Bridging the potential gap between pre- and post-retirement income.
This week our country celebrates Independence Day. It marks the moment when America became truly self-reliant.
Retiring with financial security at the end of a career marks a personal independence day. We had an acronym for this state of being when I worked at the FBI, and I’m sure employees at other federal agencies used it, too: KMA. It didn’t stand for “Keep Me Advised” or “Known Medical Allergies,” if you get my drift.
How do you know if you’re in a state of financial independence from your federal career? One way is to compare your net income while you’re employed to the net income you’ll have when you retire.
For example, let’s say that Kate has a salary of $90,461 (GS-11, Step 10 in the Washington, D.C. locality pay area). She has the following amounts withheld from her salary every two weeks:
- Federal Employees Retirement System contributions: $27.74
- Thrift Savings Plan contributions: $346.72
- Social Security tax: $199.02
- Federal income tax: 438.50
- State income ax: $220.76
- Basic Federal Employees Group Life Insurance: $13.95
- FEGLI Option B, 5 multiples: $91.00
- Federal Employees Health Benefits Program coverage: $209.98
- Federal Employees Dental and Vision Insurance Program coverage: $47.14
- Medicare Tax: $46.56
The total withholding amounts to $1,641.37 every two weeks. Her gross salary for 80 hours of work is $3,467.20, leaving her with a net income of $1,825.83. So Kate is living on a little more than half her actual salary. (Does that sound familiar?)
Kate brings home an average of $3,955.96 per month. This is important to compute, because her retirement benefits will be paid on a monthly schedule. Now let’s see if she’ll net the retirement income she needs to maintain her current lifestyle.
Kate is covered under FERS, has more than 30 years of federal service and is at least the FERS minimum retirement age (55-57, depending on year of birth). So she is eligible for optional, immediate retirement benefits. Let’s say Kate is now 57 and has 35 years of creditable federal service. If her high-three average salary is $87,203, then her retirement would be computed as follows:
1% x $87,203 x 35 = $30,521 a year or $2,543 a month
In addition, since Kate is eligible for immediate retirement under age 62, she is entitled to receive the FERS supplement that will bridge the time between her retirement and age 62, when she will qualify for Social Security retirement. The supplement would add $1,362.37 per month to her FERS retirement benefit, for a total benefit of $3,905.37 per month.
From this amount, Kate will need to consider possible reductions that might be applicable: for providing a survivor benefit for a current spouse or insurable interest, part-time proration, reduction for age if retiring under MRA + 10 provisions, and reduction for benefits payable to a former spouse. Let’s assume that she won’t have any of these reductions applied.
But wait: There are monthly withholdings for taxes and insurance. In Kate’s case, these are:
- Federal income tax: $741
- State income tax: $185
- FEGLI Basic: $30.22
- FEGLI Option B, 5 multiples: $197.01
- FEHBP: $454.95
- FEDVIP: $102.13
Total withholdings from her monthly FERS retirement benefit are $1,710.31, which leaves her with a net retirement income of $2,195.06. So she has a deficit of $1,760.90 from her current monthly income if she decides to retire.
What about the TSP? Kate can use the TSP retirement income calculator to estimate a monthly payment from her retirement savings. Remember to reduce this by federal and state taxes as applicable.
For example, if she has $250,000 in her TSP at 57, she could receive a monthly payment of $746.72 a month (before taxes) using the life expectancy payment option and a 3% future annual rate of return.
Her payments would be recomputed every year based on the year-end balance from the previous year and her new age. For example, at age 58, her payment would increase to $766.65.
At the time she must take required minimum distributions at age 70 1/2, the payments would be adjusted to the RMD amount. She could change from life expectancy payments to a specific dollar amount at any time to adjust the amount of her payment to meet her needs.
Under new TSP withdrawal rules to be implemented on Sept. 15, Kate could also choose to receive partial withdrawals as needed for big expenses that come up along the way, and she could change her monthly payment as often as every month if she switched to a specific dollar amount for her payment option.
Closing the Gap
What can Kate do to bridge the gap between her pre- and post-retirement income? Here are some options:
- Work longer. Every month she works will increase the service and salary used to compute her retirement benefit. If she waits to retire until she’s 62, her benefit will be calculated at a higher rate, and her Social Security benefit will be higher than the FERS supplement. Working longer also allows additional contributions to the TSP and her existing balance will have time to grow.
- Reduce life insurance coverage under FEGLI Option B if she no longer needs it. This could increase her retirement income by almost $200 per month.
- Consider changing her FEHBP plan to something less expensive, such as a consumer-driven plan or a high deductible plan.
- Try to pay off debt before her retirement, such as a mortgage, car loan or children's college expenses.
- Work at a new job after her retirement from government.
Has Kate achieved enough financial independence to retire this year? Maybe, but it might make sense for her to do some additional financial and tax planning to create a few scenarios where she would work a bit longer to be sure that her retirement lifestyle won’t be cramped.