Retirement

The Best Strategy For Investing in Retirement Accounts

/ Patrick Facey / Leave a comment

Tax advantaged accounts, commonly known as retirement accounts, provide us with a number of benefits during the wealth building process. When optimized, attributes such as income tax deferral, tax free investment growth and creditor protection can act as beneficial forces to building and maintaining wealth. However, choosing what accounts to fund and which investments to fill them with is no easy task. Between allocation amounts, types of accounts, and investment choices, there are countless combinations to choose from. The best strategy for an individual looking to use tax advantaged accounts will of course vary, but for the average federal employee it might look something like this.

Overview: Traditional TSP contributions up to employer match -> Fully fund Roth IRA -> Remainder of annual contribution limit in traditional TSP

  1. Traditional TSP up to Employer Match: For federal employees, this means that a minimum of 5% of your salary needs to be contributed into the TSP. Because of the 100% match by the government on that first 5%, taking this first step shouldn’t even be considered optional.If your basic pay is $50,000, a contribution of $2,500 to the TSP will immediately earn you another $2,500 because of the match and agency contribution. That is a guaranteed, instant doubling of your money. No other investment or debt payoff will provide you that kind of return. Even if you have high interest credit card debt, making this investment will still increase your wealth more so than using those funds to pay down the debt. By electing to make these contributions in the traditional format instead of Roth, you also enjoy a bit of tax savings during the year that the contributions are made.
  2. Fully Fund a Roth IRA: Another reason for choosing the traditional contributions in the TSP is that some of the tax treatment can be diversified here. By choosing to fully fund a Roth IRA, instead of simply continuing to put that money into the TSP, you gain a few added benefits.(NOTE: Those in the highest income tax bracket will likely want to use a Traditional IRA here instead of the Roth due to the more beneficial tax break, although funds accessibility then becomes much more limited.)
    1. Funds Accessibility: The ability to withdraw money without any penalty on the funds that you have contributed into a Roth IRA is a huge advantage of this account. For most of us, financial objectives change over time and/or life happens. Having the flexibility to withdraw the full amount of funds that have been contributed into the account, as if it were a savings account, is invaluable. Additionally, if investments within the account have done well, the earnings can simply be left in the account to continue growing, tax free.
    2. Investment Diversification: An IRA is a great place to hold tax disadvantaged investments, such as real estate investment trusts (REITS). Since dividends and capital gains within an IRA occur tax free, holding securities that don’t get preferential tax treatment in taxable accounts is a good way to add some diversification, as well as tax efficiency, to a portfolio. Since most portfolios primarily consist of stocks and bonds, this is usually beneficial.
  3. Max Out the Traditional TSP: Making all of the contributions in the first two steps is excellent progress in itself towards building a well funded retirement. By doing so, at least $10,000 has been added to your investment portfolio for the year, which is a nice accomplishment. At this point, there should still be $10-$15k in allowable contributions to the TSP for the year. Continuing to max those contributions out to the fullest extent should be the next order of business. The tax breaks and general attributes of the TSP, such as low investment costs and appropriate diversification, make this account the ideal home for the remainder of your available investment funds. Also, each year only permits us one chance to make those TSP contributions and reap the tax deductions, so we should strive to make the most of them.

If you’ve managed to fully fund the TSP and an IRA for the year, congrats! You’re a little closer to comfortable retirement, or maybe even early retirement. If funds are still available for investing after these accounts have been maxed out, the available investment opportunities become even more varying. In any case, it’s a nice accomplishment that will hopefully become recurring during the wealth building journey.

The Best Investment in the TSP

/ Patrick Facey / 2 Comments

The Thrift Savings Plan offers a limited, yet very ideal selection of investment options for federal employees. Essentially, there are 5 investments available: the G, C, S, I and F funds. The “L” funds, or target date funds, are simply various combinations of these 5 core funds that have been professionally balanced to maximize the risk to reward tradeoffs for individuals with different time horizons for investing.

One of the biggest questions when it comes to the TSP is: what funds should I be invested in? Of course, that depends. For a 30 year old, investing in a way that is more weighted towards the C,S and I funds would be a prudent decision. These funds all track stocks, which are more volatile, but have also historically performed better over longer periods of time. With potentially 30+ years ahead until needing to use the money, these options should provide the best bang for the buck for younger individuals. On the other end of the spectrum, an individual who is 5 years or less away from retiring and wanting to soon begin accessing their TSP should take the opposite approach. With such a short amount of time left until the TSP funds will need to be used, risk in the stock market needs to be minimized. This type of individual will want to reduce exposure to stocks (C,S,I) and instead begin shifting a larger majority of the account into the G and F funds, the more stable investments. The general rule of investing in anything is that with youth invest in risk, with age invest in security. Everything in between just needs to be adjusted accordingly.

Determining a specific asset allocation( I.e how much should be in the C, S or I funds) is a difficult task. Some people enjoy spending the time researching markets to determine which sector is a better buy right now, but that’s neither practical nor prudent for most people. Heck, even the professionals attempting that feat rarely succeed. Most of us should prefer to just set it and forget it; have the contributions to the TSP deducted from our pay every two weeks, and go about living life. For that reason, I strongly favor the use of L funds. The meager cost of .03% ($3 for each $10,000) and a professional allocation of investments with automatic rebalancing makes it an attractive investment. It’s as simple as selecting the fund with the date that closely matches the anticipated date of withdrawal, E.g L2040 for withdrawing funds in the year 2040. As time goes on, these funds will automatically adjust the appropriate mix of stocks and bonds on their own, relieving the individual of having to continuously figure out how much should be invested in what. The L funds can simply operate on autopilot, providing us the most sensible range of investments while freeing us up to go spend time doing things that we enjoy. For the average federal employee, this is the most sound course of action when it comes to investing in the TSP.