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.

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.

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.

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.

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.