How do you determine how much money you will need in retirement? A lot depends on the retirement lifestyle that you desire. A person who wants to travel and has a large “bucket list” will need more money than one who has simpler needs. There are many schools of thought about how much money is necessary, but two of them bear special mention.
First, there’s the “80% Rule”. The 80% Rule is a good guideline for those a long way from retiring who want to, at a minimum, retain the standard of living they had before retirement.
Second is the “Cash Flow Method”. The Cash Flow Method works well when you are closer to retirement and is helpful in determining whether, in fact, you can keep the same standard of living you had before retirement. We will look at the 80% Rule in this article and the Cash Flow Method in an upcoming article.
Many financial planners suggest that 80% of your pre-retirement income will give you a retirement standard of living that is substantially similar to your pre-retirement standard of living. This is based on three assumptions:
- You will not be paying payroll taxes (Social Security and Medicare) or making pension contributions (CSRS or FERS). For most federal employees, these mandatory taxes and contributions take 8.45% out of our paycheck. You will not be making these contributions out of your retirement income (pension, TSP and Social Security). Some employees (those hired on or after 01/01/2013 and special category employees) contribute more and will, thereby “save” more after they retire.
- Your mortgage will be paid off. Only you know if this will be true. A 2011 report from the Consumer Financial Protection Bureau said almost 1/3 of Americans 65 and over still had a mortgage and the average balance was $79,000. This report, though five years old, was cited in recent articles in the Los Angeles Times and on Bloomberg.com.
- Your expenses will be lower. If you count voluntary savings for retirement, such as TSP contributions (which cannot be made after retirement) this will be true for almost all of us. Other expenses that might go down are commuting, clothing, and food outside the home. Of course travel and recreation expenses might increase.
So, how do you get to the point where you will have 80% of your pre-retirement income? It requires significant and disciplined saving in the TSP and other retirement investments.
We’ll look at a couple of examples and try to estimate how much we will need to save over and above our federal pension and Social Security. In these examples, we are looking at a federal employee who retires at age 62 after 32 years of service with a high-three salary of $100,000. Both of the examples are for “regular” employees.
If this employee were CSRS, their pension would be $60,250 and they would likely have no (or very limited) Social Security. They would be roughly $20,000 short of the 80% goal.
If this employee were FERS, their pension would be $35,200. Their Social Security would likely be in the vicinity of $20,000, giving them a total of $55,000. They would be roughly $25,000 short of the 80% goal.
This shortfall of 20% to 25% would have to be made up from sources such as the TSP or other retirement savings if these individuals were to have the same standard of living after retirement as they did before retirement. If we were to use another “Rule” put forth by financial planners, the “4% Rule”, this would argue for a TSP balance in the vicinity of $500,000. The 4% Rule states that an individual has an excellent chance of not running out of money over a 30 year period (the age of 92 for the person in our example) if they begin withdrawing at a 4% rate and adjust that rate annually for inflation.
So, is it possible to have a half million dollar balance in your TSP at the time you retire? Well, it depends on how much money you have in your TSP today and how many more years you have to work. If you’re in the early part of your career it’s not at all out of the realm of possibility that you could have more than $500,000 at retirement. The TSP website has several calculators available, including one called “How Much Will My Savings Grow?”, that can help you determine where you will be in the future. Of course, it asks you to make assumptions about your future salary and future investment growth, but it can give you an idea.
This article has looked at only your federal retirement benefits (CSRS or FERS pension, TSP and Social Security); we haven’t looked at other resources you might have such as IRAs, real estate, etc. Regardless of what we’re looking at, it is to your advantage to save early and save often.
This article has also appeared in the TSPSafetyNet Newsletter (http://tspsafetynet.com).
John Grobe’s latest book, The Answer Book on Your Federal Employee Benefits, has just been released by LRP Publications. Order your copy at shoplrp.com. Ask your human resources office to contact Federal Career Experts about pre-retirement training.