Ask The Experts: Money Matters

By Mike Miles

Buyback, Social Security, high-3 and TSP

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Q. I have 33 years in and am under CSRS. I will be 60 years old in May. I served less than two years in the Army in my 20s. I am a WG-8 making almost $25 an hour. I receive correspondence statements from Social Security that if I retire at age 62, I would be eligible for approximately $300 based on a second job 12 years ago and jobs before joining the government in the 1980s.

1. Should I buy back the time I have in the Army?

2. Will the buyback help increase my Social Security? Or will the money from Social Security lower my pension?

3. Should I get a part-time job to increase my Social Security benefit? I know I am not eligible for disability based on not having 40 quarters, but will the small amount of time I have paid into Social Security help or hurt me when I want to retire at 62?

4. Is there anything current on whether the top three years will be changed to top five? And, if it gets changed, should I retire before it is implemented?

5. Are there any ways to increase my pension other than saving with the Thrift Savings Plan or getting a second job (see above question)? I have reservations with TSP because of the taxes. I have money in it but am not saving. My understanding is I can’t touch it without penalty until age 62. Is this correct?

A. Mike: You’ll have access to your TSP money, without any early withdrawal penalty, as soon as you retire from federal service.

Reg: Because you were first employed before Oct. 1, 1982, you’ll get credit for your active-duty service in determining your eligibility to retire and in your annuity computation. If you aren’t eligible for a Social Security benefit at age 62, your annuity won’t be affected. The Office of Personnel Management only checks once, at age 62, if you are already retired, or when you retire if it’s at age 62 or later.

If you take a job after retirement and earn enough credits to be eligible for a Social Security benefit, it will be affected by the windfall elimination provision. The WEP reduces the Social Security benefit of anyone who receives an annuity from a retirement system where he didn’t pay Social Security taxes, such as CSRS, and has fewer than 30 years of substantial earnings under Social Security.

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Which L Fund?

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Q. Since I won’t be forced to take the required minimum distribution until six years from now, I’m going to take your advice and transfer my money from the G Fund to one of the L funds. I can’t put money into the Thrift Savings Plan anymore, since I’m retired. How do I determine which L Fund to put my money in?

A. If I were you, I’d put my money into the L Fund that most closely corresponds to my life expectancy.

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Which TSP plan?

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Q. I have six years in the Navy. I understand I can pay back/down those years for maximum retirement benefit. I’m 48 years old, have no savings and started this job to get on with planning for the future. I am a GS-7, step 1. I’m planning on contributing at least 5 percent a month of my pay, and I understand the Veterans Affairs Department will match 4 percent. I’d like to retire at 62ish.

Here is a copy of my latest leave and earnings statement:


Pay Period: 12-22                       Name: ALLEN, TROY J

Gross Pay                   1,586.40

Federal Tax Amt Withheld                179.76

Medicare Amt Withheld                    23.00

OASDI Tax Amt Withheld                   66.63

FEGLI Basic Deduction                     6.60

Retirement Ded                           12.69

Union Dues-1 Deduction                   17.00

TSP Gsf Emp Ded                          47.59

Net Pay                     1,233.13

What TSP plan I should go with?

A. Mike: If you’re not sure what else to do, you might want to consider using the TSP L Fund that most closely corresponds to your life expectancy.

Reg: Yes, you can make a deposit to get credit for your active-duty service and have it used to determine your total years of civilian service and in your annuity computation when you retire. You could do that and get an unreduced annuity at age 62. The formula used would be: .01 x your highest three consecutive years of average basic pay x your years and full months of service (combined actual and active-duty military for which you’ve made a deposit.)

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Q. For about 10 years, I have been taking money out of my IRA using the Rule 72(t) with no issues. I am 58 years old and am planning to continue doing this well past when I turn 59½.

Our daughter has some very high college expenses. I understand you can take funds out of an IRA to help pay for eligible college expenses (tuition, fees and books) along with room and board if the student is enrolled at least 12 credit hours.  Can I take money out of my IRA for educational purposes while still taking money out using Rule 72(t)? I do not run the risk of running out of money as, even with the 72(t) withdrawals, the account balance continues to increase.

A. This is really a question for your tax preparer, but to the best of my knowledge, any deviation from the 72(t) withdrawals before their term is up and you’ll trigger the early withdrawal penalty.

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Two ways to diversify and reduce investment risk

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Diversification. It’s a concept every investor responsible for managing a portfolio for retirement income must understand and use to his advantage.

Over the past 15 years, there have been calls from participants to add all manner of specialized investment funds to the Thrift Savings Plan — Internet, real estate, energy, gold, health care or any other market that has been hot — in the name of diversification. Ironically, these calls for more ability to diversify wouldn’t really provide that to any appreciable extent. Instead, adding these kinds of funds will, more than anything, allow participants to concentrate their portfolios in riskier assets and degrade expected performance characteristics.

These calls for new funds in the name of diversification, along with a lack of any audible response from participants or observers pointing out the error in defining diversification, is evidence that diversification is not clearly understood by many. It’s diversification, though, that makes it possible to manage your TSP account in a way that will reliably produce the maximum income possible over your lifetime. This is because volatility in your account’s value is the enemy of predictable income, and diversification is the best way to manage volatility.

Every investor should be using two basic types of diversification, as appropriate:

  • Intramarket, or within-market, diversification. This means owning more than one security of a given type at a time. It reduces the risk associated with an individual security without reducing the expected rate of return for that type of security. If you own one large company stock, for example, you are bearing all of the risk that the company might fail to deliver the expected results, even though the market for large company stocks does not. Own two large company stocks and you reduce that risk by half. Own three and you reduce it by two-thirds. Own the C Fund, instead, and you reduce the risk to 0.2 percent of what it would be with only one stock. By owning fully or widely diversified index funds, you can minimize the security-specific risk you face without significantly reducing the expected rate of return for an asset type or your portfolio as a whole. The TSP’s funds, as market index funds, are inherently well-diversified within the markets each fund represents, so they are foolproof in this aspect of portfolio construction.
  • Intermarket, or between-market or types of securities, diversification. Like its intramarket cousin, it is a means to reduce portfolio risk. The idea is to combine securities from different markets — like stocks and bonds, for example — in ways that tend to reduce portfolio risk more than they reduce the expected rate of return. Stocks tend to have a higher expected rate of return than bonds, but their prices tend to move in opposite directions at the same time.

Combining these two assets in a single portfolio averages their expected rates of return to give the portfolio an expected rate of return between that for each of them on their own. But, since when one is up, the other is often down, and vice versa, mixing them tends to smooth out the bumps that come from market fluctuations. In many cases, a less volatile portfolio with a lower rate of return will actually support a higher income stream than a more volatile, but higher-returning, alternative.

When managing money for retirement income, risk is the primary concern, not return. The TSP, through its five basic funds, offers you exposure to well-diversified markets in stocks, bonds and cash, the only tools you need to construct a well-diversified and risk-efficient portfolio. Carving out and concentrating your investment in narrow slices of the larger investment universe, like the “hot market” examples I mentioned, doesn’t increase diversification beyond what is already available in the TSP. Instead, it reduces diversification. It concentrates risk, increases volatility and reduces risk-adjusted expected rates of return.

In short, it’s counterproductive to maximizing a predictable income stream from your account. Add to that the likelihood that adding funds will only add costs and you can see why the TSP has been reluctant to allow new funds to its lineup.

Avoiding the early withdrawal penalty

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Q. I am a firefighter with a county fire department in Florida. As such, I am part of the Florida Retirement System in the special risk class. I started my career early and will be eligible for retirement with full benefits and no FRS penalties by age 48. (This is 25 years of service.) However, because of the Internal Revenue Service penalty for retiring before age 50, I would receive a 10 percent tax penalty in addition to the normal taxes I will pay on my retirement income. I understand that I will receive the penalty of 10 percent. However, I want to know whether that penalty goes away after I have reached age 50, or if it continues until I am 59?

A. The early withdrawal penalty rules will continue to apply until you reach age 59½. You can avoid the penalty by withdrawing from your Thrift Savings Plan account in a series of Substantially Equal Periodic Payments under section 72(t) of the tax code.

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Military buyback and 401(k) rollover

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Q. My husband has 10 years of Air Force service and is in the process of negotiating to take a federal position. Is it possible to use a 401(k) rollover to buy back his service? I am thinking not, since a rollover is only allowable to an IRA or other “qualified plan.” We certainly can take a direct taxable distribution of a portion of that 401(k) plan and use that money to buy back, but he wondered if it can be done with the rollover.

A. No.

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TSP withdrawal penalty?

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Q. I involuntary separated from federal employment due to a reduction in force at age 53. I receive a small FERS monthly annuity. I am now 59½, and I would like to withdraw $25,000 from my Thrift Savings Plan, which I have never touched. I will have to pay taxes, but will this withdrawal be subject to the 10 percent penalty at my age?

A. No.

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Military service and Roth TSP

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Q. I am 25 and now have the option to contribute to a Roth TSP. I have four years left on my military contract before I have the opportunity to get out. Seeing that my future with the military is somewhat questionable, would the Roth TSP still be a favorable option?

A. Except for tax-free pay earned in a combat zone, I don’t see any reason to expect that contributions to the Roth TSP are somehow better than contributions to the traditional TSP. In fact, I recommend that you favor the traditional TSP over the Roth TSP unless your circumstances make the Roth contribution more attractive.

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TSP goals

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Q. You state that we should invest in the Thrift Savings Program based on goals for retirement. My goal is to have $1 million in my TSP account by the time I retire; $1.5 million to $2 million would be even better. My TSP account has about $350,000. What can I do to grow my TSP to $1.5M to $2M over the next 10 to 15 years, given that I will max out the contributions (TSP $17,500 and TSP catch-up $5,500) every year until then?

A. There is no way to answer this since you’ve provided a very wide range of possible combinations; $1.5 million over 15 years requires about a 7 percent rate of return, and $2 million over 10 years requires a rate of return of close to 15 percent. You’ll need to be more specific in setting your goals.

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