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.