Editor’s Note: This is the first of several articles on “Retirement Shocks and How to Avoid Them.”
Perhaps you have planned for years on how you are going to spend your retirement. You have socked money away in the TSP funds; you know how much your Social Security payments will be (if any); you have calculated your annuity payments; you know how much your health insurance will cost; and you may have even added in a little extra such as the Mediterranean cruise you and your spouse have always wanted to take.
What could go wrong?
Not to throw a wet towel over the daydream while munching on your hamburger as you save money by eating in the government cafeteria, but there are a few things that could go wrong. The Wall Street Journal has recently described some of the more common assumptions about retirement and how all your planning may not lead to the safe, secure retirement you envision.
To help you with realistic planning for retirement, there are several potential retirement shocks you may want to be aware of and try to plan for.
Here is the first potential shock. Your investments may not pay you as much as you think they will. Historically, stocks have returned about 10.6% per year (from 1926 – 2003). If you have made your retirement plans based on leaving your money in the G fund and averaging about 4% a year, this potential shock may not be a problem. But, what if you have $500,000 or so in your TSP fund and it is a major part of your retirement planning? Can you afford to withdraw as little as 4% a year?
Most retirees want to get a higher rate of return. Many investment advisors say retirees should leave some money in stocks to prevent outliving their retirement resources. But what percentage should you leave in stocks and isn’t that risky?
It can be risky, of course. The market may go down. But if you want to keep up with inflation, you will want to continue investing in stocks.
And, as you may know from friends who retired earlier, say in 1998 or so, leaving your money in the G fund may not be the windfall you think it will either. Back in 1994, the G fund provided a return rate of 7.22%. In 1998, the return rate was down to 5.74%. And last year it only returned 4.11%. Keep in mind this fluctuation is in the most conservative investment you can make in the TSP. The C fund, in contrast, returned 1.33% in 1994 and hit 33.17% in 1997. (And the C fund lost about 12% in 2001.)
The Journal quotes a retirement expert from the mutual fund company T. Rowe Price who advises leaving at least 30-40% of your retirement funds in stocks. Keep in mind, you may be needing that money for another thirty years or so. And, if you are a healthy female, the statistical chances are you may live longer than that and you don’t want to go broke.
You can cushion the full impact of a lower rate of return. While you may get lucky and your stock funds may return 10% or so over time, they may go down when you first retire.
If you curb your spending and expenses, you can minimize this problem by limiting the amount of money you withdraw. If you are conservative in your rate of withdrawal when you first retire, you will see the benefit later on. Once that money is gone, you lose the benefit of compound interest and future higher returns.
If you are fortunate to have as much as $1 million in your retirment funds, financial advisors often suggest a withdrawal rate of about 4% ($40,000) per year. If you take that cruise to Italy as soon as you walk out the door of the federal building, and withdraw $100,000 or more in the first year, you may want to consider a future career as the local Wal-Mart greeter after a few years of living high.
Of course, you could also work longer and delay withdrawing any money at all from your TSP funds. A number of government employees are obviously having to face the real possibility of imminent retirement, instead of dreaming about it at some future date, and a number of people decide to work longer. Potential federal retirees are not retiring as fast as the retirement experts at OPM had previously estimated. That may be a good move for reasons that will be explored in the follow-up article on “Potential Retirement Shock.”