Should Federal Employees Invest in a Roth IRA?

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By on August 17, 2017 in Retirement with 0 Comments

With so many acronyms and account types out there, it can be a good idea to check with a certified financial planner if you are trying to figure out the best way to manage your finances.

That being said, there are some pros and cons to investing in a Roth IRA that are worth looking at.

Thrift Savings Plan First

Especially if you qualify for agency matching, adding money to your TSP before anything else is a no-brainer.

The TSP has among the lowest investment fees in the world, has a reasonably diverse set of investments, is tax-advantaged, is protected from creditors in the event of bankruptcy, and overall is a rock-solid place to put retirement money.

With a decent income and some discipline, it’s even possible to become a TSP millionaire.

Roth IRA Benefits

If you’ve maxed out your TSP contributions (up to $18,000 or $24,000 per year, depending on your age) and are saving enough to invest even more, then a Roth IRA is the next logical choice for many people. You can invest in both the TSP and a Roth IRA.

Traditional IRAs are problematic for a lot of federal employees, because since you have a retirement plan at work, in many cases you only get a full tax deduction on your IRA contributions if you make less than $62,000 per year as a single filer or $99,000 per year as a couple, according to the IRS.

Roth IRAs, however, are invested with after-tax income and grow tax-free, and you can invest the full annual amount as long as your income is below $133,000 as a single filer or $186,000 as a couple. If you make a bit more than that, as some senior employees do, then you may still be able to contribute because your TSP contributions reduce your modified adjusted gross income (MAGI), and may put you under the threshold.

Some of the main advantages of a Roth IRA are:

  • Unlimited investment diversification and choices
  • Penalty-free withdraw of principle at any time
  • No age limit where you have to start withdrawing any funds
  • Totally employer-independent

A Look at International Diversification

The Federal Retirement Thrift Investment Board is currently reviewing the possibility of broadening the I Fund to include a broader geographic mix.

Right now, the I Fund follows the MSCI EAFE index, which is heavily concentrated into just Japan and Europe, and lacks Canadian exposure and emerging markets entirely. Here’s how limited the I Fund’s international exposure is:

World map showing what countries the I Fund invests in

Source: BlackRock

Although the I Fund still has the lowest returns since inception, over the last 12 months, the I Fund has beaten all the other TSP funds. It has returned about 16% in the past year compared to the second place C fund which has returned a little under 15%.

But you know what vastly outperformed the I Fund during this past year? Emerging markets. They were the best-performing asset class at about 24% returns, blowing all others away by far. And the TSP didn’t have any exposure to them.

That’s why the low-cost Vanguard Total International Stock Index, and basically every other broad international index fund, beat the I Fund this past year. And beat it since inception. They have broader geographic exposure, including to emerging markets.

The I Fund may or may not eventually be broadened, but as long as it remains in its current form, TSP investors can still account for that limitation if they use a Roth IRA to supplement any shortcomings of the TSP, like holding low-cost emerging markets funds amid several diversified investments.

Vanguard LifeStrategy funds are low-cost automatically re-balancing stock and bond index funds that include broad diversification, as one example. Fidelity Investments, Charles Schwab, and iShares all also offer low-cost index funds or ETFs.

If you put $18,000 per year into your TSP and $5,500 into your Roth IRA, that’s $23,500 per year in retirement savings. If you’re over 50, you can put upwards of $30,500 per year into them combined.

Global Options

Although equity markets outside of the United States make up 58% of the global market capitalization, the average investor only has 15% of his or her portfolio invested abroad, according to CNBC.

For better or worse, as a whole we seem to prefer disproportionally investing domestically.

Right now, the S&P 500 is at historically high valuations. Specifically, the price-to-earnings ratio is over 21, and the price-to-book ratio is over 3. It has been a very good decade for the U.S. market.

Emerging markets, however, have not done so well over the past decade. Brazil had a severe recession between 2014 and 2017, for example. Here’s Vanguard’s 10-year chart of emerging market performance:

Line graph showing the 10 year performance from 2007-2017 of the FTSE Emerging Markets ETF

From a contrarian point of view, that makes those markets worth a look these days, even after this recent great year for them.

The average price-to-earnings ratio of emerging markets is currently about 15, and the price-to-book ratio is about 1.7. They are cheap compared to most other markets around the world, including the United States, Europe, and Japan. There’s a solid chance that they’ll do quite well over the next decade from this point, but one can never know for sure.

Star Capital has a great map of valuations across the world, showing which countries’ markets are expensive or cheap based on a variety of metrics. Red is expensive, blue is cheap:

World map showing the valuations of countries

Source: Star Capital

Wrapping it Up

I have no real idea which countries will outperform others over the next decade, although history tells us that low-valued markets tend to outperform markets that are already highly-valued over the long term.

All I know is that for me, I wouldn’t want to be entirely devoid of emerging market exposure from this point, or to have all my eggs in the U.S. basket. I’m invested globally.

Between the TSP and inexpensive Roth IRA options from Vanguard and other providers, there are countless ways for federal investors to get broad equity and bond exposure. It’s as good a time as any to review your investments and ensure that you have market exposure that meets your individual preferences and retirement goals.

Lyn Alden is an investment researcher whose background comes from a blend of engineering and finance, and her work has been featured or cited on Business Insider, Marketwatch, Money Magazine, US News and World Report, and elsewhere. She has a master’s in engineering management with a focus on engineering economics and project valuation.

© 2017 Lyn Alden. All rights reserved. This article may not be reproduced without express written consent from Lyn Alden.

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