Federal employees are fortunate in being eligible to receive two types of retirement benefits once they retire from federal service. One of those is a pension, either the older Civil Service Retirement System (CSRS) annuity or the more frequent Federal Service Retirement System (FERS) annuity. These are “defined benefit plans”, which behaves much like social security and other annuity platforms; a guaranteed dollar amount payment for life, with Cost of Living Adjustments (COLAs) annually possible to keep up with inflation.
The second retirement benefit for which federal employees are eligible is the Thrift Savings Plan (TSP). This benefit is a “defined contribution plan”, essentially the Government’s version of a 401(k) plan. As such, the TSP does not guarantee lifetime income once a federal retiree starts withdrawing from it. Rather, the Fed is offered the opportunity for tax deferred saving of an elected portion of their income, with part of that able to be matched by the Federal Government.
In my time working with federal employees, here are some mistakes that I have seen clients make that have been costly to their economic futures.
1. Keeping the default TSP contribution amount
When someone is first hired as a federal employee, they are automatically enrolled into the TSP with 3% of their bi-weekly salary being contributed to the TSP. By increasing their contribution to 5%, they get a matching contribution by Uncle Sam of another 5%. Free money! That’s doubling your money on your first 5% contribution, without even considering investment returns. You can contribute significantly more if you’re able to, which is very beneficial for your future even though the government’s matching contribution will max out at 5%. Another benefit of this is that any of your money that goes towards your TSP will not count towards earned income for that year, which means you will get taxed less on this year’s Form 1040.
2. Picking the wrong investments
This is a tough one. Investing can be a total head trip. Have you found yourself asking these questions:
"How do I pick the best investments within my TSP account? How much should I have in the S Fund or the I Fund or any of the others? Should I have it all in the L Fund? How do I know what to sell when markets are performing poorly?"
In my experience, too many clients have either been too conservatively invested, not diversified properly, or they just picked the Life Cycle fund thinking that it would adjust automatically for them and it would be a no-brainer. Others panicked when the markets were down, sold out their accounts and missed being invested in the subsequent growth.
These mistakes can have a hugely negative impact on your investments4 and your future goals. The general rule of thumb is to gauge how much time you have until you will need to withdraw the funds. The longer you have, the more risk you can afford to take in order to grow your account faster. But what about if you’re closer to retirement? If you don’t grow your account fast enough, inflation, also known as “The Silent Killer” in my office, will slowly deplete your account’s purchasing power, effectively causing you to lose wealth every year!
- Panicking when the markets are turbulent – if you’re reading this, you have a pulse. If you have a pulse, it’s likely that you’ve experienced that sinking feeling and flutter in your heart when you’ve opened up your TSP or other investment account to see that the account value has dropped dramatically. The knee-jerk reaction is to quickly get rid of the investments that have performed poorly in order to “stop the bleeding”. In 2008-2009 when the stock market fell over 40%1, many TSP participants did just that, moving their money from the C, S, and I Funds into the G Fund because “the G Fund will protect my money”. The problem with that was that those same participants missed the rocket-like start of the market recovery and their accounts never grew back. Many investors that stayed invested had even higher account values just 3 short years after the crash2, which continued to grow into triple or higher of their values throughout this ten year bull market. Timing the markets requires a crystal ball, and the last one I ordered from Amazon didn’t work very well. But fighting back the emotion that drives you to quit while you’re behind can result in returns that will help you to feel economically safe and secure throughout your retirement years. Take a look at this graph below3. It illustrates the emotional cycle of investing during the different market cycles:
- Too conservative - the thought of losing money can be daunting. When markets fluctuate up and down, so can your account value. This is an incredibly emotional experience and often hard to watch. The news doesn’t help either, as they always capitalize on the negative. If you’re invested very conservatively, your accounts won’t drop as much and everything will be fine, right? The problem with this is that your account will also not grow nearly as fast as it needs to grow in order for you to be able to retire the way you want to one day. Inflation is a problem in this situation too. If the cost of everything is growing faster than your money is, you will run out of money before you run out of time. Volatility is not the same as risk. If your long-term money goes up & down on its way up, that’s not a problem. It’s different with short-term dollars, but your marriage to your long-term portfolio needs patience through the challenges of “for better or worse.”
- Not diversifying properly – just because the S fund has done really well for you doesn’t mean that you should have 100% of your money in it, or 80% or 50%. I have helped two people that were the same age allocate their TSP investments differently. Why is that? Everyone has different goals in life and different needs. Picking the investments should be intentional and with purpose. And asset allocation is key to investment success.
- Setting & forgetting a Life Cycle (L) fund – This is the fund that gauges the time factor and adjusts automatically for me, so I’m all set, right? Not so fast. The L Fund can’t possibly know what your life goals are, how long you will live, what other investments you have, or what the global economic cycle is doing. It is an algorithm, not a strategy. The lack of flexibility inherent in these funds can inhibit long term success. The L Fund is a “one size fits all”, and that doesn’t sound like a very great investment plan.
3. Making Withdrawals vs. Rolling the account into an IRA at retirement
The final critical mistake that I’ve seen people make with their TSP is when they move their account by means of withdrawal instead of rolling the account into an IRA. While the TSP is a great vehicle for many reasons, there are also reasons that you would want to move it away from TSP into your own IRA. For one, you’re no longer bound by the investment restrictions that the TSP (and most employer retirement plans) have. In an IRA you’re able to “self-direct,” to customize your investments from an enormous array of choices to suit your specific needs. You can also do this by just pulling the money out of your TSP to put in your individual account, but the process of moving your assets over in that manner can cost you a fortune in taxes. Taking the money out of your TSP to put into an investment account is not the same as rolling the assets into an IRA. I have seen people create huge tax liabilities for themselves by doing it incorrectly. It’s a simple mistake, and it happens more often than people realize, and if you lose 40% of your assets just at the moment when you need it to provide income, that’s an unnecessary mistake from which you may never recover.
Making investment decisions can be a hard and emotional process. The TSP is a great opportunity for retirement investment, but it has its limitations and challenges. We work hard for our money and deserve that our money is working hard for us. We want to ensure that our economic outlook is good, that we are safe, and that we can do all of the things that we want in life. After all, it’s not just your money, it’s your future.
2- www.tsp.gov historical pricing
4- There are risks involved with investing, including possible loss of principal. Investments will fluctuate and may be worth more or less than when originally purchased.