For many people, thinking about retirement is a double-edged sword. On one hand, it’s exciting to contemplate the freedom that comes when you stop working full time and can devote yourself to projects, travel or spending time with loved ones. On the other hand, retirement planning can be incredibly stressful — especially if you started to save later in life or are concerned that you won’t have enough income to live the life you’ve always dreamed of.
So how, exactly, should you plan your retirement income from your TSP and other investment accounts?
There are four reliable strategies that work for most people. However, only one of the strategies can be implemented while your money is in the Thrift Savings Plan. Understanding these income strategies is a good first step in laying out your future income so that you can live with financial peace of mind in retirement.
1. The Systematic Withdrawal Strategy
Systematic withdrawal is probably the most common retirement income strategy. After many years of depositing money into your retirement account, you finally begin to take it out again. This is, however, more complex than just adding and subtracting cash from an investment account. It is also the only one of the four strategies we cover that can be implemented in the TSP. The TSP lacks the flexibility needed for the other strategies.
When you add money to an IRA, TSP or 401(k), it is used to purchase a variety of investment products, including mutual funds, bonds, CDs, stocks, and more. Each of these items fluctuates in value over time. When you take money out of your retirement account, you end up selling off a portion of these investments, cashing out of your stocks and bonds.
As you do so, you’ll have a bit less in your account to continue earning money, so a systematic withdrawal strategy must take into account both how much money you need and also how many years you will need it for to ensure your income lasts.
Pros: Having a well-rounded portfolio lets you continue to earn money in the long term even as you begin to sell off stocks and other investments in retirement.
Cons: If the market goes down early in your retirement, it could have a significant impact on how much you can withdraw later.
Best for: Investors who can stomach some risk in the stock market even after they retire.
2. The Bucket Strategy
The bucket strategy for retirement income is also known as time segmentation. Instead of selling your investments equally across the board for income, you instead divide your investments into categories based on when you plan to use the money they generate.
For example, if you plan to be retired for 30 years, you may have a near-term bucket designed to provide income for the first third of your retirement, a mid-range bucket for the next third, and a long-term investment bucket for the final third.
The near-term bucket is typically filled with lower-risk investments such as CDs, annuities, bonds or cash, which you don’t have to worry about during market fluctuations. Your longest-range bucket would be filled with riskier investments that have the potential to bring higher rewards over time. Since you won’t be using that money right away, you can weather the ups and downs more easily.
Of course, it’s still important to keep each bucket carefully diversified and to adjust for risk over time. As you enter your final third of retirement, you don’t want to keep all of your money in high-risk investments. Buckets need to be adjusted regularly to keep the proper allocation between lower and higher risk investments.
Pros: Bucket strategies can help you better understand risk and take market fluctuations in stride.
Cons: There are a lot of moving parts, and you’ll need to pay attention and regularly adjust the buckets over time. This is not a set-it-and-forget it strategy.
Best for: Investors who are engaged in the process and want to feel in control of their risk.
3. The Income Portfolio Strategy
While the first two strategies involved selling off investments to generate income, the income portfolio instead relies on the investments to deliver earnings for you to live on. For example, if you had millions of dollars, you could simply place it in a savings account and live off of the interest without touching a dime of the principal.
Of course, there are other places to put your money than a savings account to deliver income. Creating a bond ladder is one way to create income over time. It’s also possible to buy bonds and CDs with staggered maturity dates so you reap the interest over time. Stocks that pay dividends are another way to ensure that you live off your earnings rather than selling your investments. You may want to consider diversifying your income portfolio among CDs, bonds and stocks.
Pros: When you avoid selling investments, you may have a very stable foundation of money for peace of mind — and for your legacy to your heirs.
Cons: The income may fluctuate from month to month as investments have different payment schedules (monthly, quarterly and bi-annually).
Best for: Investors with lower investment income needs during retirement and perhaps those that have other sources of income like a pension or rental income.
4. The Essentials vs. Discretionary Strategy
The essentials vs. discretionary income strategy is also known as a flooring strategy. In this scenario, you carefully divide your wants from your needs during your retirement.
The most important goal is to always have enough income for your needs: food, housing, utilities, taxes, health insurance, etc. Because these expenses are non-negotiable, the income you need to pay for them should come from a stable, low-risk source: social security payments would fall into this category, as would any guaranteed pension income, annuities, and bond ladders.
Once you’ve planned for your needs, the rest is the icing. You may plan to travel, indulge in sporting and entertainment, give regularly to charity, or pursue your passions. The funding for these activities comes from riskier investments like stocks or commodities, which will have greater fluctuations over time. The idea is that you can adjust your wants easily, enjoying yourself more in good economic times and tightening your belt in lean times.
Pros: This strategy helps balance risk and reward while providing basic security.
Cons: You need to be willing to deny yourself certain pleasures in an economic downturn.
Best for: People with a flexible outlook who are willing to roll with economic ups and downs.
Next Steps: Turning Your Retirement Savings Into Sustainable Income
If balancing all of these numbers on your own feel overwhelming, we can help. We are happy to assess your current portfolio, analyze your needs, and help you choose an income strategy that works for you. These are complex decisions with many moving parts, and we’re here to help you make sense of it all.