financial planner Stephen Zelcer

MAKING YOUR TSP WORK WITH YOUR OUTSIDE INVESTMENTS

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A mistake that Federal Employees make with their TSP is NOT coordinating their TSP with their outside investments.  This mistake is very common and has many different applications.

Here’s a true story to illustrate:

My client (at that time they weren’t yet a client) took me up on my free consultation offer.  One of the points we discussed was maximizing their investments.  They showed me their investment portfolio totaling about $1 million.

Pay attention to the following details of their portfolio:

  • Their $1 million was split between their TSP and their regular investment account (the technical term for “regular” account is “non-qualified”).  That means they had about $500k in TSP and $500k in the non-qualified account.
  • Each account had the same stock/bond mix which was pretty much exactly 50% stock and 50% bond.

I usually need to know a ton of info about a person before I can make any investment recommendation, however in this case I don’t need to know much at all and I can already tell there’s something wrong with their portfolio.

 

Can you spot the problem?

 

This is tricky to the untrained eye, but here’s what i can see…

They have stock in their TSP.  The stock in the TSP can grow and provide long-term capital gains.  Long-term capital gains are taxed at a much lower rate than regular income.  However long-term capital gains inside the TSP do NOT get the lower tax treatment but instead get taxed as regular income which is a higher tax hit than necessary!

 

What could this client do?

Here’s what I proposed.  She should reallocate both her TSP and non-qualified accounts so that her stock exposure in the TSP is now in her non-qualified account, while her bond exposure in her non-qualified account are now in the TSP.

 

How would that help her?

By exchanging the TSP stock portion with the non-qualified bond portion, she now would be able to get the favorable long-term capital gains tax treatment on that stock portion of her portfolio.  Before she came to me, half of her non-qualified portfolio was being taxed more than it should have been; that’s poor taxation of $250k!!!  By doing my switch she would have her entire non-qualified portfolio benefiting from better tax treatment.

 

While I was basking in my brilliance she looked at me like I was from Mars.  She thought I was crazy because the result of my recommendation would mean the following:

  • Her TSP would become 100% bonds.  Isn’t that super-conservative?
  • Her non-qualified account would become 100% stock.  Isn’t that super-aggressive?

I had to draw it out for her that her combined portfolio (TSP & non-qualified TOGETHER) would still remain 50%/50% which is exactly how she was currently invested!

 

Not coordinating your TSP with your outside investments is a mistake.  It’s easy to lose sight of the overall portfolio in the presence of individual accounts.  Each account in a vacuum may be “good” or “bad” but when you look at them in relation to each other you may see how they complement each other or stifle each other.

 

In the above example this mistake was causing an over-taxation of $250k.  But there are other manifestations of this mistake.  Here are a few:

  • Ignoring the cash in your bank – depending on how much money you have in cash, you may not need to have any portion of your TSP in the G-fund.  Having both may cause an unnecessary drag on your portfolios growth.
  • Ignoring the equity in your home –  If you are planning to sell your house soon and extract the equity, you may not need so much bond exposure in your TSP.  Having both may stifle the rise of your total net worth.
  • Ignoring the annuities you already have – Having annuities which provide guaranteed lifetime income may allow you to grow your non-annuity investments in a more aggressive way.

These are mistakes the stunt your growth and prevent you from MAXIMIZING your TSP.

 

If you need help with this, just let me know!

~Stephen

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