Don’t Overestimate Your Expected Income

They say time flies when you’re having fun. To me, it seems like yesterday that I was first learning about the Thrift Savings Plan and how it fit into the three-tiered Federal Employees Retirement System. That was in 1987, when investing for retirement was a new concept for most federal employees.  

A lot has happened since then.

For many federal employees retiring today, the income generated in retirement from FERS, Social Security and investments in the Thrift Savings Plan will fully replace the net income they earned while employed.

While that probably sounds great, remember that there is a big difference between your gross salary and the net income that you spend every two weeks. Similarly, there is also a difference between your gross retirement income and the net. Each of the three components of your retirement is subject to a variety of withholdings, and your FERS benefit may also be subject to various reductions. Consider the following:

• The FERS basic retirement benefit, sometimes referred to as a pension or annuity, is subject to reductions for part-time work schedules, survivor benefit elections, age penalties (in some cases when an employee retires early). You may also need to provide a portion and/or survivor benefits to a former spouse.
• There are also FERS withholdings for federal income tax and possibly state income tax (depending on the state) and insurance premiums.
• There will be withholdings from your Social Security benefit for federal income tax and possibly state income tax (although most states exempt SSA benefits from taxation, there are some exceptions).
• If you enroll in Medicare Part B, the premium will generally be withheld from your Social Security retirement benefit.  
• The TSP payments that you receive after your separation may also be subject to federal income tax withholding and state tax.

Although you may have to do some homework to determine the tax withholding from your various sources of retirement income, it is possible to compute your net retirement income. This is important to be sure you will have an adequate income stream to meet your requirements as well as unexpected future expenses.  

Considering that many people spend their net income, it might be important to generate the same net income as you receive in your biweekly salary. Think about it. What expenses will go down when you retire? Maybe none:

• Yes, you might pay off the mortgage, but the house will still require upkeep, and you’ll have property taxes and possibly homeowners association dues and fees.  
• Yes, you may get the youngest child through college, but do you plan to help with wedding expenses, graduate school or family vacations? What about spoiling your future grandchildren?  
• Yes, you no longer have to pay for commuting and business attire, but you’ll have many other ways to spend your retirement income.   

Any good financial plan is going to start with some common sense. You’ll need to prepare for potential future health care costs and the possibility of requiring long term care. You may need to do some estate planning and even some mental preparation to be sure that you are truly ready for the next chapter of your life.

Estimate Your Retirement Income

It is pretty easy to compute your likely income from the old Civil Service Retirement System or FERS. In most cases, you may ask a retirement specialist in your HR division to prepare an estimate for your possible future retirement date.

To get a good idea of the income you will have from Social Security, you may visit www.ssa.gov to request a personal benefits statement. These statements are available online if you establish a “mySocialSecurity” account, or you may request one by mail, by phone (1-800-772-1213) or at your local Social Security office. The Social Security Administration currently mails Social Security statements to workers age 60 and over who aren’t receiving Social Security benefits and do not yet have a my Social Security account. The Statements are mailed three months prior to your birthday.   

It’s a little trickier to estimate the amount of income will you receive from your investments in the TSP. There are three basic ways to create income from your TSP investment. The first is to simply determine how much monthly income you need to supplement your FERS and Social Security benefits and withdraw a specific dollar amount on a monthly basis (remember to allow for taxes). The risk is that you may withdraw too much too early and eventually run out of money.

One rule of thumb is to never withdraw more than three or four percent of your account balance in a single year. To lessen this risk, the TSP offers a second option—to withdraw monthly payments computed on your life expectancy. The younger you are, the smaller the payments, but as you get older (and your life expectancy is reduced), the payments will increase. Whatever withdrawal option you choose, your balance in the TSP will continue to be invested and you may elect interfund transfers while receiving payments.  

The final way to receive income from your TSP account is to purchase a life annuity to provide a stream of income that will continue over your lifetime. The annuity option has a variety of features that provide increasing payments to offset inflation, a cash refund or a 10-year certain feature to allow the balance of your original investment to be paid to your beneficiary should you not live long enough to recover your original investment.

There are two drawbacks to the annuity option—loss of control over your investment, and you will no longer be able to receive partial withdrawals or change your investment options once the annuity is purchased. In addition, annuities purchased today will be computed based on a three percent annuity interest rate index that is locked in for the life of the annuity. If interest rates increase in the future, well, too bad. The benefit, of course, is a sense of security that your money will never run out over your lifetime. And if you elect increasing payments, the payout will be adjusted annually up to 3 percent to offset future inflation.

You don’t have to settle for one withdrawal option—you may elect a combination of monthly payments and annuity. To learn more about these options and to estimate the payments, the TSP has an online retirement income calculator as well as a booklet outlining the details of each withdrawal option.  

You may also transfer some or all of your TSP investment to an individual retirement account (IRA) so that you can make other types of investments or purchase other types of annuity products. Be careful before electing to move your savings out of the TSP, however. It is prudent to do financial planning on your own or with a trusted financial adviser. Before moving your money, review these TSP resources: Stay with the TSP; the Don’t Move brochure; and Don’t Move video.

For those of you just starting out in federal service, I can assure you that you will someday look back and think about how quickly the years have gone by. Just don’t wait too long to take advantage of your opportunity to invest in your future.