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Author: KudieM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 83  
Subject: New Lifestyle funds Date: 7/24/2006 4:05 PM
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Just trying to get some interest in this board going from some Foolish Fellow Federales........

I am currently contributing the matching 5% of pay into the TSP-75% to the L2020, 20% L2030, and 5% small cap (S) fund. I am about 20 years from retirement and just opened a Roth this year. Doing the math, right now the TSP is about 65% in all stock categories. My Roth is 100% in small-cap stocks (Hidden Gems) and that's about 4% of my total retirement investment.

For any TSP Fools, does that sound too stock-heavy? I know the TSP would "recommend" all of my $$$ for the L2020 b/c I'm perfectly balanced with that outcome, but I'm weighing converting my entire TSP to the L2020 and leaving my Roth to the small cap world.

My other option I'm considering is stopping payments into the Roth and upping my %age to the TSP to get current tax advantages (without matching funds). Is there a way to guage the tax benefits of either choice, i.e.-taking current tax credit for the TSP vs. after-retirement tax treatment with the Roth?

Thanks much in advance. Cheers!
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Author: kaudrey Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 10 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 10:47 AM
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Hi Kudie,

I am also a federal employee. Take this not as advice but just as something to help you think about the issues.

First, as far as where to invest, to me it's somewhat of a toss up, but not just for tax reasons. I'll explain: General wisdom says invest in the 401(k) up to the match, then fully fund a Roth, then continue to invest in the 401(k) up to the maximum ($15K). The Roth, because of the tax-free withdrawals, is really one of the best deals around from a tax perspective.

Now, the reason I think this thinking may be questioned for federal employees is that the fees charged for TSP are so low that it can really make a difference. It can make enough of a difference to offset the taxes.

Here's an example (sorry if this seems complicated):

Say someone today has $50K in a Roth and the TSP. Assume the TSP funds expense ratio is .05%, and the funds in the Roth have expenses of 1.05% (so a 1%). This is not unrealistic in the real world.

Assume a person adds $4K to each per year (since that's the limit on the Roth) and there is no company match (just for simplicity).

Say the funds in each return the same amount before fees (ignore taxes), so that AFTER tax the TSP earns 8% and the Roth earns 7%.

With me so far? :)

TSP: $50K today, $4K every year for 20 years, 8% return = 416,095
Roth: $50K today, $4K every year for 20 years, 7% return = 357,466

Difference = $58,629.

Now, that's not the full story, because of taxes.

With the TSP, you pay income tax on the withdrawals. But in retirement, you will likely be in a low tax bracket. If you are in a 10% tax bracket over the life of the TSP account, and take the "safe withdrawal rate" of 4% every year, it will take 23 years for you to pay out the $59K in taxes that you are saving in the Roth (even assuming the TSP continues to earn 8% per year). If you are in the 15% bracket, it would take 17 years.

I guess the point is that the Roth is a great tool, but so is the TSP. Since we can't know how long we will live or how many years we will be retired for, it's a guess as to which is better, IMHO.

Next post on your allocation...

Karen



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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 11 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 11:02 AM
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Say the funds in each return the same amount before fees (ignore taxes),

But you *can't* ignore taxes if you want a good comparison.

Remember:

Transactions in a Roth, or in a TSP, do not incur taxes. No taxes on dividends. No taxes on capital gains (and no deduction for losses). They're identical in that respect.

Where they differ is when you put the money in, and (as you noted) when you take the money out.

Money put in the TSP is removed from your taxable income (in other words, it's just as if it were tax-deductible). But when you withdraw, the amount of the withdrawals will be counted as income for both federal and state purposes (unless you live in a state that exempts pension income).

Money put in the Roth does not reduce your taxes at all.

So, putting $4000 in the Roth has a similar impact as putting around $6000 in the TSP (with respect to your spendable cash).

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Author: kaudrey Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 11:05 AM
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It will take 23 years for you to pay out the $59K in taxes that you are saving in the Roth (even assuming the TSP continues to earn 8% per year).

----

That wasn't worded quite right. But I'm sure you knew what I meant. With the Roth, you are starting out with less money, but no taxes. With the TSP, you have to pay taxes, but the reduction in your net TSP dollars will take a long time for the advantage of the Roth to show up.

Does that make sense? Clear as mud...

Anyway, on to the allocation. This is a personal thing as to how much risk you are willing to tolerate, but here's my two cents.

Just so you know a little about me so you can see where I am coming from. I am 37, been with the feds for 15 years, and plan to retire early at 52 with 30 years in.

I have about 85% of my portfolio in mutual funds and stocks.

The reasoning is: I have a long time horizon (and yours in even longer); I have a high risk tolerance (I see dips in the market as buying opportunities - how about you?), and I am a buy and hold investor. I DCA and don't try to time the market.

But, the biggest reason for federal employees (again, IMO) to be heavily invested in stocks is our PENSION. A pension is like a bond or an annuity. You can figure out an approximate "worth" of a pension by using the "safe withdrawal rate" idea:

The SWR is generally considered to be 4% of your portfolio each year. So, if you have a $1M portfolio, you can withdraw $40K a year (and adjust upward for inflation). In other words, $40K a year is "worth" 25 times that, or $1M.

If your pension will be, say, $20K a year, then it's "worth" $500K. This $500K is pretty much like having a $500K bond or annuity that is earning 4%. If you "add" that $500K to your portfolio, and recalculate your allocations, you are now heavily invested in "bonds", instead of stocks.

Now, since nothing is absolutely guaranteed, I wouldn't count on the pension until you are fully vested, and I wouldn't count on the amount you think you'll get if you stay in until your MRA. Nonetheless, I know in my mind how much I would get if I left today, in 5 years (when I hit 20 years), and if I stay until I hit 30 years (since the rules are different at these points). And knowing these amounts, I am OK with my high stock allocation.

I hope this makes some kind of sense. When I talk to my DBF like this, he tells me his head is going to explode. :)

Karen




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Author: kaudrey Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 11:09 AM
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So, putting $4000 in the Roth has a similar impact as putting around $6000 in the TSP (with respect to your spendable cash).

----

True jrr - I guess I was thinking more like - if you put $4K in each, you'll save on taxes by putting it in the TSP, which makes it even MORE attractive as compared to the Roth.

Karen

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Author: KudieM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 14 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 11:41 AM
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It does make sense, but yeah, when I think about it myself, my head wants to explode, too! When I write it out it makes more sense, but then seeing a more competent person analyze it for me, brings it that much clearer! Thanks a bunch.

I'm not so far off from you. I'm 40 and just hit 15 years in service a couple of weeks ago. I reach MRA at 57 and change, but rounded to an even 20 years to retirement to account for paying my house off b4 I retire.

I hadn't thought about the pension at all, but you're right, even if in the future they change the rules for pensions, they usually change it for new hires, much like they did when they went from CSRS to FERS so I probably should add that to my calculations. I've been ignoring it much like I have social security, trying to make sure I can take care of myself by myself and leaving everything (pension and social security) else to gravy. Thinking about the pension as akin to an allocation in bond-type instruments really knocks my presumption of 65% in stocks down significantly! Wow, that's very liberating in fact to think about it like that.........

I guess that says it all, I'm really not that stock heavy after all and can actually "afford" to dig into them even more heavily. All of my Roth money has been going into Hidden Gems selections, not doing too well right now, but yes, I'm plowing every dime I can spare into new shares with the market lower. And the lower it goes, I'll be turning out my pockets and rifling through the couch cushions to find more dimes to throw into the ring!

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Author: kaudrey Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 1:36 PM
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Glad it helped somewhat! Sounds like you are doing great.

I don't count Social Security either when I am running my numbers, but the federal pension is much more secure, IMHO. The only problem with the FERS annuity is that it doesn't keep up with inflation, which is kind of annoying, but what can you do?

Karen

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 16 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 3:44 PM
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With the TSP, you have to pay taxes, but the reduction in your net TSP dollars will take a long time for the advantage of the Roth to show up.

If your tax rate in the future is the same as your tax rate now, there is no difference financially between a Roth IRA and the TSP. If you put the same amount in to each, and invest identically, you get the same amount out at the end (after properly accounting for all tax effects).

A Roth is preferable if you expect income tax rates to be higher in the future, and a TSP is preferable if you expect your income tax rate to be lower in the future.

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 3:47 PM
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if you put $4K in each, you'll save on taxes by putting it in the TSP, which makes it even MORE attractive as compared to the Roth.

No. If you put $4k nominal in the TSP, your taxable income is reduced and you'll pay less tax (or get a bigger refund). If you put $4k nominal in the Roth, there is no current tax impact.

However, at retirement when you withdraw, you'll net less from the TSP than from the Roth because the TSP withdrawal is taxed as income.

So, contributing to the TSP is tax savings now but less money down the road than if you'd contributed the same amount to the Roth.

Of course if you can it's best to do both. The TSP's low fees are splendid, but the Roth is a lot more flexible.

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Author: KudieM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 18 of 83
Subject: Re: New Lifestyle funds Date: 7/25/2006 11:28 PM
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Yes, thanks, that's why I opened the Roth. I figure I can't do anything about the TSP's tax consequences after I retire, so I'll leave that as the taxable account (what choice do I have?), but when I get to retirement age, I'll sell my (hopefully!) well appreciated, 100-bagger, Hidden Gem stocks and put the $$$ into cash yielding equities.

I'm not sure exactly what my retirement tax status will be. I know that sounds weird, but I work in a state (which shall remain nameless, but it's OREGON!) with a high income tax (currently 9% but I usually claim less than that due to taking sick and vacation days in my home state which has no income tax), but I live in Washington, so I am not sure if my pension, TSP, or even social security, will be subject to Oregon income taxes after I retire. I've been told it is all taxed by Oregon since the earnings it's all based on were earned in Oregon, but I don't know that for a fact. Something I will have to nail down........

Thanks again!

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19 of 83
Subject: Re: New Lifestyle funds Date: 8/24/2006 12:29 PM
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I am not sure if my pension, TSP, or even social security, will be subject to Oregon income taxes after I retire. I've been told it is all taxed by Oregon since the earnings it's all based on were earned in Oregon, but I don't know that for a fact. Something I will have to nail down........

I don't think a state can tax you unless you live or work there. Check on the Tax Strategies board to be sure.

SS is not taxable by a state you're not in(the constitution prevents the states from taxing the federal government).

Pension/TSP *may* be taxable though since it is deferred salary. However I suspect that it's only taxable by the state you're living in.

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Author: KudieM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20 of 83
Subject: Re: New Lifestyle funds Date: 8/24/2006 2:23 PM
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Thanks, I will take a look at that board and post the question or see if it's ever been addressed.

Yeah, it's that *may* that makes the difference since Oregon has a high (9%) income tax and my state, Washington, doesn't have any. Although, it's intesting to note that I can currently deduct all of my vacation and sick time from Oregon income taxes since that pay is based on staying home to accumulate it. Seems that since I will be permanently based in Washington after retirement, all of that earnings time would be based on Washington, but I do see your point...........

Thanks again!

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Author: Gotalilstinker Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21 of 83
Subject: Re: New Lifestyle funds Date: 9/21/2006 9:14 PM
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I'm not sure if it applies to anyone here, but there is a $1000 tax credit for saving using an IRA. You have to meet some requirements though:

-- Born before Jan 1988
-- Not a full-time student
-- No one else claims you on their taxes
-- Adjusted gross is less than: $50k married filing joint, $37,500 head of household, $25k single or married filing separately

I'm military so a large potion of my income isn't taxed so it makes it easier to get to these income levels, but just a hint for everyone out there. If you need more info you can go to IRS Pub 590, chapter 5

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Author: KudieM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 22 of 83
Subject: Re: New Lifestyle funds Date: 9/22/2006 10:31 AM
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I wonder if that applies to Roth IRA's as well? Might be worth checking into if I ever decide to start doing foreign TDY's again. Not likely, but the only time my personal income drops to that level is when I can exclude foreign-earned income..........Thanks for the info, though. Cheers!

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