Ask The Experts: Money Matters

By Mike Miles

Take a lesson from the gulf oil spill: Manage risk wisely

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Watching the news about the Gulf of Mexico oil spill, I am struck by the similarities between drilling for oil and trying to extract wealth from an investment portfolio. After wondering — and worrying — about the impact of the spill on life and livelihood, my question was: How could this well have been drilled without a reliable plan to stop the flow of oil in the event of a problem?”

I realized that most investors — Thrift Savings Plan investors included — make the same mistake with their portfolios every day: They take risks that they don’t understand, or choose to ignore, and can’t afford.

Like drilling for oil, managing your investment portfolio for retirement income is an exercise in risk management. Failing to plan for, and manage, risk properly can result in disaster.

Some of the oil-spill lessons to be applied to management of your retirement portfolio:

• Understand your capabilities. One way to do this is to rank yourself against an imaginary perfect investment manager using attributes such as “ethical,” “reliable,” “capable,” “committed,” “skilled” and “experienced.” We’ll assume that since you’re considering managing your own money, you’re ethical, but what about skilled and experienced? Incompetent operators shouldn’t be allowed to drill oil wells because the risk is so great. Doesn’t managing your savings deserve the same respect?

• Accept your limitations. Not great in math and statistical analysis? Don’t have the time to spend managing your portfolio properly? Then admit it. If you’re not an expert in “drilling,” you should probably find someone you can trust to help you until you can become one. Learning on the job at your own expense, or the expense of those you care about, can be catastrophic. Successful investment management is more about avoiding critical mistakes than about striking a gusher.

• Take a long-term view — your lifetime, at least. Your investment strategy should be designed to support your long-term goals, and the tactics you employ should be consistent with this strategy. Does it make sense to risk everything in pursuit of a relatively unimportant goal? Is looking for short-term gains that you don’t need, or avoiding short-term losses that won’t really hurt you, worth risking your ability to pay your bills 10 or 20 years from now? Look at the mess that one failure on one oil well produced. I would argue that the risk taken in drilling that one well was not worth the potential gain from drilling it — particularly when the risk could have been avoided without sacrificing the benefit.

• Minimize unnecessary risk. Of course, we need fuel for energy. But are we choosing the lowest-risk ways to get it? While it’s important to obtain enough investment return to support your goals, do everything in your power to realize the needed returns with the minimum risk. Properly diversifying your portfolio is the secret to minimizing the risk to generate the returns you need. Notice that minimizing risk is not the same as avoiding all risk. Every investment involves risk. Rather than fear risk, manage it to your advantage.

• Don’t accept unacceptable risk. If a low-probability event will prove devastating, then find a way to reduce the potential damage to an acceptable level or find a way to avoid the risk, if possible. If a bad year in the markets will devastate your retirement plan, that’s an unacceptable risk. Likewise, if failing to realize the needed returns from your portfolio over time will devastate your retirement plan, then this is also an unacceptable risk. Bad years in the investment markets can, and will, happen. Insufficient rates of return from overly conservative strategies can, and will, happen. Either, if it results in a failure to achieve your key goals, is an unacceptable outcome and your investment strategy should seek to eliminate this possibility.

There are a lot of things you might worry about in the world today. But, if you do things right, your TSP account doesn’t have to be.

Reaching 59 1/2

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Q: My birthday is Dec. 27. I will be 60 this year. How do I calculate when I am exactly 59 1/2 years old?

A: Adding 6 months to your birthday will work. You’ll be 59 1/2 on June 27, 2010.

TSP withdrawals, taxes and loans

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Q: I turned 55 this year and just applied for disability retirement under the Federal Employees Retirement System. I have large bills I want to pay off. My income will drop the first year, then will decrease $1,000 the following year before continuing at that rate. I realize if I keep my Thrift Savings Plan or roll it over once I leave service, I will not be able too take a loan on it.

I realize I will need to pay my fair share of taxes, but is there a way I can work it out that I can take a loan on the money and pay it back over the next few years until I turn 62, thereby avoiding such a large amount of tax for this year (the income will put me in a higher tax bracket)? Also, could you explain how I could prevent a penalty if I should have to withdraw funds?

A: You’ll have to take withdrawals and pay the taxes, but because you’re separating from service during or after the year in which you reached age 55, you will not be subject to the early withdrawal penalty.

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Vested TSP and breaks in service

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Q: I am a Senior Executive Service employee with two years of active federal civilian service and 34 years of prior active military service. I have been discussing a possible opportunity wherein I would leave the federal government for a year or so and work as a contractor. I would then hope to compete for another SES position with a different agency and return to active federal civilian service.

Because I have only two years of active federal civilian service, will I lose the agency matching contributions I have received in my Thrift Savings Plan account to date if I leave active federal civilian service for a short period? Or, because of my previous federal military service, are those matching contributions already vested? My official federal service commencement date is 1974, my TSP account is above $3,500 and I plan to leave everything in the account during this possible break in civilian service. I believe that I will still earn interest on my account as my plans perform, but I am concerned about losing the agency matching funds now in my account.

A: From the TSP website: “All federal civilian service counts toward vesting in your TSP account, not just your service while you are a TSP participant. Service covered by USERRA [the Uniform Services Employment and Reemployment Rights Act] also counts toward vesting. If you are a [Federal Employee Retirement System] participant, your agency reports your TSP service computation date (TSP-SCD), which is used by the TSP record keeper to determine whether you are vested. Your TSP-SCD is shown on your participant statement; if you believe it is incorrect or have questions about it, contact your personnel office. (Your TSP-SCD will never be earlier than January 1, 1984.)”

More information is available at http://www.tsp.gov/features/chapter04.html.

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G Fund percentages

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Q: I read your May 3 piece regarding the G Fund. You said it should represent 10 percent or less of an investor’s Thrift Savings Plan assets. Maybe I’m not understanding correctly, because the suggested G Fund distribution in the L Funds has 32 percent in the L 2020, 64 percent in the L 2010 and 74 percent in the L Income. My opinion is that these are very high percentages, but I also think your 10 percent is rather low.

I’m not currently in the L Funds and probably won’t be. I plan to retire in 2014 so I can take advantage of the Federal Employees Retirement System sick leave provision.

A: I simply stated a fact: that most of the planning cases I’ve worked on have been best supported by G Fund allocations of 10 percent or less. I did not say that your G Fund allocation should be 10 percent or less. Since you’re not my client, I have no idea what it should be.

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Finding out TSP basics

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Q: I’m working for the federal government and plan on retiring there. I wanted to get some information on the Thrift Savings Plan. I have about 10 percent going to the G Fund and was wondering whether you recommend it or whether I should move my money into another fund.

A: Unfortuantely, I can’t provide you with specific investment advice because I don’t know nearly enough about you, your goals and your circumstances. You can learn more about the TSP by visiting the TSP website.

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Switching TSP funds

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Q: I am an active-duty soldier participating in the Thrift Savings Plan. I do not get a matching contribution. My money is invested in the S and I Funds, and this week I have lost $4,000. My investment had been exclusively in the G Fund, and my account was slowly growing. When I switched money in February from the G Fund to the I Fund, I began to make more money. I want to switch back to the G Fund for stability but am afraid that since the share prices are lower, the value of my account will drop because of the difference in share price between the funds. I only have two years before retirement.

A: The difference in share price, on its own, will not result in a loss if you switch from one fund to another. Your attempts to time the markets are a poor bet, however.

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Early retirement and TSP

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Q: I made a deposit to the Federal Employees Retirement System for 20 years of military service and have been working for the federal government for 10 years, which gives me 30 years of federal service. If I was to resign today, at age 50, would I continue to keep my military retirement pay until I reached my minimum retirement age (56) and could start drawing my FERS retirement? Will the FERS retirement consist of 10 years of Social Security Supplement, FERS and my Thrift Savings Plan payout, or would I have to wait on the TSP?

A: Because you are separating from service before the year in which you reach age 55, your TSP withdrawals will be subject to the early withdrawal penalty rules. There are exceptions to the penalty, however, which are explained in IRS Publication 590 IRS Publication 590 and in the tax notice at www.tsp.gov.

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One-time withdrawals

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Q: How much money can you take out for your one-time withdrawal without tax penalties? I am retiring under 6c, federal law enforcement retirement, at age 50.

A: Unless you meet one of the special exceptions to the early withdrawal penalty, the amount will depend upon your life expectancy and the calculation method you choose. This excerpt from my July 23, 2007, Money Matters column should help:

“Another exception to the early withdrawal penalty — one that is available to anyone — is to take distributions before reaching age 59 1/2 as a series of so-called substantially equal periodic payments (SEPP). By agreeing to begin converting your account balance to a stream of income designed to last for life, you avoid the penalty. There are three methods of computing the amount of each distribution, including one that produces a varying stream of annual income and two that produce fixed streams. What they all have in common is the distributions must continue uninterrupted for at least five years or until you reach 59 1/2, whichever period is longer. The SEPP exception requires only that the exact amount of the computed withdrawal be taken by Dec. 31 each year, so the number and timing of the distributions during each year are up to you.

“[The Thrift Savings Plan's] withdrawal limitations will require a monthly payment schedule, but the SEPP exception applies to IRA distributions, so you could roll your TSP balance over to an IRA to gain more withdrawal flexibility. While your SEPP plan must be designed to provide income over a lifetime, it doesn’t actually have to do so. Once you’re 59 1/2 and the payments have continued for at least five years, you may terminate the payments and begin withdrawing money according to your needs, without penalty.

“An important fact to remember when considering using a SEPP series to extract money from your account without penalty: The calculations and rules that govern this exception are complex, and the penalty for mistakes can be high. So make sure that you, or someone you trust to guide you, have a thorough understanding of the requirements before proceeding down this path.

“One of the attractive aspects of the SEPP exception is that it allows you to retain ownership and control of your savings, while providing penalty-free income before age 59½. Alternately, you can avoid the penalty by using part or all of your TSP balance to purchase an immediate life annuity after separating from service. This produces a regular stream on income that is guaranteed to last, at least, for life, but in exchange, you forfeit ownership and control of the principal used to purchase the annuity. I wouldn’t suggest using an annuity only to avoid the early withdrawal penalty for a few years, but if it’s something you would consider anyway, it’s useful to know that it can begin at any age without being subject to the penalty.

“Other exceptions to the early withdrawal penalty are available for total and permanent disability, death, certain court-ordered payments and qualifying medical expenses. These exceptions are based on circumstances that are largely outside the control of the plan participant and available only in a minority of cases.

“You can learn more about all of the exceptions to the early withdrawal penalty by reading IRS Publication 590, at www.irs.gov; and TSP Tax Notices, under ‘Publications’ at www.tsp.gov.”

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Did the G Fund lose value?

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Q: I noticed that today (May 6), the G Fund lost value ($0.01 per share). I don’t understand how this can be. I would greatly appreciate an explanation.

A: The price you cited in your question was incorrect. The G Fund’s closing price on May 6 was $13.2680 per share, and on May 5 it was $13.2669. Recent share prices for the G Fund and for other Thrift Savings Plan investments can be found at http://www.tsp.gov/rates/share-prices.html.

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