Federal retirees can augment their TSP account with an outside IRA and use the bucket system. One bucket for INCOME (TSP G-fund), and the other bucket for GROWTH (IRA).
So why would you do that? Well, a shortcoming of the TSP is the inability to withdraw from only the G-fund. Your withdrawals will come out of your TSP account proportionately to where your funds are allocated. And does anyone believe it would have been a good idea to withdraw from their TSP account allocated in equities (C, S & I) right after COVID hit in 2020? Of course not. But many people depend on regular, monthly TSP withdrawals for income and cannot wait for their accounts to recover. That’s why you see so many questions about moving to the G-fund close to or after retirement. Many others recommend a split between stocks/bonds/G-fund. But that still doesn’t solve the shortcoming mentioned above.
NOTE: (Modify the $ and % amounts below to fit your own situation.)
Now consider this. Let’s say when you retire you have about $900,000 in your Traditional TSP account. You also have an outside Traditional IRA account. You could roll over about $700,000 of that TSP amount into your IRA and still have $200,000 in your TSP account which you would keep in the ultra-safe G-Fund. That $200,000 in your TSP G-fund is now your INCOME bucket. Now you can set up regular monthly withdrawals of about $3,000 from TSP and it will last you for about 5 years. During those same 5 years, you invest the $700,000 in your IRA into something like the *Vanguard Growth Index Fund Admiral Shares (VIGAX). This is your GROWTH bucket. If you use a conservative growth rate of only 7%, that bucket grows to $900,000 in 5 years. The actual growth of VIGAX over the last 5 years is over 19%. You can do the math on that rate if you want.
The TSP has a little-known rule that can be your friend in retirement years. As long as a TSP account has $200 or more in the account, you may transfer money back into the TSP.
So after 5 years of withdrawals from your TSP G-fund, you can roll another $200,000 from your IRA back into your TSP account G-fund for 5 more years of income.
By the way, *fees the Vanguard Growth Index Fund Admiral Shares (VIGAX) referenced above are $5 for every $10,000 invested. That’s no higher than TSP funds expenses. And there are many more funds out there with similar expense ratios and returns.
Additionally, if you also have a Roth IRA, you then have the ability to convert portions of your Traditional IRA to your Roth IRA. That’s something you cannot do in the TSP. Just don’t convert any more than you can pay in taxes in any one year. Again, your IRAs constitute your GROWTH component, so it’s important NOT to react to short-term market fluctuations. Resist the urge to buy and sell. Another great thing about a Roth IRA is there are no RMDs…..ever! And, there is no income tax on Roth IRA funds inherited by your beneficiaries.
Just keep in mind that you have to be at least 59½ years old to make penalty-free withdrawals from a Traditional IRA. However, you can withdraw your Roth IRA contributions at any age for any reason, penalty-free.
Also.....IRAs and TSP accounts generally become subject to IRS Required Minimum Distributions (RMD) at age 70½ and beyond. A great way to hedge against the subsequent tax hit as well as significantly improving your long-term tax planning strategy is to convert a portion of your traditional IRA into a Roth IRA before age 70½. You CAN’T convert your traditional TSP money to Roth within your TSP account.
Keep in mind that traditional IRA funds converted to a Roth IRA are taxed as income within that tax year, so you need to calculate the amount of tax you will owe. Keeping the conversion to 10% or less of the total balance is a good rule of thumb. If you invest the Roth IRA in the same fund in which the traditional IRA was invested, brokerage firms typically do not charge a fee for the conversion. Also, note that Roth balances provide tax-free growth when held for 5 years or more, although you should anticipate that your Roth balances will be invested and growing for many more years beyond 5. Roth IRA balances are exempt from IRS RMD. (BUT ROTH TSP IS NOT!). In addition, Roth IRAs are not taxed as income to beneficiaries so they become extremely useful tools in estate planning.