As autumn brings renewed thoughts of financial plans, Open Season for the federal health benefits plans is approaching. For some fresh thinking, Federal Drive with Tom Temin spoke with Thiago Glieger, Wealth Adviser with RMG Advisers of Rockville, Maryland, who firm specializes in federal employees. The discussion addressed, among other things, what feds should be thinking about financially as 2024 draws closer, starting with the question of traditional or Roth Plan for your Thrift Savings Plan.
Thiago Glieger The name of the game is figuring out when are you going to owe the least amount of taxes. When you think about the taxes that you’re going to have to pay, you owe the taxes at some point. And so, if you think about what your tax bracket is right now relative to what your tax bracket might be later in life, then you can start to determine, Ok, does it make sense to pay the taxes right now, use the Roth, compared to later. Because we have things like the Tax Cuts and Jobs Act that will be sunsetting, which means that it’s going to go back to the old tax rates here in a couple of years, unless there’s no law changes. And so if that happens, then federal employees can expect to see tax rates bump up by three or 4%. And so if you consider what rates will be three or 4% from now compared to now, you might think, Ok, well, maybe we do a Roth contribution or Roth conversion. You can’t convert within the TSP, but you can switch to Roth contributions. And so you get to save yourself a couple of points in taxes here, and then that money gets to grow totally tax free for the rest of your life.
Tom Temin Right. To clarify the Roth option you pay with after tax dollars so that they are not taxed upon withdrawal.
Tom Temin All right. And there’s a complication to this calculus, though, because the standard model is you retire, your income goes down, your taxes are lower. Great. That’s why you have an IRA, a non Roth. But the reality is a lot of people and a lot of feds work after they retire from the federal government. In fact, at the higher levels, they go on to sometimes executive positions at contractors and companies where they continue to ply their expertise. And that can last another 10, 12, 15 years after the official Fed retirement. And then you could be in a situation where you’re still working. Yet, you have reached the required minimum distribution stage. So how the heck do you calculate all that in terms of the least tax liability?
Thiago Glieger Yeah, that’s really tough because if you’re expecting to be earning through your retirement years and still right up to your RMD or minimum distribution, then you could be sitting on a tax bomb, especially if your whole life you’ve contributed to traditional TSP or pretax TSP. And so you want to make use of possibly these years that we have slightly reduced rates right now, unless Congress changes the tax laws coming up here in a couple of years. Now, the key with earning beyond your federal service is understanding where your tax rates will be in the future relative to where they are now. So you can do some income projecting. If you are maxed out at the 183 500, whatever the GS-15 top maxes right now. What do you think you’re going to be earning if you’re not working in federal service? You might be earning more, you might be earning less depending on how much time you want to commit to that. And so try and project out your income and think about where will your income be if you have your minimum distributions from the retirement accounts. Those also stack on top of your income. And so you get to see where your bracket falls and determine how much taxes are you paying then, Right. Compared to what you would be paying now if you were to just do the Roth contribution right now, or if you do a Roth conversion?
Tom Temin And can you get the calculus close enough, say with your own financial or tax advisor such that you might opt for voluntarily lower income because you might net more and you’ll have more take home for that pen collection. You want to keep building when you’re in retirement because of that tax effect.
Thiago Glieger Yeah, for sure.
Tom Temin Don’t pay me so much, I don’t want to hit the tax bomb.
Thiago Glieger Exactly, and we see that with a lot of retirees. They do an analysis of what it would look like if they didn’t do Roth at all. Then they’re maxed out on their minimum distributions versus if they just pay a little bit of taxes along the way. And if you can get yourself into lower brackets and retirement, think about retirement is as long as your career for most people. And so if you can be in low tax brackets for as long as you were working in retirement, then you’re paying the least amount of taxes compared to if you were to just go ahead and pay the taxes when you were actually working. And so that’s something that a lot of people can do in an A scenario and a B scenario to try and figure out what would be the overall estimated tax liability throughout my whole life if I did a Roth, versus if I didn’t. And sometimes we’ll find people take a couple of years off between federal service and post retirement work. They those are years that their income has gone way down. And so you might consider doing accelerated Roth conversions, fill up those tax brackets up until whatever bracket you’re comfortable, maybe the 22. Because that might prevent you from being in the 28 or higher later depending on how big your retirement account is.
Tom Temin Which also shows how tax policy affects so much in the economy. And everybody’s worried about a recession, yes or no at the moment. Imagine what happens if tax rates shoot up three or 4% in a couple of years. Say what you want, but that could really have a recessionary impact on the economy. Well, if my retirement last as long as my career, that means I’ll live to 117. I don’t think that’s going to happen. I don’t really want it to happen to me or be the world’s first 117 year old. And speaking of the economy it’s rocky right now, in terms of the gyrations of the market, even though the fundamentals look good, in some sense, they don’t look so good and other. Let’s talk about what you call the G Fund trap, which is just that idea of defaulting to the safest fund because you don’t know what’s going to happen, can really not be such a great strategy.
Thiago Glieger Yeah, especially when we think long term inflation is the silent retirement killer. And so when we look at what the impact of inflation is over 10, 20, 30 years, if your investments are not outpacing that inflation, plus the spending that you’re doing, you could be in a situation where you’re running out of money before you run out of time. And so the G Fund struggles in outpacing inflation, because it’s not designed to do so. The G Fund is designed to be principal protection, and it does give you some interest rate along the way. Bond markets become volatile. Investors have this visceral response of protecting what they’ve worked really hard for, and they get into this emotional trap of trying to protect as it’s going down. But the issue and why it’s a trap is when are people actually ready to get back into the markets. If we think about the flows of the different TSP funds earlier this year, the TSP gave us information, I think it was around April, May, June. Billions of dollars were flowing back into the C,S and I fund from the G Fund. And the reason billions of dollars were moving back are because federal employees were saying, hey, they’re paying well this year. But the challenge is you’re jumping on a moving train. The markets have already begun to recover. And so it’s taking you a little bit of time to get comfortable with the markets again, to get back in. And the chances are is you already missed a big part of that recovery. And that’s why it’s such a trap, because you’re scared to get back in because you were just punished for being in the C,S and I fund in the markets. But then by the time you’re ready to get back in, you’ve likely already missed a big chunk of that return already. And that’s where federal employees can trade themselves into oblivion sometimes.
Tom Temin Yeah, you’re selling low and buying high.
Thiago Glieger Essentially.
Tom Temin Timing, chasing. Never a good idea for the average single investor, is it?
Thiago Glieger Yeah. And in fact, I think consistently timing the markets correctly, I don’t believe is very possible. I think it’s really hard to do that over an entire lifetime. There may be periods of times here and there where you can get the timing right, and that’s great. But I think in the long run, it’s really hard to do that.
Tom Temin People never tell you how lousy they did. They just tell you when they hit that one machine. We’re speaking with Thiago Glieger. He’s a wealth advisor with RMG Advisors of Rockville, Maryland. And we are on the doorstep of open season. And there’s a lot of changes because of OPM rules, for example, that you coming in fertility benefit payments that will be available to, I guess, those on the child bearing age feds. This is a time when you also got to do some real hard thinking rather than default to just sticking with the plan you might have now.
Thiago Glieger Yeah, I think that a lot of federal employees are on cruise control during open season. They’re happy with their plan, because they didn’t have any issues with their plan. But I think what they don’t realize is they could be saving money by making sure that they have the right benefits in place. So, for instance, sometimes we see people ramp up their benefits when they have kids or maybe they have some procedures that are coming up and they kind of stick with that plan for a long time and they don’t ratchet it back down for the less premium plans when they have lesser needs. And so that’s the money that you could be saving. The other component is [Federal Employees’ Group Life Insurance (Fegli)]. The life insurance. That’s a really big area where we either see people over insured or underinsured. And so going through an exercise of understanding what we would call with our clients the the life insurance gap, how much life insurance is actually appropriate for you, because it does get expensive over time.