The TSP is a major component of the federal retirement system, and the only part you actually have any direct control over. You have the ability to change contribution levels, change allocations, and contribute to the Roth option. These mechanisms give a real sense of ownership, and that is why many people factor their TSP balance so largely into their retirement decisions.
Too often, however, the TSP becomes the only factor. I have had discussions with numerous people who could easily afford to retire and very much wanted to, but they were holding on until they hit a “magic number” for their TSP balance so they could feel good about retiring.
What is my “Magic Number”?
Many people have a “magic number” in their head for a TSP balance at retirement, and aren’t comfortable taking that next step until they reach it. Striving to hit a benchmark or goal can be a powerful motivator along the way, and even help you to save more than you otherwise would have. When it comes down to the timing for actual retirement, it is important to remember that the TSP is only one of many factors and shouldn’t be the sole determination.
There is actually a “magic number” that matters, but it is a regular income level to support spending needs rather than an account balance. For most people, this is essentially an attempt to recreate their working take-home budget. The key is to look at the budgetary need on one side of the equation, and all of the income sources on the other. For any given year, the sum total of the various income streams should add up to the budget. Any gaps left from the regular monthly income sources (FERS annuity, Social Security, etc.) can be made up by other sources, including the TSP, other savings, part-time employment, etc.
Determining whether you have enough in the TSP to make up those gaps for the rest of your life is best done with a comprehensive retirement income plan. That plan should include all income sources as well as all expected changes to the budget over time. That could include paying off a mortgage, kids moving out, etc. Once the road map is laid out, you can then work backward to see what needs the TSP will be targeted to address and evaluate where you stand.
What is my TSP actually worth?
One way to get a feel for how well your TSP will work to fill in the gaps in your income plan is to break down your overall balance into a potential monthly payment. The actual utilization of the money won’t be consistent from year to year and a rule of thumb cannot replace an actual plan, but there are times when a basic estimate can be useful.
The most widely-referenced concept with regard to retirement income is known as the “4% rule”. This derives from a study done by William Bengen in 1994, and uses historical return data for a moderately invested portfolio to state that an investment account can sustain withdrawals of 4% of the initial balance, increased annually with inflation, and will last for the duration of retirement.
This concept is obviously somewhat simplistic, but can give a very good starting point when trying to get a handle on the income possibility with your TSP. Using that basic analysis, a $100,000 portfolio could theoretically generate $4,000 per year, or $333.33 per month. Similarly, a $500,000 portfolio could provide $20,000 per year to start, or $1,666.67 per month.
There have been many different analyses done about the 4% rule, some stating that it is too high and others that it is too low. Still more prefer the concept of something that fluctuates with market performance. A level withdrawal strategy (as the above calculations would indicate) is also rarely the most appropriate plan when considering the larger picture. In addition to budget changes, regular income sources often vary significantly throughout retirement. That can include the FERS supplement stopping, delaying Social Security, and even spousal income and retirement. For that reason, a calculation using an idea like the 4% rule should only be used as a rough estimate only, and not be considered an functional plan.
What about my retirement date?
The selection of an actual retirement date should really be an evaluation of all of the factors affecting retirement, including non-financial factors. Many people work long after they could afford to retire, for reasons that are very important. Of the financial implications, though, achieving and maintaining a comfortable monthly retirement income will mean a lot more in the long run than meeting an arbitrary account total goal. You should work through your entire retirement income plan before coming up with a firm date, so that you know you can be comfortable in your decision when the time comes.
Once you are satisfied that the monthly income requirements can be met, it is also important to consider other possible needs for the TSP funds. Those could include extra funds to take the place of life insurance or possibly an estate to pass on to future generations. Every individual and family situation will be different in those regards, but they are still important considerations when evaluating how much you need and how best to utilize your savings. There are even times when a desire for an estate may keep you working past when you would have been able to provide for your own retirement income.
I strongly encourage everyone getting close to retirement to put together a comprehensive income plan before nailing down a specific retirement date. That can provide peace of mind for those who are retiring soon, and may even present a sooner date for those who thought they had longer to go.
The TSP is certainly a large part of that analysis, but only in its ability to provide a regular income to complement the other income sources. Actually managing the investments and withdrawals moving into retirement is another topic entirely, but that as well will be based on the overall income plan.