Retirement Planning - TSP of Roth IRA?

[arcticbubba]

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I am 23 years old andhave working for thefederal government for almost a year now. I started with 5% payroll deduction and recently bumped it up to 6%. In my TSP I currently have my contribution allocation as 15% in the C fund, 60% in the S fund, and 25% in the I fund.So as I sit here planning for retirement, I am wondering what my next step should be. I have a roth IRA in some mutual funds through Edward Jones. I am wonderingwhat I shoulddo next. Bump up my TSP contribution or start pumping money into myroth IRA?? Thanks foryour rsponse.

 

[tsptalk]

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Welcome bubba -
Use yourpromotion and cost of living raises to get you up to the 15% TSP deductions.Other folks may have other suggestions but if you do that and continue to contibute to a Roth,I think you are wellon your way to being a multi-millionaire by the time you are close to retirement. I think some people go over board and forget to enjoy life. You are fine and are probably ahead of 95% of most 23 year olds.

 

[arcticbubba]

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My plan is to use my promotions and my COLA's as a way to get to 15%. But my question is: should I go for 15% as soon as possible, or back off and do a 50/50 split in my agressiveness between my roth IRA and TSP? 1% to TSP, next 1% to Roth, next 1% to TSP, etc. Just not sure on what approach I should take. My Roth IRA was established when I was 16 and I contributed to that until off and on. So I only have about $1500. I haven't contributed to that since I was 18 and I wonder if I should start now or focus on my TSP. I would like to contribute 15% right now, but like tsptalk mentioned, enjoying life is also a priority.

Also, at what age should I start to back off my aggressive approach I have with the C,S, and I funds. A 5 year, 10 year, 20 year,on contribution allocations would be appreciated. At what age should I start to consider investing in G and F Funds?

Thanks. Bubba

 

[tsptalk]

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arcticbubba wrote:

should I go for 15% as soon as possible, or back off and do a 50/50 split in my agressiveness between my roth IRA and TSP? 1% to TSP, next 1% to Roth, next 1% to TSP, etc.

Retirement planning is not my expertise but I would say your current tax situation may be the answer. If you don't need a tax deduction now you may want to go for the Roth. If you are in a situation where you'd like a tax deductionnow, TSP will give that to you.

 

[pyriel]

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Hello Arctic,

Whichever one you choose to fund first, you will be ahead of your peers. There are alot of discussions on this issue so just read around. I max on my tsp and max on my Roth IRA. Some likes the idea of maxing ROTH and contribute only 5% to TSP. Just like what Tom had said on his post, it is really up to you to decide that. Read up on this type of discussion and you should be able to get the pros and cons of peoples perception on this issue.

Pyriel

 

[Rolo]

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Welcome, Bubba!

This is a no-brainer: Max the TSP FIRST, then fund your Roth. Always.

Say your tax rate is 15%. Whatever contributions you make to the TSP will not be taxed until withdrawal far in the future; you do notpay takes now, that is more of your money you keep. Since you will pay less tax, contributing $100 into the TSP would only cost you $85.

Since that $100 investment only costs you $85, it is as if you made $15 off of your investment, or 15%, right? Wrong..a 15% discount is equivalent to a 17.64%increase (100 / 85 = 1.17647).



"What if my tax rate is higher at retirement?"

1. Irrelevant. You will have so much money that it will be inconsequential.

2. You will have other tax advantages available to you; "Investment planning" should also encompass "Tax planning".

3. Wealth equals money times time. $100 compounded over 30 years is far more valuable than some speculative tax savings in 30 years.

 

[Show-me]

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Well said Rolo. I've never heard it like that before. I have always been torn between just funding 5% in the TSP and the rest in my ROTH and funding the TSP fully. I feel better after your great explanation.

 

[Rolo]

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Whoo! One thing I forgot to mention; I just remembered it in strategising my finances today:

The difference,and the reason the Roth IRA was created by said Senator, is the comfort that your contributions can be withdrawn at any time for any reason without penalty. This is to get people who avoided the Traditional IRA because they were hung up on forgetting about that money for a long time to invest for retirement.

I call it "Leveln cash reserves", only to be used if I am stuck out in the freezing cold, starving, and the only way I out is to withdraw from my IRA. (Level 1 = Money Market Account, Level 2 = Scottrade,normal brokerage,account, Level 3 = borrow against equity, Level 4 = pimp the girlfriend, ... Level n.)

I have my Roth IRA going and therefore have "Oh! Shit!" money. For tax year 2005, I will open a Traditional IRA for the tax benefit; I am trying to get as close to zero taxes as possible, last year was 6.5%.

So, ya, always fund matched stuff first, tax-advantaged stuff next, then capital-gains rate stuff, then normal income tax rate stuff.

Oh...hmm...What if your effectiveincome-tax rate is LESS than the capital gains rate? I'll bet AMT will kick in before that. GUH, I think I will hire a tax accountant/planner this year...too much to remember. (It is good to know as much as possible yourself, though, so you know how to invest/spend/sell/structure.)



Wow...my RSI (Rambling Strength Indicator) is pretty high today.

 

[Show-me]

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Nothing wrong with rambling. It gives people like me the opportunity hear what's on your mind and why you are going in a certain direction. Just like the emergency money point. I read that before but your "rambling" reminded me why it's a good idea to continue funding the ROTH.

 

[pyriel]

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Well said Rolo...

 

[Mike]

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Here are my two cents...

Here's a hypothetical example of what happens with TSP v Roth investments (assuming the same return / fees / etc):

Tax rate schedule per the IRS website is $4000+25% of any income over $29,050 (assuming you are in the $29,050-$70,350 tax bracket and are single). Given that, here is what happens based on investment:

For every $1000 you invest into TSP, you are cutting your federal tax liability by $250 (and if your state has an income tax, you are cutting that liability as well, though by a lesser amount). Given that, let's compare the TSP and the Roth - assumptions being the fees/expenses are identical as are the returns (you can get them to be pretty close with a low fee index fund from Vanguard or something similar):

$4000 invested into TSP = $1000 tax savings* (current). After 30 years @10% return, this $4000 investment grows to $69,797.61, which is subject to whatever the income tax rate is in 2035 when you take it out. The 2004 tax rate on this amount would be $14,186.90, leaving you with $55,610.71. A Roth investment would simply provide you the $69,797.61, though you would miss out on the $1000 tax savings. Given that, the Roth is the better choice, to the tune of $13,186.90. I don't know about Rolo over there, but I'd certainly notice a difference of that amount in my distribution. :^

Note: this example pertains to what you do with TSP contributions above and beyond the 5% necessary to get matching. I would never recommend a contribution < 5%, which would lose a lot of free money over the years.

As for your specific allocations, that's just a personal choice. Most allocation sites recommend something along the lines of 15% bonds/securities, 40% large caps, 25% small caps, and 20% international for younger investors at / near the beginning of their careers.

Lastly, I recommendthat you hold emergency funds in a money market account. This way, you will basically keep up with inflation *and* retain easy access to the money if it's needed. I use Netbank for this, and their current APY is close to 2% (gotta have at least $500 in there to avoid a $5 fee for minimum balance in a month, though).

 

[Rolo]

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Mike wrote:

$4000 invested into TSP = $1000 tax savings* (current). After 30 years @10% return, this $4000 investment grows to $69,797.61, which is subject to whatever the income tax rate is in 2035 when you take it out....I don't know about Rolo over there, but I'd certainly notice a difference of that amount in my distribution. :^

There are a few flaws with this argument.

1. Are you planning to take your entire TSP/Roth IRA balance in one distribution, and therefore get taxed on it? Taking normal distrubutions and applying tax deductions to it means all of it will not be taxed, effectively lowering your tax rate. Taking distributions from a TSP/Traditional and Roth combo can help in keeping your taxable income low.

2. I am in the 25% tax bracket, but my effective tax rate the last time I paid taxes was 6.55%.

3. You didn't do anything with the $1000 savings from contributing to the TSP. Put that into a Traditional IRA, which would make for another $250 tax savings. For $4000 you contributed $5250. Compound that over 30 years and compare.

4. Compounding one-time investment is not telling the story: IRA's are done every year. A $4000 contribution every year for 30 years at 10% yields $657,976.09. A $5250 contribution yields $863,593.62 andmeets the first scenario's balancein 27-1/2 years.

I recommendthat you hold emergency funds in a money market account. This way, you will basically keep up with inflation *and* retain easy access to the money if it's needed. I use Netbank for this

hehe, me too! I use their checking as well.

 

[Mike]

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Rolo, I was trying to keep the example artificially simple. If I tried accounting for everything, it would probably just lead to confusion.

I'm also accounting for human behavior in the example I gave. How many people take their tax savings/refunds and invest them? Most coworkers I know will just take the money and spend it. Some anticipate the refund and spend before they get it. :shock:

Your points on taxes basically balance each other out. All of our effective tax rates are lower than what I posted, which means you get less of a benefit now off the TSP witholding than in my example - and youtake less of a hitat age 65 when you take distributions. That was another hidden assumption in my argument for simplicity's sake. You'll also note that I was comparing what happens with just one year's contribution over that timeframe. I have no idea how much money he plans on taking out per year in retirement (do any of us know that about ourselves?). An annualized distribution based on what each year's contribution does is a fairly reasonable ballpark guess, isn't it? It'd amount to roughly 1/40th of his retirement account in the first year. That's actually a small distribution. :^

The bottom line is that if you can afford it, invest. Max out the TSP if you can. Max out the Roth if you can. Having each one is important to protect you in different market environments. With TSP, our only protection against a bear is G and F - which are limited in returns to 6% or so in that environment (which is not much!). With a Roth, you could find funds specifically meant to make money in bear markets. I'll start looking for one of these funds for this year's contribution, since I don't have one yet.

 

[pyriel]

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I took the liberty of putting Rolo's point of view into an excel worksheet. I didn't even put in the agency matching contribution because some of us are in the military and are not getting them.



Pyriel

 

[Guest]

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BEARX, $2000 minimum.Am I correct when after 59 a half, you can withdraw from a Roth, tax-free?

 

[arcticbubba]

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Allright guys, you got my head spinning now. As for my current tax rate, how do I figure that out? I am 23, single, and don't own a house. So I really don't have any tax deductions at this time. Obviously things are going to change in the future. I am more concerned with my decisions that affect me now. I will revisit my contributions later on when things do change. I know I am ahead than most of my peers and I realize the money I put away now, is only going to benefit my financial future. After reading your posts, I am looking at funding my ROTH IRA instead of my TSP. Obviously, I will keep the 5% going into my TSP to take advantage of the matching contributions. But I like Mikes explanation that funding a ROTH now is more beneficial than funding the TSP. Pay the tax now on the contribution to the ROTH and don't pay the tax on the earnings when you withdraw. Seems like a no brainer, but your explanations got my head spinning. Maybe make it a simple answer on which one I should fund NOW.

TSP or ROTH IRA

If you need anymore information regarding my financial or tax situation, feel free to ask. It will only help you convince me on which one I should fund. Obviously I can't max my TSP or my Roth at this time, but I want to invest more than 5% because I can afford to, just can't afford 15% or $4,000 right now.

Thanks for you replys. Keep them coming.

Bubba

 

[pyriel]

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Arctic,

Please see the following worksheet before you make a decision.

Breakdown are as follows:

15% TSP without any ROTH contribution but tax savings are reinvested to TSP (Starting 2006 you may put in $15K)

15% TSP w/tax savings reinvested to ROTH. Assumption is that you will not add anything to ROTH IRA contribution.

Minimum TSP w/max ROTH IRA contribution. Assumption is for you to match your agency matching contribution (5%) and max out your TSP.

Max TSP and reinvest tax savings to ROTH without adding any contribution to your ROTH IRA.

MAX TSP and max ROTH. Savings made from TSP is applied to ROTH so you don't have to put the whole entire amount to fund your ROTH.

Don't make any hasty decision. Both point of view base on what you can afford. Most of us here are maxing TSP and ROTH. This is because we can afford them. 2006 is going to be big because max is $15K for everyone. To me, if you are saying you can't afford to max both, then increase your TSP get the tax savings and reinvest them. The tax savings reinvest is money that you made just by contributing. Just my small thought on all this.

Pyriel

Please click right arrow to see all the worksheets.

 

[pyriel]

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pyriel wrote:

Both point of view are valid but you have to base your decision on what you can afford.

This is what I meant to say on previous post.

 

[azanon]

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Welcome, Bubba!

This is a no-brainer: Max the TSP FIRST, then fund your Roth. Always.

First things first, its definitely NOT a no-brainer. It really is a tough decision with several factors to consider. First of all, if you were to search Roth vs Traditional IRA (sub TSP here since they work similarly) on the internet, or Roth IRA vs maxing your 401(K) (tsp) you'll find that 80+% of these articles will conclude that in most cases, they recommend using the Roth over a Traditional and they recommend only contributing to the employer plan to the match point, then switch to Roth, before going back to your employer plan to finish it off.

Second thing i have to disagree with Rolo on, is that in most cases, a Roth IRA will, leave you more money in the end, after taxes are paid on the TSP/Traditional. Sure you'll have to pay the taxes upfront with a Roth, but then you enjoy the benefit of tax-free compounded growth, AND in the end, you actually get to keep every single penny in the account (no tax owed). The only way Traditionals even have a chance of winning in a head-to-head scenario is if your tax rate while working is REALLY high, and you end up in a 15% bracket or less when you retire. Do you feel lucky?

The second potential problem a TSP can cause, is because you'll have to draw on it to liveafter you retire (and pay taxes on that), doing that will end up bumping your tax bracket so highin retirement, that your SS money will get eaten away by taxes as a result. Much better to just have SS, your federal pension, and only a 5% contributed TSP supplimented by Roth than to have a 15% TSP that's going to skyrocket your taxes owed and put you in a high tax bracket to eat up your SS check.

Third benefit of Roth, which Rolo pointed out, is you can take out contributions in a Roth tax free and Penalty free if need be at any time. Granted, i'll do everything in my power to never have to withdraw from a Roth except for retirement, still s*&t sometimes happens. If it does, you want to pay a nasty tax penalty breaking your TSP or borrowing from it or not? I prefer to not have to.

Fourth, TSP currently has 5 funds all run by monkeys (aka index funds), you can make a Roth IRA anything you like, with any investment company you like, including funds run and managed by homo sapiens.

Fifth, if you havent "locked" your money at a 15% rate into TSP,that gives you more flexibility with your paycheck if you need to temporary not contribute to your Roth for a couple months to deal with a financial hardship.

Sixth, its just nice being able to look at a Roth in, say, Quicken and knowing that every single penny you see is yours, and will always be yours. You will never owe Uncle Sam anything from them, ever.

I'm sure there's a few more things, but those are what came to mind.

This is all a minor issue compared to just making sure you're contributing as much as possible to all of your available IRA/TSP options!

Azanon

 

[Guest]

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arcticbubba wrote:

I am 23 years old andhave working for thefederal government for almost a year now. I started with 5% payroll deduction and recently bumped it up to 6%. In my TSP I currently have my contribution allocation as 15% in the C fund, 60% in the S fund, and 25% in the I fund.So as I sit here planning for retirement, I am wondering what my next step should be. I have a roth IRA in some mutual funds through Edward Jones. I am wonderingwhat I shoulddo next. Bump up my TSP contribution or start pumping money into myroth IRA?? Thanks foryour rsponse.

If you think tax reform will go through then you would want to work on the TSP. Why? When tax reform goes through you will lose the tax deduction. So if you are in the 25% tax rate...you will lose the 25% "return" of being able to deduct it against your taxable income. Remember the tax reform will be what you buy and not what you earn...which will be extremely regressive for lower income folks...since a larger percentage of their income goes to day to day stuff.

There will be two classes of folks in the U.S. poor and rich. Just look at your property taxes, state staxes, utility increases, etc...who is getting squeezed? The middle class. Your grandma probably did not need to work....now the two adults are working full time and having no kids and still can not make ends meet. Reason I saw that is personal savings is at ALL TIME LOWS...that means a lot of folks are three checks away from the curb.

My grandma retired in 1973 on $103,000. Now 30 years later you could not retire on 15xs that and live the same life style that she enjoyed.

OK whip me now because I speak the truth.