Ask The Experts: Money Matters

By Mike Miles

Know the odds to get the upper hand in managing funds

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If you have a Thrift Savings Plan account, you’re an investment manager. If you’re counting on that TSP account to provide income for your use in retirement, you’re a particular kind of investment manager: a pension fund manager. As a pension fund manager, it’s your job to do whatever you can to coax the fund — your TSP account — into supporting the benefits you’ve promised yourself.

If you are, or will ever be, entitled to a Civil Service Retirement System or Federal Employees Retirement System annuity, you probably, and rightfully, expect that the providers of that annuity make good on their promise and deliver the cash when the time comes. You should expect no less from yourself as the manager of your TSP account. Of course, you can hire an adviser and delegate the task to someone who is qualified, but finding someone who is deserving of your trust is not an easy task. Unfortunately, there are more wolves than good shepherds out there.

So, like many a TSP investor, you’re left to your own devices in managing this part of your pension fund. And if you’re going to do it, you should do it right.

One secret to successful pension fund management is to stop confusing sales pitches with advice. Stop relying on advertising for your financial education. Would you hire a pension fund manager if his only qualifying credential was a subscription to Money magazine?

If you’re going to be a pension fund manager, your responsibility is to understand the game you’re playing and the environment in which you’ll be playing it. I’ve found one of the most useful teaching aids in my own education to be the roulette wheel. If you’re not familiar, the European variety, which offers the best odds, contains 37 spaces, each with a unique number from 0 to 36. One space is green, 18 are red and 18 are black. You place a bet on a space or set of spaces. The wheel is then spun, and a ball is released onto the wheel. When the ball comes to rest, the space it occupies determines the winning bet.

The wheel is instructive in that it offers an easy-to-understand set of probabilities, or odds. There are lots of possible bets on a roulette wheel. You can bet on any number or possible combination of numbers in exchange for a predetermined payout. Bet $1 on a single space and win, and you’ll receive a $36 payout. The probability of winning a single-space bet is one in 37. With $1 bets, you’ll spend $37 to spin the wheel 37 times, but your expected payout for 37 spins is only $36. The odds say that if you bet a single space each time and spin the wheel 37 million times, you’ll spend $37 million to do it, lose $1 million and be left with $36 million. That’s a loss of 2.7 percent of your investment, which is the best deal you’ll get from a roulette wheel.

There are, of course, bets available that will take your money faster, but no matter how you play the game, over the long run, you must expect to lose at least 2.7 percent of your money. No matter what you do, you can’t nullify the fact that the game is biased against you and that you’re more likely to lose money than to make money playing it.

What can this teach you about pension fund management? Plenty! Your job is to understand the odds of every bet you make, and to make sure that you’re betting in such a way that the odds are skewed as far as possible in your favor. In a casino, the house has the edge. In investing, if you play the game right, the edge is yours.

If you play the right bets in your TSP account, you’re more likely to win money than lose it. Play the game the wrong way, however, and you can forfeit that edge.

As in the casino, the secret to playing the investment game well lies in avoiding the mistakes, avoiding the poor bets. Trying to time the markets or failing to diversify your investments properly decrease your odds of success. And, like the casino, paying someone to try to beat the game decreases your odds of winning.

The TSP’s funds, by design, go a long way toward helping you maximize investment performance. Implement the proper asset allocation in your account and keep it there. That’s the best you can do.

TSP fund allocation

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Q: I am an employee under the Federal Employees Retirement System. I will retire in five years at age 56 with 37 years of federal service. I plan to continue working in the private sector and not make any Thrift Savings Plan withdrawals until I turn 62. I currently contribute 20 percent of my TSP money to each of the five funds. What is your opinion on this investment allocation? If it’s not favorable, could you provide an allocation that you feel would be in my best interest? Also, if I decide to delay my federal retirement until age 62, would you recommend the same mix or a more aggressive one?

A: The information you’ve provided isn’t adequate to support the kind of analysis required to determine the right asset allocation. The allocation is a means to an end and should be chosen to support your specific goals, including the amount and timing of all future cash flows expected to affect the account, among other personal factors.

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Inflation worries and TSP

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Q: I have all of my Thrift Savings Plan money in the G Fund, but I am worried about inflation. Is there any way to buy I Bonds or other inflation-indexed securities through the TSP?

A: Not yet.

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Early withdrawal from TSP

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Q: My position was eliminated when I was 51 years old. I retired with more than 30 years of service. I would like to withdraw all of my funds from the Thrift Savings Plan; will I be required to pay the 10 percent federal penalty if money is taken out prior to age 59 1/2?

A: Unless you meet one of the special exceptions to the early withdrawal penalty, you will have to pay it. For details, see the tax notice regarding distributions from your TSP account at the TSP website.

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TSP loan vs. refinance

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Q: My wife and I will soon need money to pay for our son’s college expenses. We would either have to refinance our home using the equity that we have built up or take a loan from my Thrift Savings Plan account. The refinance would be at 4.25 percent over 20 years with approximately $2,000 in closing costs. The TSP loan would be at 2.875 percent for anywhere from one to five years for a $50 fee. What do you feel is the best option? Is the interest on the TSP loan deductible on my taxes?

A: It’s impossible to say which one will be the best choice. However, I’d be reluctant to refinance my primary residence because a default could mean foreclosure.

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Distributing TSP funds

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Q: I truly do not know what I’m doing with my Thrift Savings Plan funds. I’ve been told to divesify them; what exactly does that mean? If you were to look at this breakdown (figures rounded slightly) and know that I won’t retire for 21 years, what recommendation(s) would you make?

L 2040 Lifecycle Fund: 74.72 percent of total funds, $21,423; F Fund: 5.33 percent, $1,529; G Fund: 5.28 percent, $1,515; C Fund: 4.91 percent, $1,408; I Fund: 4,88 percent, $1,400; S Fund: 4.88 percent, $1,398.

A: Consider the following growth allocation: 55 percent C Fund, 26 percent S Fund, 9 percent I Fund, 5 percent G Fund and 5 percent F Fund.

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IRA rollover into TSP

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Q: I joined the federal government more than three years ago. Can I roll over money from my Individual Retirement Account into my Thrift Savings Plan account?

A: Yes, as long as long as your IRA doesn’t contain basis — that is, money that’s already been taxed.

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TSP vs. IRA

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Q: I am retiring next month and am not interested in assuming risk in my retirement funds at this time. Would be best to roll over Thrift Savings Plan funds into an Individual Retirement Account, or should I leave the money in the TSP? I currently have 50 percent of my money in the G Fund and 25 percent in the C and S Funds.

A: Your interests will be best served by leaving your money in the TSP as long as possible.

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Rolling over funds into TSP

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Q: Can a new federal employee roll over a pre-tax 401(k) from a private-sector job into the Thrift Savings Plan?

A: Yes.

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Inherited stocks and capital gains

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Q: I am just about to retire from the FBI, where I’ve worked for 30 years. My parents left me a stock portfolio which dates back several decades. I would like, after retiring, to find and purchase a home using the stock portfolio, which is held in a trust my parents set up for me. I have never purchased a house, and I am wondering if there is any way to get around the capital gains taxes that probably would eat up huge chunks of the value of the stock portfolio once I liquidate most of the stocks to purchase the residence.

A: You should consult a certified public accountant or other qualified tax adviser for specific advice, but I can tell you that, unless you inherited the appreciated property (investment securities) in 2010, your basis in these securities is likely their value around the time they were inherited, so the taxable gain that existed up to that point is erased. If you inherited the stocks in 2010, a different set of rules apply (so far) and you may have inherited the basis, along with the securities.

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