military woman researching TSP

Thrift Savings Plan Participants: When Can You Retire?

Are you a United States government employee or a member of the military with retirement funds in a Thrift Savings Plan (TSP)? If so, you may be wondering when you can retire, and what to do with the funds in your TSP at retirement.

With more than 30 years of experience working with clients, we have come across many TSPs. Wealth management with a proper TSP analysis can be complex, so I'll break it down in this article. To start, here are two tips that can help determine if you're ready to retire.

Assess Your Expenses and Income

To assess whether you can retire financially, you need to first determine your likely expenses and your likely income in retirement. In fact, if you can, it's prudent to live on your estimated retirement budget before you retire to see if it's appropriate and find any unexpected holes. Finding issues early on gives you more time to fix potential problems.

If you are mid-career or approaching retirement, review your current budget and compare it to what you plan to live on in your retirement years. Will major expenses, such as mortgage and taxes, change? Estimate your expenses in all categories.

Then, calculate your income. Depending on the organization you work for, you may have several income streams in retirement: A TSP, a pension, an annuity and Social Security are all possibilities. Be sure to list all retirement income streams available to you.

The organization offering a pension should provide you with a predicted monthly income; same with an annuity. The Social Security Administration calculates your likely Social Security benefit. Add all of your income streams together.

Calculate what income you can safely withdraw from your TSP every year. One metric commonly used to calculate how much retirees can withdraw without running out of money is called the 4 percent rule. (Note: This isn't the case for everyone.) The rule states that if your retirement funds are divided about evenly between bonds and stocks, you could withdraw 4 percent annually with a high probability of not running out of money over a 30-year period.

In other words, if you have $500,000 saved in your TSP in the allocation noted above, you could potentially withdraw $20,000 per year, because $500,000 x 4% = $20,000.

Let's assume that you also have a pension and Social Security benefits. If your pension will also equal $20,000 and your Social Security benefits will total roughly $20,000 per year, you have a combined retirement income prediction of $60,000 annually ($20,000 TSP withdrawals + $20,000 pension payments + $20,000 Social Security benefits = $60,000). This is about $5,000 a month before taxes.

Compare this with your expenses. Are you on track for a comfortable retirement?

What Should You Do With Your TSP Funds in Retirement?

Knowing what to do with your TSP funds once you retire is important. Let's review the options.

Leave your money in the TSP.

No withdrawals are required from your TSP until April 1 of the year in which you turn 72 years of age, at which time you'll have to start Required Minimum Distributions (RMDs).

TSPs are an excellent retirement vehicle, so leaving your retirement funds there could be a wise choice. Talk with a TSP advisor about your asset allocation and have a TSP analysis before you retire.

This option allows your money to continue to grow, depending on market performance and what funds you've chosen for investment. A drawback to leaving your money in the TSP is that the range of investment options is limited.

Withdraw funds from the TSP.

You can also withdraw your TSP funds in retirement. There are several methods to accomplish this. Talk with a TSP advisor about what method is best for you.

You could withdraw funds whenever you wish. A benefit that gives you immediate access to cash for whatever purpose you choose (there is no restriction on what the withdrawn money can be used for). But remember that withdrawals will be taxed at your applicable income tax rate at that time. If you are younger than 59-½, there is an additional 10 percent penalty to consider.

Second, you could follow the 4 percent rule and withdraw 4 percent.

Third, you could keep your retirement funds invested until you arrive at the age for RMDs. These amounts are determined using the amount of money in your account(s) and your estimated life expectancy. Failure to take RMDs can result in a very steep tax penalty.

Roll over your TSP funds to an Individual Retirement Account.

Another option you have is rolling over your TSP funds to an Individual Retirement Account (IRA). An advantage to this is you typically have access to more asset classes – stocks, bonds, mutual funds, real estate funds, precious metals funds and more.

If you roll your TSP funds directly into a Traditional IRA, you will not be taxed. You will, however, be taxed at your ordinary rate when you withdraw Traditional IRA funds in retirement. Bear in mind, too, that you will also need to take RMDs from a Traditional IRA.

Roth IRAs are a bit different. By rolling all or part of your TSP funds directly into a Roth IRA, you will be taxed at your applicable income tax rate at the time of rollover if it was not invested in the Roth TSP. This additional income, therefore, can push you into a higher marginal federal income tax bracket.

Contributions to Roth IRAs are made from money that has already been taxed – quite different from Traditional IRA contributions, which are made pre-tax. But the advantage comes when you withdraw money from a Roth IRA in retirement. At that point, you owe no tax.

Other key advantages to moving these funds into a Roth IRA is they are among the only retirement funds not subject to RMDs. You can continue to invest in Roth IRAs and watch your money grow as long as you wish. You never have to withdraw Roth IRA funds if you don’t want to and the assets may pass to your heirs tax-free.

Determining the best plan for your TSP and retirement can be complex. Discuss your situation with a TSP or qualified tax advisor before making any final decisions. Small mistakes can have long-lasting effects on your financial future.

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The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.