If you’ve chosen a flight plan that takes you to retirement in five years, it’s not too late to circle the airfield
a few more times and make changes. You need to carefully check your investment bearings and make
sure that you’re on a path that will, at least, give you a strong probability of landing safely.
At this point, the minute details aren’t as important as the big picture. The most important thing is to make sure that you are not seriously off course and that your financial expectations are reasonable. You should be more concerned with determining whether retirement is feasible than the details of how it will work. You need to know where your income and savings must be in five years to retire and how you will get there.
With only five years left, counting on exceptional investment returns to deliver your Thrift Savings Plan
account to its target is not realistic. While it might happen, it very well might not. You should expect modest returns and, as much as possible, make sure you control your own destiny.
When it comes to your TSP account, you have to figure out how much money you require to support your needs. You have to decide how much you’ll spend in retirement and when. This can be done by sitting down and working out a retirement spending budget from scratch or, more easily, by making adjustments to your current spending to accommodate future events like paying off a mortgage.
In addition to a regular, or base, spending allowance, are you planning for any large lump-sum
withdrawals to cover special needs like a wedding, vacation home or new boat? If so, this can complicate the planning process considerably, and you’ll need to make sure that either you, or a financial planner you trust, is up to the task.
Once, you figured out how much you need, you can determine if you’re on track to have it in time.
Based on the overall amount you expect to need, estimate the initial TSP withdrawal amount you’ll need
to take, and which you will then adjust for inflation and withdraw each year in retirement. Once you know
this amount, you can use the TSP annuity calculator at www.tsp.gov to estimate whether the money in
your account will reliably support the needed withdrawals throughout your retirement. Selecting the
increasing payment option will provide you a conservative estimate of the amount you’ll need to have
accumulated when you retire.
Once you know how much you’ll need, you can gauge whether you’re on track to meet your goal. If you’re behind, you’ll have to increase your savings rate, work and save longer, or compromise your expectations in retirement to close the gap.
Liabilities and obligations
Make sure that you are aware of and understand any legal liabilities or other obligations that may affect
your account and your ability to take distributions when needed.
If you have a loan outstanding, you will have to repay it by the time you retire, or shortly thereafter, or it
will be declared a taxable distribution.
If you’re married, your spouse has rights to your account that he or she will need to waive before you’ll be allowed to take any distribution other than in the form of a joint and survivor life annuity.
If you’re divorced, there may be a court order affecting the distribution of your account.
You should carefully review these potential issues and keep them in mind as you move forward. You may want to have a plan in place to pay off an outstanding loan before retirement, and discuss your withdrawal strategy with your spouse to learn if he or she will be willing to sign a spousal rights waiver when the time comes.
If you plan to retire before the year in which you reach age 55, any withdrawals from your TSP account
will be subject to IRS rules covering early withdrawal. This means that unless you meet some rather
stringent exceptions, your withdrawals will not only be subject to income tax, but also to a 10 percent
early withdrawal penalty. While there are ways around this penalty, at this point, you need to at least understand whether it will or will not be an issue for you.
When you reach age 70½ or when you retire, whichever is later, you’ll have to start taking at least the
minimum distribution amount each year. Remember, however, that having to take a withdrawal does not
mean having to spend the proceeds. You are free to save the after-tax amount in a taxable or other tax-deferred investment.
During the five years before you retire, you should maintain a diversified investment strategy that avoids
unnecessary risk. I recommend that you consider using the starting allocation for the TSP’s L Fund that
corresponds to your life expectancy, or joint life expectancy if your are married, and applying it to your
account balance. This will be necessary if you plan to maximize the sustainable withdrawal rate that will
be supported by the account.
Written by Mike Miles
For the Federal Times
Publication June 4, 2007