Bridging the Gap Between Your Federal Benefits and Investments
Planning for retirement as a federal employee seems like it would be simple: just collect your pension and enjoy, right? While that may be possible for some, the reality for most people is that their pension will only cover a fraction of their income needs when they retire. Successful retirement planning means making the most of a complex collection of benefits and investments to make sure you have enough to live the way you want to.
If your pension won’t cover all of your income needs, it’s time to figure out how to bridge the gap using your other investments. So what’s the best way to do that? Here’s a step-by-step guide to figuring out how to use your investments to your advantage.
Step One: Know Your Retirement Income
Knowledge is power, so your first step is to calculate exactly how much you expect your pension to be worth when you retire. As a reminder, the basic FERS pension calculation is
Average high-3 salary X years of service X 1% = your annual gross pension
There are a few things to keep in mind here. First, if you retire at age 62 or older with over 20 years of service, you get to use 1.1% as a multiplier, which gives you a lifetime 10% pension raise.
Second, don’t forget to calculate deductions from your pension for your healthcare premiums, survivor benefits, and taxes to arrive at your actual pension income.
Fortunately, your FERS pension isn’t your only source of retirement income. You’ll also be able to collect Social Security. You can get a ballpark estimate of your social security income using this calculator, or you can log into your personal Social Security statement to get more specific numbers. Again, don’t forget to calculate how much you’ll pay in taxes on your Social Security income.
Finally, add up your net pension income and your net Social Security income. This is how much income you can expect during your retirement to cover your expenses.
Step Two: Know What You Need Each Month
Before you can decide if that income number is big enough, you need to know how much money you’ll actually spend during retirement. Add up your projected expenses during retirement, starting with your needs. These costs will include things like:
- Housing
- Food
- Utilities
- Transportation
- Insurance
- Medical costs
As you crunch the numbers, don’t forget that your needs may change as you get older. Your mortgage may be paid off, and you’ll save money on transportation costs associated with commuting to work. On the other hand, your medical costs will likely increase as you age, and inflation will cause prices to go up over time.
Once you’ve calculated your needs, it’s time to add up the costs of the things you want. These nice-to-haves are the flexible part of your budget. Your wants may include things like:
- Travel
- Hobbies
- Gifts
- Charitable donations
- Education costs for children or grandchildren
- Entertainment
Finally, add your needs and wants categories together to get your grand total.
Step Three: Decide How to Bridge the Gap
Now for the moment of truth: subtract your projected cost of living from your projected retirement income. Do you have money left over? (If so, congrats! You can skip to Step 4.)
If you ended up with a negative number, you have an income gap. That negative number is the amount of extra income you’ll need to to bridge the gap and enjoy a comfortable retirement.
This is where your other investments come in. Your TSP account is one place where you can draw extra income to bridge the gap. Other investments, such as a Roth IRA or a taxable savings or brokerage account, can also serve this purpose.
As you develop a plan to bridge the gap, you’ll need to decide which account(s) to draw extra income from. This is a complex calculation, and there’s no single right answer that works for everyone. You’ll want to consider the tax implications of each of your accounts (i.e., whether you will owe taxes on the money you withdraw, and at what rate) so you don’t end up with a nasty surprise. You’ll also want to factor in RMDs and your overall estate plan, if leaving a portion of your nest egg to your children and grandchildren is important to you.
As you develop your income plan, make sure that you don’t outlive your money. In general, a good rule of thumb is only to withdraw 3 to 4% of your retirement savings to make sure your money lasts. By taking only this amount, you keep your principal robust enough to continue growing, thereby maintaining your account over the long haul.
Step Four: What If You Don’t Have a Gap?
If you don’t have an income gap, you’re in an excellent position! You might decide to give some extra to family or donate it to charity. If you do this, be aware that the IRS has limits on gift-giving before it becomes taxable. On the other hand, you may be able to deduct charitable donations if you itemize.
You could also keep your money intact and let it continue to grow, but that strategy won’t last forever for traditional TSP funds. By the time you turn 73, you’ll have to take a Required Minimum Distribution (RMD) from your non-Roth retirement accounts. If you don’t need this money, you’ll still have to withdraw and pay taxes on it. Working with an expert can help you do this efficiently, so you don’t pay any more than you have to.
The Bottom Line
There are lots of moving parts to a full retirement plan. Your pension, Social Security, and investments should all work together to provide you the best outcome. If you need help managing all the complexities, get in touch! We’d love to help you develop an income plan that works seamlessly with your federal benefits to get you the retirement you deserve.
