Do you know what your TSP is for?
When you were first hired, your retirement benefit may have been described to you as a three-legged stool: pension, Social Security, and TSP savings. One financial planner advises feds not to shortchange the last leg.
Undoubtedly, one of the most important perks of federal employment is access to a pension benefit –an annuity– in retirement. Combined with Social Security, most, if not all, of your must-have essential expenses can be covered by guaranteed income. So, what role does TSP play in your retirement plans?
In short, a healthy TSP balance can be the difference between a retirement that is characterized by worry and “just getting by,” and a retirement that looks like a television commercial. (You’ve seen them: the happy gray-haired couple cruising the rivers of Europe…)
Determining your TSP goal begins with quantifying how much of your nonnegotiable spending can be covered by your pension and Social Security; the remainder of your spending must be addressed by your savings. The nuance that I would like to introduce is that the “remainder” — an unfortunately pejorative term — deserves every bit as much consideration as the so-called “essentials.” It will define your happiness in retirement.
There are the obvious nonessential costs that come immediately to mind, such as travel and hobbies. Will you want to go further, perhaps purchase a second home? Is leaving a substantial legacy to your heirs a priority that you want to account for in your savings plan specifically?
Medical and long-term care costs are somewhat tricky in this formulation. On the one hand, they are clearly compulsory. On the other hand, because these costs can be extremely hard to quantify with any degree of precision, it is difficult to plan for them within the context of your guaranteed streams of income. You would not be the first person to throw their hands up in frustration and leave it to chance.
But a more useful approach would be to conceptualize your TSP savings goal as consisting of two buckets: one bucket that is truly discretionary, and another that is a reserve for non-insured health needs.
According to the most recent Fidelity Retiree Health Care Cost Estimate, an individual should aim to save $157,000 to fund out-of-pocket medical expenses over the course of a typical decades-long retirement; for a married couple, $315,000. That is a shocking number. Of course, you know your own medical history best. Some readers will consider that estimate to be almost implausibly high; others will find it lower than their expectations. Nevertheless, dividing that number over the 30 or so years you expect to live in retirement can be a way to gauge if the annual income that you expect from your federal pension and Social Security will be sufficient for this need, or if you will have to account for this from your “medical care TSP” bucket. (If you have saved money in a Health Savings Account, you can, of course, adjust for that.)
Similarly, long-term care costs vary greatly. While, according to PwC research, the average cost is $172,000 for an individual, the dispersion of experiences is wide: a quarter of the time, an individual experiences long-term care costs of less than $26,000 while an unlucky 25% of the time, costs exceed $240,000. As with medical costs, your own and your family’s health history may be your best guide to how to think about this expense. But it must be part of your TSP savings plan, most especially if you do not have long-term care insurance, or if you have elected to carry insurance at a level that still leaves room to “self-insure.”
There is yet another reason — a much more uplifting one — that may inspire you to power-save in your TSP despite your pension. Many opt to leave federal employment when they are pension-eligible, but long before they are eligible to draw their full Social Security benefit. This may be a true early retirement or a downshift to part-time employment. Your ability to make this choice will be predicated on the ability of your TSP to support you as you wait to turn on Social Security. For younger federal employees who are decades away from retirement, the prospect of having this option in the future may be all the motivation needed to contribute as much as possible, as early as possible.
A final note: Federal employees now have the option to use a traditional or a Roth TSP. The decision of which to choose is multi-faceted. However, it should be evident from this discussion that your withdrawals from your TSP may be “lumpy”; that is, much higher in some years than others. This has the potential to create significant swings in your tax liability from year to year if all your TSP savings are in a traditional-type account. For that reason alone, you may want to “tax-diversify” your TSP holdings, allowing you to manage your taxable income from year to year.
What’s the bottom line? When you were first hired, your retirement benefit may have been described to you as a three-legged stool: pension, Social Security, and TSP savings. Don’t shortchange the last leg!
Financial coach and planner Lisa Whitley retired from the federal government in 2019. Her practice, MoneyByLisa, is a registered investment advisor.