Retirement planning for federal employees

The thrift savings plan (TSP) is roughly the equivalent of the private sector’s 401(k) plan. Civilian and military employees can elect pretax salary deferrals or a Roth option and can choose from a range of low-cost index funds and lifecycle funds.

There is an automatic 1 percent government contribution for FERS participants. In addition, FERS participants get a 100 percent match on the next 3 percent contribution and a 50 percent match on the next 2 percent, which adds up to a full match on the first 5 percent contributed. CSRS and military personnel do not receive a match. Earning the full match is a powerful incentive, says Gantt, but the limited number of TSP-investment options means advisors might have to work with assets outside the plan for optimal asset allocation.

Maximizing the TSP’s effectiveness requires additional planning. For example, when a military member serving in a combat zone contributes to the TSP, those funds go into a tax-exempt “bucket,” Cermak explains. When the service member leaves active duty, those funds can be rolled into a Roth IRA to preserve their tax-free status plus tax-free growth and withdrawals.

There are several other reasons why retirees can benefit from rolling over their TSP. First, the plan only allows one withdrawal—retirees can’t take multiple partial withdrawals. Also, retired participants must use the same fund allocation in both their Roth and pre-tax accounts. You can’t decide to make one account more or less aggressive than the other, says Cermak—you must maintain the same portfolio in each.

The plan also makes post-70½ required minimum distributions proportionately from both the pretax and the Roth accounts, so rolling the pre-tax money into a traditional IRA and the Roth TSP funds into a Roth IRA prevents having to take post-70½ distributions on the Roth money.

The TSP also imposes restrictions on beneficiary distributions. Cermak gives an example. The husband, a federal employee, dies and his wife inherits his TSP as beneficiary. She names their two children as her equal beneficiaries on the account. If she dies after age 70½ when she’s taking required minimum distributions, the children cannot stretch the distributions as they could with an IRA.

Instead, the plan will send each child a check for his or her share of the account and they lose the option to roll it into an inherited IRA. “It all gets paid at once and all the future tax deferral is lost,” Cermak says.

Special Challenges (overseas)

William Carrington, CFP, RMA owns Carrington Financial Planning LLC in Arlington, Va. His wife has been a diplomat with the U.S. State Department for over 20 years, including 16 years overseas. Carrington works with numerous current and former Foreign Service employees and he’s found that the overseas assignments can create unique retirement planning problems.

For starters, he says, many couples are forced to live solely on the employee’s income because the other spouse can’t work in the foreign country. In addition, their time overseas changes employees’ financial timetables.

Many don’t buy a home in the U.S. until they are close to or in retirement to avoid becoming absentee landlords, so they enter retirement with substantial mortgages. College costs for their children are another problem.

If the parents aren’t aware of how quickly costs are increasing back home and fail to plan accordingly, they risk taking on large of amounts of student loan debt later in life.

Income loss from disability creates another exposure. Carrington points out that Foreign Service employees stationed overseas can’t buy supplemental disability income insurance. They must rely instead on employer-provided coverage, which is often insufficient to sustain a lifestyle. “You have someone who makes, say, $80,000 a year,” Carrington explains.

“If they were to become permanently disabled, they would only get 40 percent of salary, which would be $32,000 and it coordinates with Social Security. So, if they also get Social Security disability, that’s subtracted from their disability pension. And you cannot buy supplemental disability coverage for Foreign Service. Most domestic employees through their employer get 60 percent salary covered by disability insurance and they could buy supplement insurance to fill the gap, but it’s not available in Foreign Service.”