I was talking with another financial planner recently and I mentioned that I specialize in helping federal employees. He said that he didn’t specialize in federal benefits but that one of his new clients was a federal employee.
He said she had planned on retiring later—but her plans had changed and she wanted to retire right away. She knew how much she wanted to spend each month in retirement— but almost all of her money was in her TSP. She came to the planner asking how she could make retiring right away a reality, and together they came up with a plan that would allow her to do that.
But as he described their initial plan to me, it became clear that he was not familiar with some important benefits his client had as a federal employee.
The Initial Plan
*We’ve changed some of the details to protect privacy
The client was 58 and wanted to retire as soon as possible. She had enough years in service to do an MRA+10 reduced retirement right away. (Red Flag). (See What’s the Difference Between Postponed vs. Deferred Retirement? and Future Retirees: Do You Know Your MRA?)
She knew how much she wanted a month in retirement – and after calculating her reduced MRA+10 FERS pension —they figured on withdrawing the rest from the TSP money that would be transferred to an IRA (*Red Flag*).
But since she was under 59 ½, money taken out of her IRA would be subject to a 10% penalty. In order to avoid the 10% penalty, they planned on using 72(t) (*BIG Red Flag*) to withdraw the money. However the IRS has limits on how much you can take out with 72(t) – and the amount the client wanted was above that limit. So the remaining amount needed would be withdrawn from the IRA incurring the 10% penalty.
While he felt he was using the best tools he had at his disposal to help his client, his initial plan totally missed out on some unique aspects of his client’s federal benefits.
Some Red Flags
This planner really felt he was doing the right thing for his client – however, if you’re familiar with federal benefits – there are some red flags that come up:
Red Flag #1) MRA+10 Early Retirement Reduction
While it’s wonderful to have the option to retire early with FERS under MRA+10 rules, the reduction you take to do so is pretty hefty. If you plan well, you can often avoid the reduction by postponing your retirement.In this example, the client would be taking a 20% reduction in her pension to start it right away. However, if she had the proper savings available (and she did), she could delay starting her retirement until she was eligible for a regular retirement and she could receive her pension without reduction for the rest of her life.
The key is knowing about the nuances of postponed retirement. But most financial planners wouldn’t know about postponed FERS Retirement rules.
Red Flag #2) Transferring TSP to IRA Before Age 59 ½
There are times where it makes sense to transfer your TSP to an IRA – however – if you’re thinking about transferring your TSP *before* age 59 ½ make sure you understand the implications of the transfer.The TSP has a unique benefit that allows you to access your money without the 10% penalty as early as age 55 if you’re separated from service. But once you transfer your TSP to an IRA – you must now play by the rules of an IRA. So if she had left money in her TSP – she would have been able to access it without a 10% penalty.
Now – there are limitations to taking money out of your TSP – but the ability to access money at 55 without a 10% penalty (if you’re separated from service) is a unique benefit that might play an important role in your retirement. (See TSP Pamphlet – Important Tax Information About Payments From Your TSP Account)
However, most planners think the TSP is just like a 401(k), and so they wouldn’t know about that unique access feature of the TSP.
Red Flag #3) 72(t) Distributions from IRA
Many people have heard of 72(t) – a special tax rule that allows you to access money from an IRA before age 59 ½ without the 10% early withdrawal penalty.On paper, 72(t) sounds like a good idea. But in my experience people get into a lot of trouble with 72(t). I’ve *heard* many people talk about how 72(t) has worked out well for them. But – from what I’ve *seen*… 72(t) usually ends up causing a much bigger tax headache in the end.
There’s not enough space in this article to cover everything about 72(t)… but if you’re thinking about going down that path – proceed with caution.
Missing Out on Important Benefits
While the initial plan would have ‘worked’ on paper – it was missing out on some important aspects of her federal benefits.
The planner really felt he was using all the tools he knew about to help his client achieve her goal. The client said she wanted to retire right away- and the plan they came up with would have allowed her to do that.
And here’s another kicker – if the client had sought out a second professional opinion – most other financial planners would have seen it as a valid plan – because most financial planners don’t understand just truly how unique your federal retirement benefits are.
Importance of Understanding Your Federal Benefits
This is just another reason why it’s important for you to understand your federal benefits.
Whether you’re doing it yourself or working with a financial planner – it always makes sense for you to be familiar with your benefits.
If this client had understood her benefits from a financial planning perspective – she would have seen right away that the initial plan was not the best use of her benefits.