This is a multi-part series on tips, tricks, and tactics for managing your TSP in uncertain times.
While no expert on directions for men, I can help answer one of the common questions federal employees ask about money – “What do I do with my TSP when I retire?” You can choose to simply leave your funds in the TSP and enjoy the low fees, but today’s column addresses alternatives for creating income from your Thrift Savings Plan.
The easiest way to generate income from your TSP at retirement is to have TSP send your funds to MetLife and create an annuity. However, easy doesn’t always provide the most options or the best value.
MetLife’s current interest rate is 3.75%, so you’re tying up your hard-earned TSP dollars at a low interest rate for the remainder of your life. There are ways to ensure that your heirs are refunded any unused portion of your original investment in the immediate annuity, all of which lower your monthly payout.
What are some other choices?
An age-old strategy known as split income lays out the wisdom of diversifying your assets not only by asset allocation but also over time. When you retire, you do not need access to your entire TSP account balance immediately. In fact, part of the equation is making sure that you don’t outlast your TSP funds. By dividing the TSP balance into segments based on when you plan to use them (i.e., immediately, 5 years, 10 years, 15 years), you can possibly avail yourself of higher returns over time and utilize guarantees.
This chart illustrates how the funds might be divided for a federal employee who retires at 57. The funding for the initial income will come directly from funds left in the Thrift Savings Plan due to IRA withdrawal rules before age 59 ½. These rules do not apply to federal employees who retire or separate at age 55 or better. The $10,877 shown in Leg 1 would remain in the G Fund and the retiree would receive $468 per month (before taxes) until they turned 59 ½. At that point the $10,877 would be depleted.
The retiree is now 59 ½ and the $25,036 in Leg 2 would have grown at 5% to $27,602. This would generate a little raise in the retiree’s monthly income to $496 for the next five years. One consideration for the Leg 2 investment would be a guaranteed annuity of some type. During the early years of retirement, one of the biggest risks you face is the erosion of your principal as you begin taking withdrawals. This makes the “guaranteed” feature of an annuity a good option. Since you’re only “locking” in the funds for 5 years, this is not the same type of annuity that was discussed above from MetLife.
Once Leg 2 is depleted in five years and the retiree is 64 ½, they would begin using from Leg 3 which would have grown to $49,018 and would generate income of $575 per month (sorry, still before taxes). This would last for the next 8 years for a total of $96,175 of income over the total fifteen years. At the end of fifteen years, the original $31,487 in Leg 4 would have grown back to nearly the original $100,000 value. In other words, the retiree would have only used $117 of their principal!
At that time, you could start the strategy over and begin taking from the principal, if necessary, since the risk of beginning to use principal at age 73 is much lower than beginning to withdraw principal at age 57. You could also utilize some of the wide range of investment choices available now that provide for guaranteed income in the future for Leg 4 so that at age 73, you’d have the option of generating a set amount of income if you chose.
Another benefit of using the split-income strategy is that you still have access to your funds during the time you’re taking income from any of the legs. Depending on the investment you choose, you could have access to all or a portion of the funds in the unused legs. Any withdrawals would, of course, reduce your future income on that leg.
A common question about this strategy is whether you have to move the funds out of the TSP to implement it. Couldn’t you just put Leg 1 in the G Fund, Leg 2 in the F Fund, Leg 3 in the C Fund and Leg 4 in the I Fund? There are a couple of roadblocks here including the lack of any guarantees (except that you cannot lose your investment in the G Fund) and withdrawal issues.
Most retirees want at least some type of assurance about the sustainability of their income for retirement, but by having some of your income generating funds in the F, C and I Funds, you’re still at the mercy of the market. Additionally, when you’re taking withdrawals for income, you can’t simply elect to take those funds from the G Fund during the first few years – they are automatically withdrawn on a pro rata basis. This keeps the money you have in the I Fund for 15 years from now working for you over all 15 years because it’s being depleted each month.
A future column will show how to make the funds even more efficient by taking Leg 4 and converting it to a Roth IRA at retirement, so when you reach the point of taking it for income, it would be tax-free! That might be even more important advice than any instruction on understanding men!