While Mike Causey is away, please enjoy this column which originally published April 20, 2022.
If you have a simple exit strategy that provides the best deal for you in retirement, there is a good chance it may be wrong. Or at least not very simple. That’s especially if you work for Uncle Sam. As most insiders know, government can be complicated. And frustrating. But also very rewarding. If you do it right and take advantage of your best exit options.
Whatever your plan and goal, there are many cases where people don’t get the best deal for themselves. That’s because they don’t know all the rules, or the questions to ask, about their annuity, and the timing to get the best deal. There are a number of “best dates” to retire. Mostly for tax purposes or to get a piece of the new pay raise. Days like Dec. 31 or Jan. 3 depending on your retirement plan. But in addition there are definitely best times to retire, based on the answers to what seem — to we laymen — simple. But aren’t. By a long shot.
Example: Recently, a reader/listener sent us a “simple” question about retirement. Like most “simple” questions it turned out to be complex. So we passed it on to Tammy Flanagan. She’s a retired fed who now makes her living advising clients on retirement, and other job-related issues. Tammy will be my guest on today’s Your Turn radio show at 10 a.m. EDT. And we’ll talk about general retirement questions. Meantime, here’s an example as to why many people should get help in planning their retirement. The question is seemingly “simple.” The correct answer, anything but! The Defense civilian writes:
I am a federal employee with DoD and currently have 30 years of service but am 52. I’ve invested in TSP since 1992 at max allowance. I believe my retirement age eligibility is 57 — five years. Is there any benefit to taking an early retirement? I am married with two sons, currently 13 and 11, so by the time I am eligible to retire they will be entering/preparing for college.
Simple, right? Turns out not so much. Here is Tammy’s professional answer:
There are three main options to consider for this employee to plan her retirement.
It is important for her to run estimates of all three parts of FERS (FERS Basic Retirement benefit; FERS Supplement or Social Security retirement; various TSP distribution options).
Consider that all three benefit streams will be subject to federal income tax and depending on the state, also state income tax.
She will continue paying premiums for her insurance on a monthly basis in retirement using after-tax dollars.
If she is married, a spousal survivor election must be considered that will result in a 10% reduction to her FERS basic retirement benefit.
It is also important to plan for long term care so that future needs for care won’t derail her financial plan.
When planning for TSP withdrawals, be conservative with projecting future rates of return as the market will fluctuate over time and may not provide returns that have occurred over the past years of a bull market.
Years of lower returns can be devastating and stressful if her FERS retirement and Social Security retirement benefits aren’t adequate to stand up to these fluctuations in rates of return.
Here are the three options along with some considerations to keep in mind for each one:
Resign before her MRA and apply for a deferred retirement at her MRA.
Her future benefit will be based on her high-three average salary at the time she separates from federal service.
She will not receive any cost of living adjustments to her FERS retirement benefit until age 62. The benefit will be the same value for 10 years if she leaves federal service at age 52. Consider what your salary was 10 years ago. How much different was it from today? If high inflation continues, this will substantially erode your buying power of your FERS benefit and may cause you to deplete your retirement savings too quickly.
It is going to be difficult to stop working and not receive income for the next five years. Life expectancy payments from the TSP based on $500,000 starting at age 52 with a 3% future rate of return would provide a starting monthly payment under $1,300 / month. Use the TSP payment and annuity calculator to run different scenarios (remember that these payments will be subject to federal and possibly state income tax withholding, depending on what state you live).
Payments other than life expectancy payments or a life annuity will result in a 10% early withdrawal penalty tax.
Continue working to age 57 (MRA)
This is her first eligibility for an “immediate” unreduced retirement.
The FERS retirement supplement will be payable to provide another source of immediate income in addition to the FERS Basic Retirement Benefit.
There are no cost of living adjustments on the FERS supplement and the FERS basic benefit will be a level payment until age 62 when cost of living adjustments will commence.
There will be no 10% early withdrawal penalty on TSP distributions, allowing more flexibility in the type of withdrawal option selected.
Depending on the TSP balance, this may be the first realistic opportunity for retirement with enough income to replace your net income while employed.
Continue working to age 62
Eligible for the 1.1% annuity computation factor for the FERS basic benefit which is a 10% increase besides having more service and a more generous high-three average salary as a result of continuing to work.
Eligible for Social Security retirement which is more tax friendly than the FERS supplement.
FERS and Social Security retirement receive annual cost of living adjustments.
There is a better chance of having TSP distributions that will be adequate to last for a 30+ year life expectancy that will allow for future market fluctuations and years of higher inflation.
Length of Service
Computation of benefit (using $80,000 high-three average salary)
Not eligible for immediate retirement; resignation with deferred retirement payable at age 57
30 x 1% x $80,000 = $24,000; Social Security payable at age 62*; May take TSP withdrawals without penalty at age 59 ½ or life expectancy payments at any age.
First eligibility for immediate retirement
35 x 1% x $80,000 = $28,000; FERS Annuity Supplement = 35/40 of age 62 SSA benefit*; eligible to withdraw payments from TSP without a 10% early withdrawal tax penalty.
Eligible for immediate retirement and higher calculation factor
40 x 1.1% x $80,000 = $35,200; Eligible for Social Security*; eligible to withdraw payments from TSP without a 10% early withdrawal tax penalty.
Your retirement age is the age you begin receiving Social Security retirement benefits. For many people, this is not the same age you’ll stop working.
The age you stop working can affect the amount of your Social Security retirement benefits. We base your retirement benefit on your highest 35 years of earnings and the age you start receiving benefits.
If You Stop Work Before You Start Receiving Benefits
If you stop work before you start receiving benefits and you have less than 35 years of earnings, your benefit amount is affected. We use a zero for each year without earnings when we calculate the amount of retirement benefits you are due. Years with no earnings reduces your retirement benefit amount.
Even if you have 35 years of earnings when you stopped working, some of those years may be low-earning years. When you file for retirement benefits, those years are averaged into your calculation, creating a lower benefit. However, if you continue to work, your low earning years are replaced with your high earning years. Higher earnings increase your benefit amount.
If You Stop Work Between Age 62 and Your Full Retirement Age
You can stop working before your full retirement age and receive reduced benefits. The earliest age you can start receiving retirement benefits is age 62. If you file for benefits when you reach full retirement age, you will receive full retirement benefits.
If You Stop Work After Full Retirement Age
If you choose to work beyond your full retirement age, you have two options:
You can work and get full retirement benefits no matter how much you earn.
You can delay getting retirement benefits and earn credits that increase your benefit amount.
Imagine if that had been a complicated question? Gulp!