Ask The Experts: Money Matters

By Mike Miles

Deductible IRAs

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Q. I am a rehired federal annuitant. Am I eligible for a deductible IRA?

A. That will depend upon your age, marital status, whether or not you or your spouse are covered by an employer-sponsored retirement plan and your income. Check IRS Publication 590, consult a tax advisor or run one of the many IRA eligibility calculators available online.

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TSP withdrawals

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Q. I have approximately 200K in my TSP. I would like to leave the principle to my children and take a yearly withdrawal of the interest earned. What, and I know it is an estimation, would you think is a safe percentage to withdrawal yearly?

A. Interest does not accrue in a TSP account. The share values change in response to changes in value. The maximum safe withdrawal rate will depend upon a number of factors including your age, health and how the money is invested and managed over time. Calculating this estimate is beyond the scope of this forum.

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TSP distribution

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Q. I am a Department of the Air Force civilian and I plan to retire in June 2014.  I will be 60 and have 20 years of federal civilian service.  I currently have my entire TSP tied up in the 2020 L fund.  Is it too early to put all of my funds into government funds for stability purposes?

A. It’s not a question of timing, but of spending. You can move all of your money into the G Fund, if that’s what you mean, any time you like, but you’ll be limited to the lifestyle that can be supported by its performance.

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G Fund

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Q. In the past, I had read that a fixed amount of money in (not making active contributions to) the G fund would grow over time based on the G fund’s rate of return.  Is this correct?

A. It is correct.

TSP Snapshot column

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Q. I read your column in the Federal times regularly.  I am at a loss to understand how you calculate (in percentages) the return on the individual funds.  Can you share with me how you do the math?

A. Since all dividends and capital gains are retained in the funds, you calculate the percentage return on a TSP fund investment by dividing the fund’s share price at the end of the measurement period by its price at the beginning of the period and multiply the result by 100.

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Diversifying can help you get the most from your investments

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As a Thrift Savings Plan participant responsible for managing your own pension fund, you would be wise to understand investment diversification, which means allocating your money among different investment assets — putting your eggs in many baskets.

Why diversify? The usual answer — to reduce risk — is only part of the answer. The real reason to diversify is to improve — or better yet, optimize — your portfolio’s risk-adjusted expected rate of return, which is the rate of return your portfolio is most likely to produce in the future, adjusted for the risk that it will fail to produce that rate or return.

For example, a portfolio with a 10 percent probability of producing a 20 percent rate of return has a considerably lower risk-adjusted expected rate of return (RAEROR) than one with a 90 percent probability of producing a 10 percent rate of return. The former might produce its expected return, while the latter probably will.

Diversification is instrumental to maximizing the probability that you will earn a given rate of return from your portfolio. Optimizing the risk-adjusted expected rate of return is the process of identifying the rate of return you will need to support your lifestyle in retirement and then combining various types of investments to maximize the probability of actually achieving that required rate of return.

Every investment portfolio has an expected rate of return and associated probabilities, and an infinite number of alternative rates. As an investment manager, it is your responsibility — in fact, it is critical — to know what those rates and probabilities are for your portfolio.

For our purposes, there are two basic types of diversification: intramarket and intermarket. Intramarket diversification occurs within a particular market or group of investments, while intermarket diversification occurs among two or more investment markets or groups.

Let’s start with intramarket diversification, something the TSP takes care of automatically.

If you own stocks or bonds issued by a single entity, there is a potentially large risk that the issuing entity will falter or fail to perform as expected. Intramarket diversification can help to insulate you from this risk without costing much in the way of expected rate of return.

If you own the stock of two large computer hardware manufacturing companies, for example, they both probably have about the same expected rate of return. If each stock has a 10 percent expected rate of return, combining them into a portfolio will produce the same 10 percent expected rate of return. But by owning both stocks, the potential for losses resulting from problems specific to one of the companies — say, accounting fraud — is reduced.

So, combining these two assets together in the portfolio did not reduce the expected rate of return for the portfolio, but, at the same time, it reduced at least one type of risk, producing an improved RAEROR.

Taking this logic to the extreme, you can maximize the RAEROR for a portfolio composed of large computer hardware manufacturing companies by owning all such companies. This will minimize the company-specific risk you bear without substantially reducing the portfolio’s expected rate of return.

The same principle can be expanded to larger groups of investment assets, with similar results, and is the part of the rationale for investing in index funds like those offered in the TSP. The TSP’s funds tend to produce high RAEROR values for the types of investment assets they represent — cash, bonds and stocks.

Based on historical evidence, I estimate that large-cap domestic stocks will most likely produce a return of around 12 percent in any given year, before investment expenses. This expectation applies to all large-cap domestic stocks, individually and as a group. But history also tells us that there is about a 17 percent chance that, as a group, they will produce a loss of at least 6 percent in any year. Owning less than the entire group of large-cap domestic stocks will produce the same 12 percent expected return, but with higher probability of loss, owing to the increased company-specific risk associated with owning fewer than the maximum number of stocks.

The TSP’s C Fund gives you the optimal large-cap domestic stock exposure — or something close to it — with about the highest RAEROR for the asset type you will find. Any alternative you consider should be compared with this standard.

The same is true of the TSP’s other four basic funds with respect to the asset types they represent.

In my next column, I’ll explain intermarket diversification.

Lump-sum annual leave and TSP

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Q. If I retire on Oct. 30 and receive a lump-sum payout for annual leave, can I have that directly deposited into my TSP account?

A. Not under the current rules.

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TSP contributed funds while working

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Q. I understand that when I turn 59 1/2,  I can begin withdrawing my TSP contributions without a tax penalty.  May I continue working for the federal government after age 59 1/2 while augmenting my take-home pay with something like a TSP life annuity?  Right now it’s looking like I’ll never be able to retire and am looking for ways to bring more money home to live on.  An extra $1,000 per month or so from a TSP life annuity in addition to my regular federal salary would really help to make ends meet.

A. Yes

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TSP withdrawals

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Q. I’m currently on active duty as a retired recall, servicing in Kuwait.  I will reach age 54 in December; can I withdraw my TSP funds in January without penalties?

A. From the TSP’s website: “Relief from the 10% early withdrawal penalty is availableto eligible Reservists called to duty for more than 179 days. The Reservist must have been activated after September 11, 2001 and must have received his or her TSP distribution between the date of the order or call and the close of the active duty period. The Reservist may also be eligible to repay the distribution to an IRA (not the TSP). Participants should consult with their tax advisors, legal assistance officers, or the IRS regarding this relief.”

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Retiring at age 75

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Q. I just want to be clear that if I choose to remain working (GS) until age 75, will my TSP account continue to be active? Then at what point must I make a TSP withdrawal decision?

A. Following your retirement.

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