Turning accumulated savings in the Thrift Savings Plan (TSP) into a stream of income is a goal for federal employees who are hoping to retire at a comfortable level. This is particularly true for FERS employees who get a less generous pension than employees who are covered by CSRS.
If you are a FERS employee who has worked 35 years, your pension will be 35% of your high-three salary if you are under age 62, or 38.5% of your high-three average annual salary if you are 62 or older.
The average Social Security benefit is slightly less than $14,000 per year. Let’s look at an employee who retires at age 62 with 35 years of service. How much will this employee need to make up from their TSP and other investments to have a retirement income that is 90% of their final salary? A 90% replacement rate would let a retiree continue to live at or near the standard of living they had before they retired.
The employee in this example has a final salary of $64,000 and a high-three salary of $60,000. In order to replace 90% of the final salary of $64,000, the retiree will need $57,600.
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90% of Final Salary
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$57,600
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Annual FERS annuity (high-three x 1.1% per year for 35 years, a total of 38.5%)
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$23,100
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Annual Social Security (this employee would receive a somewhat larger than average benefit)
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$15,000
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Total FERS and SS
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$38,100
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$38,100
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Shortfall
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$19,500
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Making Up Lost Income During Retirement
Where could you get an income of $19,500 a year?
The TSP would be one source. So would IRAs, the proceeds from selling your home and downsizing or even working part time during the early years of retirement. This article will not address the topic of how much money is needed to generate an annual income of $19,500. (See, for example, How Much Income Do You Need in Retirement? It Depends; and How Much Money Will I Receive in Retirement?) We will simply look at the choices you have inside and outside your Thrift Savings Plan to generate a stream of income for your retirement.
Withdrawal Choices
If you leave your money in the TSP after you retire, there are two withdrawal choices that can generate a stream of income.
One of these choices is what the TSP refers to as “Substantially Equal Monthly Payments”. You can choose to have payments of a certain dollar amount per month, or you can choose to have the TSP send you payments based on the IRS life expectancy table. If you choose payments of a specific dollar amount they cannot be less than $25 per month and can be changed once a year, during an open season in December.
As long as you retire in the year in which you reach the age of 55 (or later) you will not be subject to the 10% early withdrawal penalty on any monthly payments from the TSP. Those who retired earlier than the year in which they reached age 55 (e.g., law enforcement, firefighters, etc.) will be subject to the 10% early withdrawal penalty on all monthly payments taken before reaching 59 ½.
If you retire earlier than the year in which you reach 55, you can manage to avoid the penalty if you follow IRS rule 72(t). Under 72(t), if you base your monthly payments on the IRS life expectancy table and continue following the table for the longer of reaching age 59 ½ , or five years, you are exempt from the penalty.
The other choice for those who leave their money in the TSP is purchasing a TSP annuity. TSP annuities are sold by MetLife. A TSP annuity will guarantee that you will not run out of money in your lifetime. Joint annuities provide that protection for spouses as well as for those who have an insurable interest in your life. There are no early withdrawal penalties with TSP annuities, regardless of your age when you begin payments.
The book, Withdrawing Your TSP Account After Leaving Federal Service, has detailed information on these two withdrawal methods (as well as other methods). The book is available on the TSP website.
Rolling Over Your TSP
Of course, you are not required to leave your money in the TSP. Many retirees choose to move their money into an Individual Retirement Account (IRA). (See IRAs and Your Retirement) Within an IRA you can set up monthly payments, just like you can in the TSP. IRAs however, give you more flexibility in changing the amount of your payments. You can change the amount at any time. In fact, your payments do not even have to be taken monthly. You could set them up bi-monthly, semi-annually, or however you want.
Once you roll money into an IRA, you will face the 10% early withdrawal penalty on any money you withdraw before you reach the age of 59 ½. You can, just like with the TSP, follow IRS rule 72(t) to avoid the penalty.
Money that is in an IRA can also be used to purchase an annuity. You should thoroughly investigate any annuity investments, because all annuities are not created equal. Make sure you completely understand what you are getting in to before you invest your money. There are no early withdrawal penalties with annuities.
