A serious downfall of the 4% rule is that it treats all your retirement spending as being equally important, Whitley explains.

A serious downfall of the 4% rule is that it treats all your retirement spending as being equally important, Whitley explains. mikroman6/Getty Images

Saving for retirement in your TSP with a federal annuity: How much is enough?

Planning for retirement with a federal pension is different from planning for retirement without one.

As you surely know, one of the most valuable benefits of federal employment is the prospect of a guaranteed stream of income in retirement. That is, a pension (annuity). At the same time, you might suspect that your pension alone will not be adequate to fund the retirement lifestyle that you desire. And so, you also regularly invest through your TSP account. But how much is enough? 

Likely you have heard of the 4% rule. While the word “rule” is a bit of an overstatement, the general idea is that when an imminent retiree observes their nest egg, there is an amount that they can withdraw each year and, assuming common investment return assumptions, not run out of money before they die. That amount is 4% (adjusted for inflation). 

This rule of thumb is based on 1994 research by Bill Bengen. While it has been poked and prodded over the years — at various times, commentators have suggested 3%, others 5% in some circumstances — there really hasn’t been a substantial deviation from the original figure. 

Although not always obviously so, this “rule” underpins many popular online retirement calculators that illustrate how much you need to save each year during your working career to fund a comfortable retirement. The most simplistic “plug and play” calculators assume that your retirement will be funded by a combination of Social Security and your accumulated savings. For federal retirees, this poses something of a (good) problem. With a pension in the mix, surely it should be the case that you can save less in your TSP than the 4% rule assumes. How do you put a number on that?

In fact, we can employ the handy “4% rule” to back-of-the-envelope our way to a result. If your projected annuity is $40,000 a year, the “rule” tells you that you need to save $1,000,000 to achieve the same result. ($1,000,000 x 4% = $40,000) So you might then say, “Well, as I do have an annuity, I can plan to save $1 million less in my TSP than recommended by the simple calculators.” (Or you may be more conservative, and reduce your goal by, say, $750,000.) 

That’s not a bad approach, but it does feel a bit…simplistic. A serious downfall of that method — and the 4% rule in general — is that it treats all your retirement spending as being equally important. 

At some point, you may have completed an exercise to determine how much you will likely spend in retirement. Or you may have settled on the other common retirement assumption that your expenses in retirement will be 80% of what you spent while working. But if your analysis stops there, I’m afraid that you have only done half the work. And this brings us back to how planning for retirement with a federal pension is different from planning without.

Generally, your living expenses fall into two camps: must-have and discretionary. In retirement, the goal is to be able to cover all your “musts” with guaranteed income. For federal retirees, that means Social Security and your pension. A more nuanced calculation of your TSP goal would be to first determine your non-discretionary expenses (housing, food, medical care, transportation, etc.), and subtract that from your projected guaranteed income stream. Ideally, the result would be a positive number. (Will you decide to work longer than originally intended to increase your annuity and make this so?

Your TSP goal, then, would be the amount of money necessary to fund your discretionary spending, such as travel, a second home, or a more elevated day-to-day existence.

There is one other aspect to consider when a future federal annuity recipient is investing in their TSP. Simply put, can you take on more investment risk because you have a pension that, combined with Social Security, could cover all your non-discretionary expenses? Or should you take less investment risk because you already “won the game” and don’t need to generate an outsized rate of return to secure a happy retirement? There is no math answer to this question; it is a matter of your personal risk preference. That is, with a pension in hand, you may objectively have the capacity to take on more investment risk, but do you have the emotional desire to do so?

Does having a federal pension make it easier or harder to plan for your retirement? On balance, I think that most of us would vote “easier” because it removes much (but not all) of the risk of “getting it wrong.” But there are still critical decisions to be made, particularly how much to devote to your TSP savings during your working career. Understanding how you might use this nest egg in retirement could help you answer that question.

Financial coach and planner Lisa Whitley retired from the federal government in 2019. Her practice, MoneyByLisa, is a registered investment advisor.