Look, the game has changed. High frequency trading, leveraged derivatives, robo-investors. Your grandma’s retirement plan won’t cut it anymore and since the biggest portion of the population is entering retirement in full blown crisis mode, most financial planning messages are still aimed at the baby boomers.
So here is a new approach for young federal employees.
Utilize the Roth TSP
We currently are living in one of the lowest tax periods in US history. With political campaigns underway, changes to the tax code have already been proposed by both parties. With national debt topping $20 trillion dollars and the unfunded liability for SS and Medicare above $100 trillion, future tax revenue will need to increase.
If you believe tax rates are going up before your retirement, then contribute to your Roth TSP. The government match (5%) always goes into your traditional TSP. This gives you 2 buckets being funded simultaneously.
Remember, tax diversity is just as important as portfolio diversity, and because of the long time-horizon before your retirement, these funds can be aggressively invested in the TSP but should still be monitored.
Never drop below 5% TSP contribution
Stopping contributions is a TSP cardinal sin. Let us say you missed just one year of contributions early in your career. In that situation, you went from an annual contribution of 10% of your salary to an annual contribution of 1% (agency automatic contribution).
But it gets worse when you consider the compounded growth over the course of a long career. Let’s use actual TSP returns to give you an idea of how much missing just $1,000 of government TSP contributions can cost you over your career.
If $1,000 from the government match was invested in 1990 in the S fund, it would now be $14,315. That’s 17% of the average federal employee’s annual salary, and it was 100% free!
Compound interest never sleeps or calls out sick, and because of it’s incredible power, you need to realize that the “free money” the government is giving you now will be a major piece of your freedom fund later.
Use budgeting apps to avoid credit card debt
Credit card debt is a silent killer. Marketers glamorize 1% cash back or airline miles, but remember, 1% cashback on an 18% APR CC is still just about the worst investment you can make.
Put another way, the C fund has averaged 15.8% over the last 5 years during one of the biggest bull runs in US history.
As 2008 showed investors the hard way, those types of returns do not come without risk… but your credit card APR is a guaranteed loss, regardless of the market. Paper budgeting is time intensive, but budgeting apps that are secure can automate this process by linking to your accounts/cards and help you save for big purchase goals without utilizing credit.
Pay yourself more tomorrow
This is a psychological approach that recognizes that no one wants to have their lifestyle take a haircut. It feels like a punishment to go from a 10% contribution to 15% because it leaves less in the monthly budget, but in reality, it is not a punishment but a payment into your freedom fund, a payment to yourself that will replace your paycheck one day.
So when you get a pay raise, pay as much as possible into your freedom fund first! If you pay it into your TSP before you establish a larger lifestyle, then you have the best of both worlds: you can retire sooner and you don’t have to go back to eating like a college student to get there.
Build your emergency funds in a Roth IRA
This is the most flexible retirement plan in all the land and it happens to be the best approach for protection from increases in future income tax rates.
Establishing a Roth IRA that you fund early in your career when you are in the lower tax brackets is arguably one of the best ways to build an emergency fund too because of how the preferential tax treatment couples with the access to your Roth IRA contributions.
You can always access your Roth IRA contributions without penalty, unlike traditional IRAs or other tax deferred vehicles. If you utilize this approach it is important to invest conservatively because your emergency may come at a down time in the markets and your emergency funds still need to be there. If your Roth TSP is invested aggressively and this is doubling as your emergency fund it needs to be accessible and reliable.
Critical note: do not withdraw more than your contributions, otherwise you’ll lose the tax free treatment on all of the gains. Consult with a tax professional to balance the appropriate mix for you at your household income level.