is the driving force behind achieving a satisfying position–in both a career and life.