Have you ever felt confused trying to figure out the “best” day to retire this year? The reason it’s so difficult to find the answer is because everyone’s situation is a bit different. Instead, focus on selecting a S.M.A.R.T. retirement date, aka one picked after considering the following:
- Start Your Pension with Purpose: You can easily predict exactly when your pension will begin
- Maximize Your Service: Don’t get tripped up with errors or stop 3 feet from gold
- Annual Leave: Parts I and II
- Retiring Early (Before 59 ½) or Late (72 or Later)? You’ve got an additional TSP planning step
- Tax Questions: Got a toothache? See a dentist. Got tax questions? See a tax preparer!
The Best Date in the World
With all of the moving parts in retirement, it’s easy to want to bail out and focus on selecting the perfect date, so you can move on to retirement daydreaming and escape the chaos.
The problem with that strategy—seeking the “perfect” date—is that getting there requires you to deepen your knowledge in a few areas.
Your mission is to figure out the best date for YOUR situation. It’s not cut and dry, nor is there one date that necessarily works well across the board. Instead, get a S.M.A.R.T. retirement date!
Start Your Pension with Purpose
You’ll need to know this first: When does your FERS pension start?
Your pension begins on the first day of the month following the month in which you retire.
- If you retire on January 18th, your pension will start on February 1st.
- If you retire on March 5th, your pension will start on April 1st.
- If you retire on June 30th, your pension will start on July 1st.
In the third scenario above—retiring June 30th—your pension will start the very next day and you won’t be stuck in limbo for days or weeks like the first two.
You’re either working (earning a check) or retired (earning a pension), but you can also fall into a void between the two.
It’s okay if your retirement date falls on a weekend or holiday, too. It doesn’t have to be a workday at all. It’s just the date that you officially Separate from Service and retire.
Maximize Your Service
DON’T GET TRIPPED UP WITH ERRORS. Do perform a Service History Audit.
When do you want to know about a gap in your service history that might not count towards retirement? This could have been the result of performing temporary or seasonal service, or simply a clerical error when your records were input by a fellow human being capable of making mistakes. You need to perform a Service History Audit: pull down each and every SF-50 from your eOPF (Electronic Official Personnel Folder) and make sure that each one that you’re counting towards retirement says “FERS” in the retirement credit box.
DON’T STOP 3 FEET FROM GOLD. Do make sure you’re not close to getting a significant increase if you stayed a little longer.
Your FERS pension is a multiplication equation. It’s your Years/Months of Creditable Service [multiplied by] your Pension Factor [multiplied by] your High-3 Average [which equals] your annual FERS Pension.
The Pension Factor mentioned above is going to be one of two options:
Now, before you scoff at that extra .1%, know this: that’s a ten (10) percent increase in your pension, FOR LIFE! The 1.1% option is called the Enhanced Pension Factor and it’s only available to those who meet both of the following criteria:
Retiring with at least 20 years of creditable service
Retiring at age 62 or later
Meet Edith Example
Edith is getting close to retirement—in fact, she’s ready to go N-O-W. She has worked for the government for 21 years and she’s 61 years old. Her High-3 Average is $100,000. What might you tell Edith?
We’d tell Edith to consider hanging around for just one more year until age 62—so she can get the Enhanced Pension Factor of 1.1%. Let’s compare the two situations for Edith. We’ll list the estimated figures, then the math in both words and numbers you can type into your calculator.
Situation 1: Edith retires N-O-W
Annual Pension: $21,000*
21 years of service [times] 1% pension factor [times] $100,000 = $21,000 annually*
21 x .01 x 100,000 = 21,000
Monthly Pension: $1,750*
$21,000 annual FERS pension [divided by] 12 months = $1,750 monthly*
21,000 / 12 = 1,750
Situation 2: Edith waits one more year to retire at age 62
Annual Pension: $24,200*
22 years of service [times] 1.1% pension factor [times] $100,000 = $24,200 annually*
22 x .011 x 100,000 = 24,200
Monthly Pension: $2,017*
$24,200 annual FERS pension [divided by] 12 months = approx. $2,017 monthly*
24,200 / 12 = 2,016.67
Since Edith has over 20 years of service and she’s close to the age of 62, she should consider how much more she’ll get by holding on for just another year which makes her eligible for the Enhanced Pension Factor. That extra 10% will add up over her lifetime (and her spouse’s life, too, if she’s elected a Survivor Benefit). Of course, Edith may have other outside circumstances that shape her decision as well. But she should weigh her options carefully.
*Gross amount before any deductions or taxes are withheld
Annual Leave: Part I
When you retire, any Annual Leave that you “have on the books,” or haven’t used as vacation, is paid out to you in a one-time lump sum payment.
But if you’re in a “use or lose” scenario with Annual Leave and want leave paid out at retirement, then you’ll NEED to retire BY that Leave Ending Date that year. Otherwise, you’ll miss out on that “use or lose” leave!
But isn’t it the same every year?
Here’s the challenge: The Leave Ending Date changes every year, so this can be tricky. Check here to see OPM’s Leave Ending Dates so that you can avoid this potentially costly mistake.
Annual Leave: Part II
If you have a lot of Annual Leave saved up when you retire, you’re likely to get a pretty big check—BUT IT’S TAXABLE! This income is going to be added to all your other earnings that year.
Meet Sam Sample.
Sam retired on October 31, meaning he’s earned most of his regular income since he worked for most of the year. Now, Sam gets a big Annual Leave payment and it puts him into a higher tax bracket. He’s worried because he might have to pay more taxes unexpectedly in April.
Retiring Early (Before Age 59 ½)
If you’re retiring early, there’s a distinct tax advantage inside of the Thrift Savings Plan (TSP) that you need to know about. TSP is classified as a “retirement account” by IRS standards, and they have special rules in place to encourage participants to save money and then keep it in the account until retirement.
Normally, if you take money out of TSP (or any retirement account) before age 59 ½, the IRS will assess a 10% Early Withdrawal Penalty in addition to any income taxes owed on the amount taken—plus depending on where you live, you may incur a penalty on your state income taxes as well.
Since this rule could potentially harm someone who retired early, the IRS has created an exception to the rule, but it’s important to fully understand how it works:
As long as your money remains at TSP, if you retire (or separate from service) between the year in which you reach age 55 and the year in which you reach age 59 ½, the Early Withdrawal Penalty can be waived. See TSP Publication TSP 536, Important Tax Information About Payments From Your TSP Account, for complete details.
The most important takeaway: if you transfer your funds out of TSP to an IRA, you will lose this waiver. So if you’re retiring early, consider very carefully before transferring your funds out of TSP (at least until you’ve reached the age of 59 ½).
Note: For Retired Public Safety Officers under FERS Special Provisions, the ages have been expanded. Your rule states as long as your money remains at TSP, if you retire (or separate from service) between the year in which you reach age 50 and the year in which you reach age 59 ½, the Early Withdrawal Penalty can be waived. See TSP Publication TSP 536, Important Tax Information About Payments From Your TSP Account, for complete details.
Retiring Late (Age 72 or Later)
Starting at age 72, you must take a little bit out of your TSP account each year. This is called the RMD—Required Minimum Distribution. (Note: The S.E.C.U.R.E. Act of 2019 changed the RMD start age from the year in which you reach 70 ½ to the year in which you reach age 72 for ANYONE BORN ON OR AFTER July 1, 1949. For those born before July 1, 1949, the RMD start age is the former age of 70 ½.)
Required because it’s required per IRS Rules. Failure to do so results in a 50% penalty plus income taxes due on the entire amount—think of it as giving most of the RMD amount directly to the taxman—ouch.
Minimum because there is a certain amount you must take out to meet the RMD. It’s based on a calculation of your previous year-end balance divided by your age factor on the Uniform Lifetime Table on the IRS website. The amount changes every year.
Distribution because the funds are coming out of the account (being distributed). And if you’re taking money out of the Traditional TSP, you’ll owe income taxes. If you’re wondering what the big idea is with these RMDs, it’s exactly that: income taxes. While you’re working, you got a tax break for any money contributed (put in) to Traditional TSP. And when you take it out, that’s when the taxes are due. The taxman is waiting very patiently for you to turn age 72.
Don’t Forget About Roth TSP…
With all of this talk about Traditional TSP, you might be wondering about Roth TSP.
Your Roth TSP is subject to an RMD as well. However, the distribution may be tax free as long as you follow the two simple IRS rules: you must be 59½ or older, and the account has been established for at least 5 years. If you would prefer not to take an RMD out of your Roth TSP, consider rolling it over to a Roth IRA which is not currently subject to RMDs.
FOR THOSE RETIRING AT AGE 72 OR LATER: There’s one exception to the RMD rules for TSP: for those still working as Federal employee at age 72 and beyond, you can skip taking your TSP RMDs until the year in which you retire.
The most important takeaway: OPM needs to notify TSP, who in turn notifies you that they acknowledge that you’ve officially retired, before you can take out your RMD—a process that could take 6-8 weeks! Here’s the deal: even if your official notice comes from TSP in a new tax year, you’ll still owe the RMD for the previous year in which you retired, PLUS the current year’s RMD. Taking two RMDs in one year can mean you pay more in taxes on that amount if you end up in a higher tax bracket as a result. See TSP Publication TSP 775, Important Tax Information About Your TSP Withdrawal and Required Minimum Distributions, for complete details.
Those retiring at 72 or later should consider retiring no later than October so they have plenty of time or waiting until the following January so the previous tax year is not subject to an RMD.
Tax planning and retirement go hand-in-hand! (Unless you like tax surprises, which most of us prefer to avoid like the plague.)
“What happened last year? Why didn’t you call me?”
Talk with your tax professional. Ask if it might be better to pick a retirement date on the last day of the year or within the first few months of the year when your work earnings will be less so that your Annual Leave payment may be taxed at a lower rate.
And if you’re someone who has happily prepared their own taxes (or have a spouse or partner who has helped you prepare them), retirement can be a whole different ball game—lots of moving parts. It may be time to get some additional help. There’s no shame in hiring a pro for a few years as you get the hang of things. Taking this extra step can help save you from potentially unpleasant and expensive surprises.
Before You Go: A Reminder
It’s true that your FERS pension begins the first day of the month after you retire, BUT that doesn’t mean you’ll immediately start receiving payments that fast!
Be prepared to wait because OPM’s retirement application processing time can vary quite a bit. I’ve seen 6 weeks’ time all the way up to 9 months before the full pension is received.
It can be a big mistake to retire without enough savings to take care of expenses—and money can get very tight fast. Even TSP can take 4-6 weeks after you retire before you can request payments. It makes good financial sense to start retirement with at least 4 – 6 months of expenses in a savings account.
Be sure to get your free companion guide, Pick Your S.M.A.R.T. Retirement Date Checklist to help you retire with more clarity.