TSP or Vanguard Index funds?

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macnatty
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TSP or Vanguard Index funds?

Post by macnatty »

I have a Traditional IRA that contains a rolled-over 401K from my last job. It is currently holding a bunch of actively managed mutual funds that I have decided are expensive garbage, and I intend to liquidate this in favor of low-cost index funds. My question is whether I should roll this into my TSP account (I am now a Federal employee), or whether I should purchase Vanguard index funds with it. The TSP funds have expense ratios of 0.029%, but of course they are not publicly-traded mutual funds so I have no control over the diversity, etc. With Vanguard, I would be purchasing funds like the Total Stock Market Index Admiral Shares, with an expense ratio of 0.05%.

In case it matters, I currently hold roughly one-third of my overall portfolio in the TSP (the Target Retirement 2040 fund), another third in a non-retirement Vanguard mutual fund account that already owns these kinds of index funds, and this Traditional IRA bucket that I'm asking about is the final third. So once I made the decision of what to do with this Traditional IRA, I will essentially be going from three buckets down to two. So I guess a follow-on question is, is this TOO much consolidation? Should I keep this third bucket in something else? I'm in my late thirties and intend to work until my late sixties, as additional background. Thanks so much.
sawhorse
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Re: TSP or Vanguard Index funds?

Post by sawhorse »

You can't go wrong either way unless one of the following situations applies to you.

Better to put it in TSP if...

*You want to keep open the option of doing a backdoor Roth. Having money already in the traditional IRA triggers the pro rata problem.

*You are in a state that has poor protection of IRAs in lawsuits. Your TSP money is untouchable by federal law; no state can override that. IRA protection depends on state. I don't know if this list is up to date.
http://www.irafinancialgroup.com/selfdi ... ection.php

Better to leave it in IRA if...

*You want to be able to convert the money into a Roth IRA (paying taxes on all of it then) and reap the benefits of that. One thing to know is that the ability to withdraw contributions without penalty (the "backup emergency fund" benefit of Roth IRAs) kicks in after 5 years rather than immediately.
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ruralavalon
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Re: TSP or Vanguard Index funds?

Post by ruralavalon »

I see no real downside to transferring that traditional IRA to the Thrift Savings Plan. The TSP very low expense ratio index funds are enough to create a very diversified portfolio in whatever asset allocation you wish. If you want some sort of fund not covered by what the TSP offers, you have your other Vanguard account that you could use for that purpose.
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ogd
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Re: TSP or Vanguard Index funds?

Post by ogd »

+1 TSP.

It's the one place to hold money better than Vanguard.
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macnatty
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Re: TSP or Vanguard Index funds?

Post by macnatty »

Thank you all so much! That's an especially good point about the backdoor-Roth issue. I tried funding a Roth this way a couple of years ago, on the advice of a financial advisor who did NOT warn me about the tax implications when you own a sizable Traditional IRA. That pro-rata thing caused me a massive tax headache!
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retiredjg
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Re: TSP or Vanguard Index funds?

Post by retiredjg »

macnatty wrote:Thank you all so much! That's an especially good point about the backdoor-Roth issue. I tried funding a Roth this way a couple of years ago, on the advice of a financial advisor who did NOT warn me about the tax implications when you own a sizable Traditional IRA. That pro-rata thing caused me a massive tax headache!
Do you still have a tIRA with some basis as the result of this bungled back door contribution? People here might be able to help you get rid of it.
Topic Author
macnatty
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Re: TSP or Vanguard Index funds?

Post by macnatty »

retiredjg wrote:
macnatty wrote:Thank you all so much! That's an especially good point about the backdoor-Roth issue. I tried funding a Roth this way a couple of years ago, on the advice of a financial advisor who did NOT warn me about the tax implications when you own a sizable Traditional IRA. That pro-rata thing caused me a massive tax headache!
Do you still have a tIRA with some basis as the result of this bungled back door contribution? People here might be able to help you get rid of it.
No, I did manage to get that $5K into my small Roth IRA account, and then I closed the little Traditional IRA I had used to facilitate this. It's just that nobody warned me that in pulling this maneuver - which I had thought was tax-neutral since I executed it all before any earnings accrued - it would turn out that I owed taxes on the pro-rata value of ALL my Traditional IRAs, including this (separate) one which had $85K of pre-tax, ex-401K money in it. I was really annoyed about that. If I do move this into my TSP, I won't have any Traditional IRAs anymore (pre-tax money or otherwise). My understanding is that if I then want to do the backdoor Roth thing again, it will be cleaner that way.
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Toons
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Re: TSP or Vanguard Index funds?

Post by Toons »

If I had to make the choice I would go with TSP.
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beezar
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Re: TSP or Vanguard Index funds?

Post by beezar »

Yup, TSP. Bogleheads has a wiki article on how to try to simulate the vanguard total stock market fund and the differences between TSP and vanguard funds that might be worth looking into.
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retiredjg
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Re: TSP or Vanguard Index funds?

Post by retiredjg »

I do not think you can roll this tIRA to your TSP because I believe it contains basis (already taxed money). You might be able to roll part of it though.

You said "a couple of years ago". Exactly when did you do the "back door"? When did you do the contribution and when did you do the conversion? On your form 8606 from that "back door", what is entered on lines 14, 15, and 18?

Did you have any other tIRA, SEP IRA, SIMPLE IRA or Rollover IRA when you did this?
rkhusky
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Re: TSP or Vanguard Index funds?

Post by rkhusky »

Two negatives for the TSP are 1) the I Fund, which does not have emerging markets, small international, or Canadian stocks and 2) the withdrawal rules are very limited - only 1 partial withdrawal allowed, the second must be a full withdrawal (which can be set up as a series of monthly payments). If you have other accounts you can adjust for 1), and with sufficient foreknowledge you can properly plan for 2).
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macnatty
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Re: TSP or Vanguard Index funds?

Post by macnatty »

retiredjg wrote:I do not think you can roll this tIRA to your TSP because I believe it contains basis (already taxed money). You might be able to roll part of it though.

You said "a couple of years ago". Exactly when did you do the "back door"? When did you do the contribution and when did you do the conversion? On your form 8606 from that "back door", what is entered on lines 14, 15, and 18?

Did you have any other tIRA, SEP IRA, SIMPLE IRA or Rollover IRA when you did this?
Sorry, I wasn't clear. This tIRA I'm asking about contains only pre-tax contributions I made to an old 401K, which I rolled over via direct transfer to this tIRA when I left that job in 2013. I have never commingled it with any post-tax money, so my understanding is that it has no basis and I can put the whole thing into the TSP, because it's the same status as the TSP money.

Separately, I did the backdoor Roth IRA maneuver back in 2010 (I thought it was more recent - time flies!) So this tIRA I'm asking about now didn't exist at that time - it was still an active 401k at that point. However, I was in a similar situation then - I had a different tIRA that contained the proceeds of the 401K from my job before THAT. When I went to do the Roth maneuver, I opened a fresh tIRA and contributed $5K (post-tax money, no deduction) to that, then converted it into a Roth. So I didn't technically commingle pre-tax and post-tax money then, either, since I used a different account (with a $0 starting balance) to do the conversion. For that reason, it came as a surprise to me that the value of that bigger tIRA became implicated in the tax basis for the one that had only existed (for a brief moment) as a conversion vehicle.

At any rate, when I joined the government in 2013, I did roll that tIRA (the one that had been open with a real, pre-tax balance when I did the Roth thing) into the TSP, and they accepted it without any issues. So basically, I'm thinking that I want all my former 401K money (from all my jobs) in the TSP at the end of the day, instead of any tIRAs. That way, I don't have this issue any more if I want to do the Roth conversion maneuver in the future. Does that make sense?
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macnatty
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Re: TSP or Vanguard Index funds?

Post by macnatty »

beezar wrote:Yup, TSP. Bogleheads has a wiki article on how to try to simulate the vanguard total stock market fund and the differences between TSP and vanguard funds that might be worth looking into.
Thanks! Found that wiki article - very helpful, I didn't know this existed.
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retiredjg
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Re: TSP or Vanguard Index funds?

Post by retiredjg »

macnatty wrote:
retiredjg wrote:I do not think you can roll this tIRA to your TSP because I believe it contains basis (already taxed money). You might be able to roll part of it though.

You said "a couple of years ago". Exactly when did you do the "back door"? When did you do the contribution and when did you do the conversion? On your form 8606 from that "back door", what is entered on lines 14, 15, and 18?

Did you have any other tIRA, SEP IRA, SIMPLE IRA or Rollover IRA when you did this?
Sorry, I wasn't clear. This tIRA I'm asking about contains only pre-tax contributions I made to an old 401K, which I rolled over via direct transfer to this tIRA when I left that job in 2013. I have never commingled it with any post-tax money, so my understanding is that it has no basis and I can put the whole thing into the TSP, because it's the same status as the TSP money.
This is correct but only because that tIRA didn't exist in 2010.
Separately, I did the backdoor Roth IRA maneuver back in 2010 (I thought it was more recent - time flies!) So this tIRA I'm asking about now didn't exist at that time - it was still an active 401k at that point. However, I was in a similar situation then - I had a different tIRA that contained the proceeds of the 401K from my job before THAT. When I went to do the Roth maneuver, I opened a fresh tIRA and contributed $5K (post-tax money, no deduction) to that, then converted it into a Roth. So I didn't technically commingle pre-tax and post-tax money then, either, since I used a different account (with a $0 starting balance) to do the conversion. For that reason, it came as a surprise to me that the value of that bigger tIRA became implicated in the tax basis for the one that had only existed (for a brief moment) as a conversion vehicle.
As you know now, it does not matter if you co-mingle the money or not. If there is other IRA money, it gets pro-rated with the non-deductible contribution when you do a Roth conversion (which is the second step of the "back door").

What you have not yet realized is that this leaves some "basis" (already taxed money) in the tIRA. It is not like already-taxed-money gets moved into the tIRA, but you are given "credit" for the taxes you paid at the Roth conversion. If you expected no tax and you paid $500 in tax, you "get credit" for that $500 in the remaining tIRA - same as saying that you now have $500 basis in the tIRA. As the money comes out of the tIRA, you do not pay tax on that $500 again.
At any rate, when I joined the government in 2013, I did roll that tIRA (the one that had been open with a real, pre-tax balance when I did the Roth thing) into the TSP, and they accepted it without any issues.
What you did, without intending to do it, is roll some basis into the TSP. It is too late to worry about that now and nobody is going to care other than you. That is because you will have to pay tax on that basis (the $500 in the above example) a second time as you take the money out of the TSP.
So basically, I'm thinking that I want all my former 401K money (from all my jobs) in the TSP at the end of the day, instead of any tIRAs. That way, I don't have this issue any more if I want to do the Roth conversion maneuver in the future. Does that make sense?
Yes, this is the way to go about it. However, you do need to brush up on how to do the back door before you do it again. There is information in the Wiki (link upper right) and be sure to study the external links at the bottom of the Wiki page.

One thing to keep in mind - because lots of people mess this up. It does not matter what you have in IRA on the day you do the Roth conversion. The day that matters is the last day of the year. You do not want any money (other than possibly a few stray pennies) in any tIRA, Rollover IRA, SEP IRA or SIMPLE IRA on the last day of any year in which you do a Roth conversion. If you do, the money in the IRAs will be pro-rated with your conversion and you will pay unexpected tax.
larmewar
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Re: TSP or Vanguard Index funds?

Post by larmewar »

The TSP L funds use the G fund for part of the bond allocation, with G fund accounting for more of bonds as the target date approaches. So the G fund might be part of the considerations.

Lar
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macnatty
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Re: TSP or Vanguard Index funds?

Post by macnatty »

retiredjg wrote:
macnatty wrote:
retiredjg wrote:
What you have not yet realized is that this leaves some "basis" (already taxed money) in the tIRA. It is not like already-taxed-money gets moved into the tIRA, but you are given "credit" for the taxes you paid at the Roth conversion. If you expected no tax and you paid $500 in tax, you "get credit" for that $500 in the remaining tIRA - same as saying that you now have $500 basis in the tIRA. As the money comes out of the tIRA, you do not pay tax on that $500 again.
At any rate, when I joined the government in 2013, I did roll that tIRA (the one that had been open with a real, pre-tax balance when I did the Roth thing) into the TSP, and they accepted it without any issues.
What you did, without intending to do it, is roll some basis into the TSP. It is too late to worry about that now and nobody is going to care other than you. That is because you will have to pay tax on that basis (the $500 in the above example) a second time as you take the money out of the TSP.
I looked back at my Form 8606 - I see now what you mean about the remaining basis in the traditional IRA. Thanks, that's the clearest explanation I've seen, and I wish somebody had told me back then! My remaining question is, is there anything to be done about this, at this point? Like I said, that traditional IRA is already in the TSP now. When I take a distribution from the TSP (granted that won't be for almost 30 years), is there any way to still get credit for the taxes I already paid?

If not, that's the price I pay for not knowing what I was doing, I guess!
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retiredjg
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Re: TSP or Vanguard Index funds?

Post by retiredjg »

I don't think there is a fix for this. When you roll money into the TSP (or a 401k or whatever) I think you are essentially assuring the plan that there is no basis - because they are not supposed to accept basis.

But…one work around comes to mind. Suppose you contributed $5,500 to tIRA (your next back door contribution) and let it sit during a time of market growth. Suppose that tIRA grew to $5,850 before you converted it to Roth. The basis left on your old Form 8606 could be used to offset that $350 in earnings and you would not have to pay tax on it at the conversion.

In the example in the above post with the $500 leftover basis, that would leave $150 in basis on your next Form 8606. That could be used at some other time in the future.

So I guess I do think there is a fix for this. I just had not thought of it before.
larmewar
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Re: TSP or Vanguard Index funds?

Post by larmewar »

TIRA basis is reported on your IRS forms as a lump sum. So the basis can be counted against other TIRA accounts. You might also get by with using the basis against new after tax TIRA contributions, although that wouldn't make the original move right.

Lar
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