Pondering your new withdrawal options? Here are a few principles to factor in.
So you’ve accumulated a handsome sum in your Thrift Savings Plan account and are close to being eligible to retire under the Federal Employees Retirement System. Congratulations! Have you considered how you will draw down the balance of your retirement savings? Because you will soon have more options, due to the enactment of the TSP Modernization Act.
The TSP published a fact sheet this week outlining some of the frequently asked questions about the new law. TSP officials are clearly aware of the excitement among participants about greater flexibility in drawing on their savings, but they’re also asking for some patience while they revamp their systems to roll out the new options.
In the meantime, let’s revisit some general principles about tapping into your TSP after retirement. Here are a few things to think about before making a post-separation withdrawal election:
You may want to delay your request if you don’t need the money. If you plan to go back to work after you retire, you probably won’t need to begin using your retirement savings. Many employees who retire under FERS (as well as the Civil Service Retirement System) may not be financially ready to fully retire. Others may simply want to work in another capacity for a few more years. If your plan is to go back to work on Monday after you retire on Friday, then you may benefit from allowing your retirement savings to continue to grow.
Remember that while you can’t add money to your account (other than transferring other retirement funds into the TSP), your investment will continue to be allocated among the various funds in the plan according to the way you have designated. There’s an old principle called the Rule of 72 that can help you estimate how quickly your money will double based on the anticipated rate of return. To apply it, simply divide the rate of return into 72. So, for example, if your investment earns a 6 percent rate of return, your money will double in 12 years. No one knows exactly what the future rate of return will be, but even at a fairly conservative 4 percent rate, you money will double every 18 years.
You have to pay income tax on traditional TSP withdrawals. Some employees may decide to take advantage of the ability to withdraw a large lump sum to pay off their mortgage or reduce other outstanding debt. Remember, though, that even if you’re not subject to a tax penalty, you still have to pay federal and, in most cases, state income taxes on your TSP withdrawal. A large lump-sum withdrawal will require you to pay the highest marginal tax rate.
You may lose a tax write-off. Also, remember that if you have a mortgage, you can deduct the mortgage interest from your taxes. So it might not be the best idea to pay off your mortgage.
You may have other money in a taxable account. If you’ve been saving for retirement using mutual funds or other investments outside of the TSP, then you may wish to draw on this money before tapping your tax-deferred funds. Even if you need to pay capital gains taxes on these withdrawals, the rate for most people is only 15 percent, not 28 percent or higher.
You might run out of money if you withdraw too much too soon. It’s hard to predict exactly how long your funds will last. There’s that whole life expectancy thing, and rates of return can make a big difference over the long haul. Earning a 6 percent average return will make a healthy TSP balance last many years longer than a 4 percent return.
Of course, even given all the above considerations, it may be in your interest to tap your TSP investments as soon as you retire. After all, the money you have been saving in the TSP is for your retirement years. If you’re able to retire young, then you may need to use the TSP to supplement your FERS benefit and your FERS Supplement.
To learn more about the income that your TSP can provide for your retirement, try the TSP’s retirement income calculator. Next week, we’ll review the monthly payment options available from the TSP to help you understand the choices you’ll have when making the important decision of how to create a stream of income with your retirement savings.
Photo: Flickr user Ken Teegardin