Financial planning is one of those things that most people put off, like a dentist visit or organizing your garage. You know you should go talk to a financial planner, but you are worried about the cost and whether you can trust the advisor. When it comes to choosing between watching your favorite Netflix show and talking about money—and potentially owning up to mistakes and less than ideal spending behaviors—Netflix wins out 99% of the time. I know because I had the same thoughts at times during my recently completed federal government career at the State Department!
Part one of this two-part feature article, highlights the three most common financial pitfalls for FSOs who wait to start financial planning until their 50s. They are still doing well, but there are ways they could have planned better to maximize their financial independence had they started earlier in their careers – preferably in their 30s and 40s.
1. Lifestyle Creep
Here's the standard scenario. You get sent to your first post after previously living with roommates in a small apartment in DC and can’t believe all this space is yours—and you don’t have to pay rent! While overseas your cash flow is great, so why not take (yet another) trip to visit a friend at another post? You think, these expats in this country really know how to live well – maybe we should buy a nicer car, wardrobe or other luxuries to “keep up with the Jones.” You know that expensive tutoring, school trips, travel for the kids is normal for Foreign Service kids and follow suit accordingly. You find a domestic helper that stays with you for 15 years – and feel you can’t live without her. As you progress up the ranks your spending ratchets up accordingly. You have been maxing out the TSP since you were an FS-3 but have not made any changes now that you are a FS-1, step 9 and haven't taken advantage of the opportunity to save more in different savings vehicles. All of these are normal situations that we hear from our Foreign Service colleagues and clients.
This is where a holistic, financial planner can help with your financial decisions. We can help you with your cash flow and budgeting, but more importantly, we can guide you to purpose your cash flow toward your bigger dreams and goals – the ones that are farther down the road but need a plan now to lay the groundwork for success. It doesn’t mean that you have to give up all of the lifestyle options listed in the scenario above, it just means that you have to prioritize which are most important to you. A paid-off primary residence is not going to happen without diligence. A sizable nest egg to make a career change in your 50s will not be possible for most folks without a partner to keep you accountable and marching steadily forward. Preparing for the financial hit a DC assignment entails before you arrive is important. So is setting aside a portion of every step increase and promotion throughout your career and not becoming susceptible to lifestyle creep.
2. I Think I Am Diversified
Most people think that their TSP provides a fully diversified portfolio. While the TSP has many merits, most financial pros will tell you that the TSP is lacking some asset classes that would further diversify your portfolio and potentially dampen some of the volatility. I explained this in greater detail in my article 5 Things to Know About the TSP. In short, I am in favor of adding small and medium size foreign stocks, Real Estate Investment Trust (REITs), emerging markets, global and municipal bonds and other assets classes to your mix. You can add these other asset classes in an IRA or in a taxable account in addition to your TSP. Too often, Foreign Service colleagues in their 50s do not have IRAs and only own U.S. stocks (C & S Fund), large foreign stocks (I Fund), short-term U.S. treasuries (G Fund) and U.S. investment grade bonds (F Fund) – all in their TSP. For maximum diversification in your overall portfolio, think broader and add other asset classes.
Starting with a financial planner in your 30s & 40s should lead to larger IRA balances by your 50s as we open and fund these accounts for a much longer period of time. Remember, your IRA contributions are capped at $5,500 per year below age 50 so these take time to build into a sizable balance. And don’t forget to fund a spousal IRA if one spouse is taking a career break to be a caregiver for the children or an aging parent.
3. Tax Diversification?
We just discussed how most Foreign Service colleagues in their 50s have the vast majority of their assets in the regular TSP. But, having money in a variety of different accounts is very beneficial in retirement or if you decide to pursue a less lucrative career or just work part-time after leaving State. The concept is called tax diversification. Tax diversification allows you to spread your money amongst tax-deferred accounts (TSP and traditional IRAs), tax-free accounts (Roth TSP, Roth IRAs, Health Savings Accounts HSAs) and a taxable investment account such as a brokerage account. Having money in three different account types will allow you to better control your taxes after you stop working full-time. For example, instead of pulling all of the money you need for living expenses from your TSP account and paying ordinary income taxes, you pull some money from your TSP (up to a tax bracket threshold), some money from a Roth IRA that does not add to your taxable income for the year, and perhaps sell some stock at a lower capital gains rate from your brokerage account. Controlling your tax rate in this manner could save you thousands of dollars during your retirement.
In order to best position yourself for the future, get started with a financial planner in your 30s and 40s and work together to build up a sizable Roth IRA balance and to take advantage of the Roth TSP when it makes sense. You could also consider adding a taxable account to take advantage of tax loss harvesting if the market does not perform well and to create a liquid lump sum to use in your 50s (should the need arise) when it is more difficult to access the restricted money inside of a retirement account.
4. How much will this cost?
Historically, financial advisors were only interested in serving clients with a minimum amount of assets that they could manage and charge an Asset Under Management (AUM) fee (i.e. Baby Boomers.) Happily, there are new options available now that will comfortably serve clients that have not yet built up a large amount of assets (like FSOs in their 30s & 40s) such as hourly planning, project planning and flat-fee, retainer style services. We are proud members of the XY Planning Network dedicated to providing affordable monthly flat-fee options for the planning needs of Gen X and Gen Y clients. Another option is the Garrett Planning Network that does strict hourly planning. You can also look to the other reputable fiduciary advisors that work with Foreign Service clients. Our advice is to stay away from the salespeople at broker-dealers and hybrids like Merrill Lynch, Edward Jones, Ameriprise and USAA and find a pure Registered Investment Advisor (RIA) firm that is legally required to act as a fiduciary and put your best interests first. Only then can you feel confident that your advisor picked the best investments for you rather than the ones that pay him/her the highest commission or offered other soft dollar incentives.
If you partner with the right financial planner at an earlier age you will avoid the three common pitfalls outlined above. Yes, there are fees involved, but we believe finding the right financial planner will pay for itself many times over. Get started now so you have someone to partner with during the market’s ups and downs and to help you make the right financial decisions as life changes.
Look for Part Two next month to learn about financial decisions in your 30s and 40s related to college funding, life insurance and minimizing mortgage debt.
Financial Planner & Founder
Logbook Financial Planning, LLC
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