Federal employees are fortunate in being eligible to receive two types of retirement plans once they retire from federal service. The first type of plan is either a CSRS annuity or a FERS annuity, both of which are classified defined benefit plans and, as such, guarantee income throughout the annuitant’s retirement years with some inflation protection. The second type of plan that all FERS retirees receive and most CSRS retirees receive is the Thrift Savings Plan (TSP). Unlike a CSRS or FERS annuity, the TSP is classified as a defined contribution plan. As such, the TSP does not guarantee lifetime income once a federal retiree starts withdrawing from it.
Nevertheless, there are things employees should do with their TSP accounts and certain mistakes that employees should avoid when it comes to investing in the TSP in order to maximize growth potential and to hopefully preserve the TSP throughout an annuitant’s retirement years. This column discusses the 10 biggest mistakes that result in the most damage to an employee’s TSP account.
1. Opting out of the automatic TSP enrollment
Newly-hired federal employees are automatically enrolled in the TSP with three percent of their bi-weekly salary automatically contributed to the TSP. By contributing three percent of their salary, the employee receives from his or her agency a contribution match of three percent. The only way an employee can opt out of the automatic TSP enrollment is for the employee to fill out Form TSP-25 requesting to cease TSP participation. Opting out of the TSP is a mistake on a newly hired employee’s part because the earlier an employee starts contributing to the TSP, the longer the money has to grow, tax-deferred for the traditional TSP or tax-free for the Roth TSP.
2. Staying with the default TSP contribution level
Some employees assume that the TSP’s three percent default contribution level will be sufficient to fund their retirement. According to most financial planners, a 3 percent contribution level, resulting with a FERS employee receiving a 3 percent agency match together with an agency automatic 1 percent of gross pay automatic contribution for a total 7 percent contribution level, is insufficient to fund a FERS employee’s future retirement years. The Vanguard Center for Retirement Research says that individuals with a household income of between $50,000 and $100,000 should ideally be saving 12 percent to 15 percent of their salary, divided between their contributions and agency contributions. This means that FERS employees need to save at least 7 to 10 percent of their salaries each year in order to save a total of 12 to 15 percent (with a 5 percent contribution coming from the employee’s agency) for the year.
3. Investing too conservatively while young
While some older federal employees try to grow their TSP too much and too fast, many younger employees often fail to take advantage of the growth potential of the three TSP stock funds – the C, S, and I funds. The “rule of thumb” for a moderately aggressive portfolio is to take one’s age and subtract it from 120. The resulting number is the percentage that should be invested in equities (stocks) as opposed to more conservative assets such as bonds and bond funds (that is, the F and G funds). An employee who is 25 years old should therefore have a minimum 95 percent invested in the C, S, and I funds. A 35 year old employee should have a minimum 85 percent invested in the C, S, and I funds and 10 percent invested in the F and G funds.
4. Not diversifying within the TSP
The TSP offers three stock funds – the C, S and I funds – and two bond funds – the F and G funds. In an attempt to keep things simple, some employees may contribute to only one stock fund or to only one bond fund. In doing so, the TSP participant’s portfolio lacks diversification which is bad since it is by definition, riskier. Having a balanced portfolio, a portfolio that includes stocks of different kinds and sizes, along with different types of bonds, shields an investor, in this case a TSP participant, from market volatility.
5. “Choosing and forgetting” a life cycle (L) fund
Life cycle or L funds do not get much respect because they try to apply a “one-size fits all” approach to retirement savings. Many financial advisers are lukewarm on L funds but admit that L funds have their place in the retirement savings world, especially for novice investors. L funds are a good place to start investing and certainly a better alternative than not saving at all. Although L fund allocation is designed to change over time to more conservative funds (that is, the bond funds) as time goes on, a TSP participant’s personal tolerance for risk should still come into play. This is especially true if the TSP participant is getting close to retirement.
6. “Panicking” after a bad month or quarter
Switching from one stock fund in the TSP after it tanks and switching to another TSP stock fund that is doing well sounds like a good idea, but the ultimate result is that a TSP participant who performs such a move will end up “selling low” and “buying high”, the exact opposite of basic investing principles. During 2008 – 2009, when the stock market was in a downturn, many TSP participants transferred their money out of the C, S and I funds and switched their money into the “super safe” G fund. One of the reasons given by these participants was to “stop the bleeding” in their TSP portfolios. But most of these same participants missed the start of the stock market recovery on March 9, 2009. Even if some of these participants got back into the C, S and I funds three or six months after the market started turning upward in mid-2009, they made out worse than those TSP participants who “stayed the course” and remained in the C. S and I funds.
7. Abandoning a 401(k) retirement plan after leaving a job and entering federal service
With all of the upheaval that comes with switching jobs, it can be understandable that a newly-hired federal employee may not be aware that an employer-sponsored 401(k) plan that the employee previously participated in but can no longer, can be directly transferred into the employee’s TSP account. Leaving funds in a 401(k) and not keeping track of them can have serious consequences. The funds themselves can change to the point where they no longer fit the owner’s investment goals.
8. Starting late and trying to play “catch up”
Federal employees who start saving for retirement somewhat later in their careers such as mid-career, or who stop contributing to the TSP for a period of time, are often under the mistaken impression that they can make “lost time” late contributions. But the stock market does not work that way. A period of non-participation in the TSP deprives a TSP participant of the investment returns on the money had that money been invested. It may also result in the participant using any savings to the point of “choosing returns” which most financial advisors warn is a not a wise investment approach.
9. Withdrawing too much of one’s TSP account and too soon
In general, cashing out one’s TSP funds in a lump sum is not a wise investment move for several reasons. First, the funds from the TSP withdrawal will be taxed at the participant’s regular income tax bracket. If the participant has a sizeable traditional TSP account balance, for example, $400,000; then withdrawing the entire account will result in the account being taxed at the highest federal tax bracket, 37 percent. In addition, if the participant lives in a state with an income tax, then state income taxes must be paid. On top of this, the participant is withdrawing all of the money, some of which must continue to grow throughout one’s retirement but will not.
10. Transferring one’s TSP to an IRA with high fees
There is no lack of financial planners and investment companies including banks, brokerages and insurance agencies who would like to have the opportunity of taking charge and investing a TSP participant’s account. Many of these planners or companies suggest that the participant transfer their entire TSP account to them to manage. But the important information that most of these planners and companies do not explain to the TSP participant are the fees associated with the IRAs they want to manage. The one fact that all TSP participants should be aware of is that the TSP has the lowest administrative fees of all current defined contribution plans. TSP participants pay no commissions, nor custodial fees. The same cannot be said of IRAs as every IRA has an annual custodial fee. In addition, IRA owners typically pay either a commission or higher administrative fees. These commissions and fees take away from the gross investment return that many IRA owners think they are earning but in reality they are not.