Author Topic: Reader Case Study: Mid 30s federal couple with kids needs help hacking savings  (Read 2371 times)

mamamustache

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First of all, I am a new member and can't believe that no one else had claimed my username before now. Lucky me!

We are a married couple in our mid-30s with salaried federal jobs interested in lifestyle design and FIRE so we are less dependent on 9-5 jobs and are freer to travel for a few months at a time, be with our children and pursue creative work at our own pace.

Life Situation: Married with two children under 4, VA, both parents in mid-30s

Retirement savings:

TSP me: Over $100K (up and down with stock market) in traditional funds. The maximum I can contribute to the TSP this year is $18,500. Right now I have it set up to contribute ~$500 each pay period times 27 pay periods is ~$14,600.
TSP husband: $53K in Traditional Funds
Taxable: ~$150K combined
Roth IRA (me): $50K
Roth IRA (husband): $34K

Adjusted Gross Income: Combined AGI for 2017 was ~$157K, taxable income was $115K and taxes we owed last year were around $27K ($20K federal and $7K state). We overpaid and received just over $5000 as a refund between federal and state. This is with two salaried parents, though we may go down to one salary next year.

Current expenses: Looks like our expenses are $70-80K per year (including mortgage, if I set our tracking account up correctly). Current biggest expenses since we started tracking are childcare, home/yard expenses, food and dining, shopping, and health and fitness in that order. I think we can really cut back on food and dining if we make an effort. Home mortgage:  $371,250.00 original loan amount, 3.25% interest rate, 30 years, and minimum monthly payment is $1,615.70 P&I + $1126 T&I = $2,741.70. Current outstanding amount on mortgage is $287,369.56.

We've been saving independently our whole lives and are now interested in combining some savings to pay off our mortgage and reach FIRE if practical.

I have lots of questions and would be grateful for help with any/all:

*How should we set up a Roth IRA conversion ladder from our assets? Is this better managed through just one of us rather than two? How soon should we set this up? Is it possible to do tax-free Roth conversions when one partner is still working -- even part time / hourly?

*Should I consider doing a withdrawal from TSP to do a rollover into an IRA (this has to be traditional, right?) so that I can begin doing annual Roth conversions in the zero tax bracket and take the money out tax-free starting 5 years later? Does it matter whether the TSP money to be moved is marked traditional or Roth?

*Any other obvious ways we could be smarter about savings, taxes and the accounts we have set up?

*Any other info I can provide?

« Last Edit: November 06, 2018, 11:29:34 AM by mamamustache »

MDM

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mamamustache, welcome to the forum.

You might look through Investment Order, including the links within that post.  Does that help?  After reading that, what (new) questions do you have?

mamamustache

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MDM, thank you for the warm welcome and resource. I printed it out and am poring through it. I am new to the philosophy so I think I'll continue digging through some of the deeper links. My major questions revolve around how to prioritize maxing out our TSPs vs. personal Roths and how/when to set up a backdoor Roth given our situation. Also, our mortgage interest rate is 3.25% and it sounds like we should never may extra payments toward our principal -- right? I didn't see it show up on the list. If that is the case, when can/should we pay it off? When we have enough money to do so in our taxable accounts (#8)? Would it ever make sense to pay off the mortgage more speedily?

It sounds like using your strategy we should:

0. Establish an emergency fund of a couple thousand dollars (and rely on credit cards for other emergencies)
1. Contribute to our TSPs up to the company match (5% of our basic pay)
2. [not applicable -- no debts with high interest rates]
3. N/A -- yet. We have a standard healthcare plan which proved useful for two births but now that we are not looking to have another child, I have a feeling it would be a good time to switch to an HSA.
4. Max TSP (for us, that would be $18,500 each). How much should we aim to have in our TSP before we can FIRE?
5. This is where I'm a little confused. My husband and I both have Roth IRAs through Vanguard but we haven't set up a backdoor Roth yet. Would just one of us set up the backdoor Roth, and could it be one of our accounts that already exists? At what point should we start the "backdoor" process? I think the yearly 2018 limit is $5,500 each. How much should we aim to have in our Roth before we can FIRE?
6. How is the "mega backdoor" Roth different than the Roth(s) in #5?
7. [not applicable -- no debts other than occasional credit card]
8. Invest in a taxable account with extra

THANKS again!

FIREby35

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If you start asking question about investing v. paying down your mortgage you should know you might start a holy war amongst various posters!

Some will argue (correctly) that paying down your mortgage is mathematically inefficient relative to investing on the market. Based on this logic, they will state you should never worry about your mortgage and max out the investment options outlined by MDM. Mathematically, they are correct.

On the other hand, some people like the idea of owning their home and getting off the treadmill that a $2,700 monthly payment feels like. Depending on your life situation, that can be important enough to justify taking a mathematically inefficient decision. For example, I'm an entrepreneur/small business owner and sole income producer for a family of 5. Also, my house only cost 165k. So,  I paid off my home and love having no mortgage for the security it provides with irregular paychecks and cashflow.

Since you both have super stable federal jobs my reasons for paying off the home won't apply. You can decide for yourself. But, if you decide to pay off the home, expect some naysayers to tell you that you are bad at math.

Either way, welcome and I think you will come to realize in time how lucky you are for finding this random place on the internet.

mamamustache

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FIREby35, thank you for weighing in! The decision about whether or not to pay off a mortgage given the total cost and your type of work makes total sense to me. And, I also love the idea of not having a monthly mortgage payment as well...
« Last Edit: November 04, 2018, 07:51:40 AM by mamamustache »

fuzzy math

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You both need to be maxing out your TSPs. For 2019 the limit is 19k. It will lower your taxable income. You are paying a lot in taxes because your income is still high. Why are you investing in brokerage accounts if you aren't first maxing out your TSP? You can both still make changes for 2018 and have a huge percentage go into those accounts for 2018.

Check with your husband, he should be doing a traditional TSP (not Roth). If not he should be able to switch it for 2018 still. Your income is low enough (under the $192k threshold) that you should both be able contribute to a Roth IRA come tax time.

Get your investments in order before you even consider paying extra on your house. Check out the new budget after all that money is being funneled into retirement.

JGS1980

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My 2 Cents, in response to your questions above:

*The stock market is going down at this moment. Is this a good time to buy new Vanguard shares with money that is making no interest in a money market savings account?  Don't try to Time the Market. If you have cash (that you won't need in the next 5 years or so), just invest and move on with your life. Remember that the reason so many people invest is that the market "always" goes up in 20-30 year timelines. That's the timeline that is relevant to eventual retirees.

*How should we divide up our savings between adding to Vanguard taxable funds, Vanguard Roths, paying off mortgage, and our individual TSPs? We love the idea of paying off the mortgage quickly but are thinking it makes more sense to let our savings build and then paying it off in a lump sum rather than over time, but the math makes our brains hurt. Should we occasionally pay an extra amount toward the principal? How often?

0. Agree with E-Fund. Your jobs are very stable with the Government, maybe increase to at least 1 month E-Fund in case there is a work stoppage or something like that (to 7.5 K or so). This depends on your risk tolerance too.

1. Max out your TSP's first (18500 each in 2018, 19000 beginning 2019). There are huge tax benefits to this, and you get your employer match as well. Then adjust your fed withholding so you don't get a huge tax refund. You want to break even with tax withholding and improve your month to month cash-flow.

2. With your joint incomes and tax brackets, I would focus on Roth IRA's next. 5500 each in 2018, 6000 each in 2019

3. After that, add to Taxable until you have enough to pay off your mortgage in one go. Remember that your cash flow will impacted negatively if you add extra payments to your mortgage, but won't be impacted if you continue to build your "pay off the mortgage" Taxable account. Once you get to that number, you can decide if you really want to pay it off or not. Fireby35 is right about the math.


*How should we set up a Roth IRA conversion ladder from our assets? Is this better managed through just one of us rather than two? How soon should we set this up? Is it better to use a Vanguard Roth or a TSP Roth? Is it possible to do tax-free Roth conversions when one partner is still working -- even part time / hourly?

Lots of questions here. Like I said above, the math and federal tax benefits favor maximizing the TSP's Pre-tax. The Roth Conversion ladder is only worth doing once your joint incomes is much lower, because you have to pay the extra tax on the conversions from your taxable (i.e. you want to do this when your top tax rate is 12%, not 22%). JOINT INCOME is most important, regardless of how you get there with partner A or partner B's incomes.


*Should I consider doing a withdrawal from TSP to do a rollover into an IRA (this has to be traditional, right?) so that I can begin doing annual Roth conversions in the zero tax bracket and take the money out tax-free starting 5 years later? Does it matter whether the TSP money to be moved is marked traditional or Roth?  ----> NO, probably not the best idea at your income levels right now

*Any other obvious ways we could be smarter about savings, taxes and the accounts we have set up?  See above

*Any other info I can provide?

If you haven't done so already, create an Investor Policy Statement, and stick to your IPS long term. Bogelheads.org is a great site for additional investing education.

Let me know if any of the above doesn't make any sense. It can get complicated.

All the best, JGS

P.S. Always listen to MDM, he knows what he is talking about.

MDM

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MDM, thank you for the warm welcome and resource. I printed it out and am poring through it. I am new to the philosophy so I think I'll continue digging through some of the deeper links. My major questions revolve around how to prioritize maxing out our TSPs vs. personal Roths and how/when to set up a backdoor Roth given our situation. Also, our mortgage interest rate is 3.25% and it sounds like we should never may extra payments toward our principal -- right? I didn't see it show up on the list. If that is the case, when can/should we pay it off? When we have enough money to do so in our taxable accounts (#8)? Would it ever make sense to pay off the mortgage more speedily?
A mortgage is a debt, so one should consider the mortgage interest rate when evaluating steps 2 and 7.  Note also the explanation given for step 7 about whether, mathematically, you should be comparing the mortgage rate vs. expected stock or bond returns.  Non-math reasoning I leave to you: e.g., some people feel much better working toward no mortgage, while others feel much better working toward earlier FI.  If one has a higher mortgage rate than the yield on a fixed interest rate portion of one's desired asset allocation, those feelings may be satisfied simultaneously.  Otherwise one has to choose, with the "correct" answer known only in hindsight.

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4. Max TSP (for us, that would be $18,500 each). How much should we aim to have in our TSP before we can FIRE?
See Safe withdrawal rates - Bogleheads.
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5. This is where I'm a little confused. My husband and I both have Roth IRAs through Vanguard but we haven't set up a backdoor Roth yet. Would just one of us set up the backdoor Roth, and could it be one of our accounts that already exists? At what point should we start the "backdoor" process? I think the yearly 2018 limit is $5,500 each. How much should we aim to have in our Roth before we can FIRE?
See the withdrawal rate link above for the total invested amount target, and note that taxes must be included as an expense.  As for the split between traditional and Roth, in short you want to build the pre-tax traditional amount until the marginal rate you expect to pay on withdrawals reaches the marginal rate you are saving on contributions, then switch to building Roth.  For Roth vs. taxable, fill Roth space before using taxable.
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6. How is the "mega backdoor" Roth different than the Roth(s) in #5?
The mega route involves 401k/403b/TSA accounts, while the non-mega route involves non-deductible tIRA contributions.  See Backdoor Roth IRA - Bogleheads and After-tax 401(k) - Bogleheads.
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7. [not applicable -- no debts other than occasional credit card]
And that very large debt called a mortgage. ;)

Good luck!

lhamo

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Are you paying PMI?  Your taxes/insurance seem REALLY high for that price range of house. 

Sugaree

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So, I mention this only because I *just* found out about it today.  Check into the Transportation Incentive Program.  I found out that my job will subsidize ~75% of my costs if I commute into work on a vanpool. 

mamamustache

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So, I mention this only because I *just* found out about it today.  Check into the Transportation Incentive Program.  I found out that my job will subsidize ~75% of my costs if I commute into work on a vanpool. 

Sugaree, thanks for the tip! I normally Metro or if I plan ahead really well, bike to work. :)

Are you paying PMI?  Your taxes/insurance seem REALLY high for that price range of house. 

Ihamo -- I live in an area with super high property taxes. :-/

And that very large debt called a mortgage. ;)

MDM -- I wasn't sure whether a debt with 3.25% interest counted as a debt by your guidelines! Does it? Also -- many thanks for all the follow-up! :)

JGS: Your practical steps and explanations are invaluable. Thanks for throwing the actual numbers in there. So in preparation for a Roth conversion ladder -- some TSP funds are tagged Traditional and some are tagged Roth. Am I correct that if they are tagged Roth that I can roll them directly into the Roth ladder once separating from gov't? And if they are tagged Traditional that I'd have to move them into an intermediary Traditional IRA first before converting to Roth? I will look into the Investor Policy Statement too!


P.S. Always listen to MDM, he knows what he is talking about.

JGS: Yes!!


You both need to be maxing out your TSPs. For 2019 the limit is 19k. It will lower your taxable income. You are paying a lot in taxes because your income is still high. Why are you investing in brokerage accounts if you aren't first maxing out your TSP? You can both still make changes for 2018 and have a huge percentage go into those accounts for 2018.

Check with your husband, he should be doing a traditional TSP (not Roth). If not he should be able to switch it for 2018 still. Your income is low enough (under the $192k threshold) that you should both be able contribute to a Roth IRA come tax time.

Get your investments in order before you even consider paying extra on your house. Check out the new budget after all that money is being funneled into retirement.

Fuzzy Math: Thanks for the clear guidance. We are well on our way!
« Last Edit: November 06, 2018, 11:26:35 AM by mamamustache »

lhamo

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I would max out Traditional TSPs and regular Roth accounts now.  If you both max the Roth that will be 12k/year. 10 years of that and you've got 120k of Roth contributions you can draw on in early FIRE/semi-FIRE, plus whatever you have saved in taxable accounts.  Then once your income drops due to FIRE or semi-FIRE, you can start converting the TSPs over to Roth IRAs up to the top of whatever bracket makes most sense given your income (or lack thereof) and long term tax planning strategy.

The whole strategy is even easier if you are planning to move from a HCOL area to a LCOL area -- we're basically living off the proceeds from an expensive house sale in a VHCOL and letting retirement investments grow while converting 30-50k from traditional to Roth accounts per year.  Goal is to get almost all the tax-deferred retirement money into Roths over a 20 year timeframe, before I turn 70 and hit RMD territory. We will likely only pay around a 5-10% marginal tax rate on those conversions, depending on what our investments pay out in dividends each year (deliberately trying to minimize dividends and focus on long term growth/strategic harvesting of capital gains).  We'll see how long Congress lets the Roth option stand.  It basically is ensuring our kids will be independently wealthy.....

MDM

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MDM -- I wasn't sure whether a debt with 3.25% interest counted as a debt by your guidelines! Does it? Also -- many thanks for all the follow-up! :)
OK, I think I see what you meant.  Yes it's a debt, just not one worth paying more than the minimum monthly amount.  Unless, that is, you have a large amount of fixed income investments (beyond your emergency fund) paying less than 3.25%.

mamamustache

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I would max out Traditional TSPs and regular Roth accounts now.  If you both max the Roth that will be 12k/year. 10 years of that and you've got 120k of Roth contributions you can draw on in early FIRE/semi-FIRE, plus whatever you have saved in taxable accounts.  Then once your income drops due to FIRE or semi-FIRE, you can start converting the TSPs over to Roth IRAs up to the top of whatever bracket makes most sense given your income (or lack thereof) and long term tax planning strategy.

Ihamo: congratulations on making the dream happen! Where did you all settle? I'll need to read more about dividends vs. capital gains - unsure of the strategy there. And great news that you are starting a nest egg for your kids in the process!

I did a ton more reading last night and finally understand why the Traditional Roth IRA works best for early retirees. And, it seems like with the new TSP legislation, once we separate from government we can take partial rollovers as often as every 30 days, I think without additional penalty. What I don't understand at the moment is why we should contribute to a Roth now at all, given that the money is taxed. Wouldn't it make more sense to contribute to start and contribute to a Vanguard Traditional IRA instead, which would eventually be rolled over to the Roth conversion ladder? Or does it not matter because our combined income is too high to actually get the tax break on the Traditional IRA?

Also, I wonder if I can then roll Traditional IRAs into TSP so they have better growth options/lower fees. OK, now I fear I'm going in circles.
« Last Edit: November 06, 2018, 11:25:31 AM by mamamustache »

chaskavitch

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I would max out Traditional TSPs and regular Roth accounts now.  If you both max the Roth that will be 12k/year. 10 years of that and you've got 120k of Roth contributions you can draw on in early FIRE/semi-FIRE, plus whatever you have saved in taxable accounts.  Then once your income drops due to FIRE or semi-FIRE, you can start converting the TSPs over to Roth IRAs up to the top of whatever bracket makes most sense given your income (or lack thereof) and long term tax planning strategy.

Ihamo: congratulations on making the dream happen! Where did you all settle? I'll need to read more about dividends vs. capital gains - unsure of the strategy there. And great news that you are starting a nest egg for your kids in the process!

I did a ton more reading last night and finally understand why the Traditional Roth IRA works best for early retirees. And, it seems like with the new TSP legislation, once we separate from government we can take partial rollovers as often as every 30 days, I think without additional penalty. What I don't understand at the moment is why we should contribute to a Roth now at all, given that the money is taxed. Wouldn't it make more sense to contribute to start and contribute to a Vanguard Traditional IRA instead, which would eventually be rolled over to the Roth conversion ladder? Or does it not matter because our combined income is too high to actually get the tax break on the Traditional IRA?

Also, I wonder if I can then roll Traditional IRAs into TSP so they have better growth options/lower fees. OK, now I fear I'm going in circles.

This.  If you're married filing jointly, you're covered by a workplace retirement plan, and your AGI is $121,000 or more, you don't get a tax deduction for a tIRA contribution.  On the bright side, then you don't have to worry about your Roth pipeline as early, like @lhamo said earlier :)

mamamustache

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@chaskavitch Hi! Thanks for weighing in. Just so I'm super clear -- at our AGI, we would be essentially using taxed money for both Roth or Traditional individual IRA contributions, so either one is fine too use, right?

Unless we can get our AGI below $121K, in which case we open a Traditional IRA and contribute there?

chaskavitch

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@chaskavitch Hi! Thanks for weighing in. Just so I'm super clear -- at our AGI, we would be essentially using taxed money for both Roth or Traditional individual IRA contributions, so either one is fine too use, right?

Unless we can get our AGI below $121K, in which case we open a Traditional IRA and contribute there?

I believe so, yes; you can contribute to either but it would all be post-tax money.  I over-contributed to a tIRA once and the tax software I used just let me know that only $X amount was deductible.  It's a sliding scale, here's a link to the IRS webpage with more information.  https://www.irs.gov/retirement-plans/ira-deduction-limits.

Edited to clarify because of @MMbergmann comment below - As @lhamo said, max your trad TSP and your Roth IRA, so you have money available before retirement even without starting the Roth pipeline, and you can wait until your income is lower in retirement/semi-retirement to start the pipeline with fewer taxes  HOWEVER, right now with reference only to this year's taxes, it makes no difference if you contribute to a Roth or traditional IRA.  It will matter later, but it doesn't change your tax liability now because you can't deduct your traditional contributions.
« Last Edit: November 07, 2018, 04:31:46 PM by chaskavitch »

MMbergmann

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It would be preferable to do a Roth IRA if you are not above that limit, though. Having to keep track of your basis in the traditional is a pain, unless you absolutely have to.

Sugaree

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So, I mention this only because I *just* found out about it today.  Check into the Transportation Incentive Program.  I found out that my job will subsidize ~75% of my costs if I commute into work on a vanpool. 

Sugaree, thanks for the tip! I normally Metro or if I plan ahead really well, bike to work. :)

Still check into it.  The paperwork I received makes it sound like Metro tokens/passes might be covered too.  We just don't have much in the way of public transportation other than vanpools.  My agency calls it the Mass Transportation Benefit Program.  The Navy uses the Transportation Incentive Program.  The DOT calls it Transerve.  I think a lot of agencies have something similar.

Fomerly known as something

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I would max out Traditional TSPs and regular Roth accounts now.  If you both max the Roth that will be 12k/year. 10 years of that and you've got 120k of Roth contributions you can draw on in early FIRE/semi-FIRE, plus whatever you have saved in taxable accounts.  Then once your income drops due to FIRE or semi-FIRE, you can start converting the TSPs over to Roth IRAs up to the top of whatever bracket makes most sense given your income (or lack thereof) and long term tax planning strategy.

Ihamo: congratulations on making the dream happen! Where did you all settle? I'll need to read more about dividends vs. capital gains - unsure of the strategy there. And great news that you are starting a nest egg for your kids in the process!

I did a ton more reading last night and finally understand why the Traditional Roth IRA works best for early retirees. And, it seems like with the new TSP legislation, once we separate from government we can take partial rollovers as often as every 30 days, I think without additional penalty. What I don't understand at the moment is why we should contribute to a Roth now at all, given that the money is taxed. Wouldn't it make more sense to contribute to start and contribute to a Vanguard Traditional IRA instead, which would eventually be rolled over to the Roth conversion ladder? Or does it not matter because our combined income is too high to actually get the tax break on the Traditional IRA?

Also, I wonder if I can then roll Traditional IRAs into TSP so they have better growth options/lower fees. OK, now I fear I'm going in circles.

Contribute to the ROTH IRA now because all of it will be tax free.  If you contribute to a non-dectible Traditional IRA you will have to pay taxes on any gains in that account when rolling it over. 

Also, are either of you planning on working until MRA?  If so having a pension makes roll overs less tax advantageous. 

DoNorth

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I'm a fed as well, but posted overseas.

Tax wise, maxing the TSP and using the traditional IRA for both of you is your best bet.  Also, use the HSA option and read the Mad Fientists post on this.  Any funds after that could go into taxable investments.  At your age, you could both work until you have 20 years or so of federal service and still retire early in your late 40's or early 50s.  At that point, when your income is lower (eg. living off investments or savings), you could then begin the backdoor roth process to move TSP funds to your Roth.  This means you take full advantage of the above the line tax deduction now and minimize or eliminate taxes completely on the backdoor conversion. I've heard of people moving their entire TSP to a traditional IrA and then a Roth, but you might even be able to go directly from TSP to Roth as well.

simonsez

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So, I mention this only because I *just* found out about it today.  Check into the Transportation Incentive Program.  I found out that my job will subsidize ~75% of my costs if I commute into work on a vanpool. 

Sugaree, thanks for the tip! I normally Metro or if I plan ahead really well, bike to work. :)

Still check into it.  The paperwork I received makes it sound like Metro tokens/passes might be covered too.  We just don't have much in the way of public transportation other than vanpools.  My agency calls it the Mass Transportation Benefit Program.  The Navy uses the Transportation Incentive Program.  The DOT calls it Transerve.  I think a lot of agencies have something similar.
I work for a Dep of Commerce agency, had a 100% transit subsidy to/fro work for Metro/bus when I lived in DC area.  Carpoolers received preferred parking spots and vanpool drivers received the best parking spots and a little money.

Going from a 2 car to 1 car household was one of the better financial and overall life choices DW and I have made.  That employer program helped jump start my thinking of challenging what the status quo is as an adult (this site has helped a lot as well).

Ultimately YMMV but simply being aware of options for work (even if you choose not to use them for work) can have ancillary benefits.  e.g. I forget the exact route number but that bus that goes from Rosslyn straight to IAD is something I would never known about had I not become familiar with Metro due to work.