As federal employees enter retirement, they cross into foreign territory littered with risks. These risks often fall into four categories, longevity, spending shocks, inflation, and market risk.
For most federal employees, saving for retirement was the easy part, and figuring out how to manage these risks when approaching or entering retirement will be much more complex.
While retirement should be a fulfilling new chapter in life, Feds won’t have the retirement they envisioned if they don’t chart their course ahead of time to mitigate these risks.
To help shine some light on this crucial topic and help federal employees plan for retirement, we’ll review each risk and tips on preparing for them.
One of the fundamental risks of retirement is unknown longevity. Since your retirement could be shorter or longer than the statistical life expectancy, you must estimate how long your resources must last.
While a long life is wonderful, it also requires more resources. On the other hand, most don’t plan on dying the day after they enter retirement. So, how do you strike that balance between ensuring you don’t run out of money in retirement and spending enough to enjoy the retirement you worked so hard for?
Fortunately, Feds have two sources of income that will not run out, Social Security and the FERS pension. While both income sources will keep you from living under a bridge, it’s the handling of the TSP that will determine the quality of retirement for most.
Social Security Claiming Strategy
Increasing your Social Security benefits is one way to manage the risk of outliving your TSP. You might be thinking, that’s a no-brainer; I’m in! But before you get too excited, this is no free lunch. To increase your benefits, you’ll have to delay receiving them. You can read more about Social Security claiming here.
Custom Distribution Strategy
Another way to decrease the chances of depleting your TSP in retirement is to develop a custom distribution strategy. Reviewing your estimated life expectancy and adjusting for your family and health history will give you a more accurate number for your retirement projections.
Once you have a baseline, you can adjust your TSP withdrawals periodically based on your retirement savings balance and whether anticipated investment growth rates were realized. The distribution strategy I use for my clients is called the bucket strategy (more on this later).
2: Spending Shocks
Another significant risk federal employees face in retirement are spending shocks. Meaning large unanticipated expenses, the most common of which are rising healthcare costs, changes in-home needs, and inflation (we’ll discuss inflation separately in the next section).
Health Care Costs
As you age, hospitalizations, expensive prescriptions, and visits to healthcare specialists can quickly drain your nest egg.
In addition to increased healthcare costs, you could require long-term care at some point. A 2019 U.S. Department of Health and Human Services report found that 70% of adults who survive to age 65 will need long-term care before they die.
Change In Home Needs
Unfortunately, many Feds will find that their home is not well suited for them as they age. Some homes may have too many stairs, not enough senior amenities, or could be too far from health care and family. These changes might require significant remodeling or may require relocating.
Reviewing Healthcare Coverage As You Age
One way to lower health care costs is by comparing plans, paying particular attention to annual premiums and maximum out-of-pocket limits; this will give you a quick sense of how much your total out-of-pocket costs could be if you had a major medical event. Generally, a plan with lower out-of-pocket costs but higher monthly premiums will be optimal as you age. Read this article to learn more about comparing healthcare plans.
Federal Long Term Care Insurance Program
When it comes to long-term care, be proactive and plan early! Some federal employees can self-insure, meaning they can pay for long-term care out of pocket. But for others, the Federal Long Term Care Insurance Program may be the answer. You can read more about the FLTCIP here.
Preserving Flexibility And Liquidity
Lastly, preserving flexibility and liquidity will be critical to managing spending shocks in retirement. This can be done by using conservative assumptions when planning (rates of return, inflation rates, etc.), including annual allowances for additional expenses and maintaining an emergency fund.
Easily overlooked but potentially devastating in its impact, inflation is often called the silent killer. While inflation has averaged under 3 percent for the last couple of decades, there have been more than a couple of periods with above-average inflation; our current inflation is a great example.
To make matters worse for retirees, the inflation rate for healthcare costs has outpaced that for the general cost of living. And though Social Security benefits receive cost-of-living adjustments (COLAs), the COLAs for the FERS pension often lag behind the actual inflation rate.
Read this article to learn more about the COLAs for the FERS pension.
TSP Growth Is Essential
When discussing retirement income strategies with my clients, I point to inflation as the reason why retirees must keep a portion of their TSP invested in stocks. The reason for this is straightforward; if your TSP is not growing at a rate higher than inflation, your nest egg is losing its buying power. To maintain your lifestyle throughout retirement, you must build some inflation protection into your retirement plan.
Therefore, it’s imperative that you maintain an investment strategy that provides not only the income needed for annual living expenses but also the growth needed to outpace inflation. This is the balance required in retirement; you must protect yourself against investment risk (discussed next) while maintaining enough stock market exposure to combat inflation.
A great way to achieve this balance is by utilizing time segmentation or the “bucket strategy” in retirement, which will be discussed more in the next section.
4: Market Risk
The years immediately before and after retirement are often referred to as the fragile decade because of the disproportionate impact that your TSP’s investment returns have on the longevity of your retirement.
While stock market swings are normal, when these dips occur close to or in retirement, they can be especially painful, not only because we have more money than we had when we were younger but also because we have less time to make back what we lose in a downturn. Now pair that with the fact that you’re soon to be or are already making withdrawals, and you can see why a stock market downturn is so devastating near the start of retirement.
When developing a plan for addressing market risk, you’ll want an approach that helps you avoid selling your stocks during a market decline. Two such strategies utilize “buffer assets” to avoid selling stocks in a bear market; one method uses a cash reserve, while the other uses a reverse mortgage.
Cash Reserve (The Bucket Strategy)
The bucket or time-based segmentation strategy effectively mitigates market risk and is my approach when creating a retirement income plan for clients. This method divides assets into different “buckets” based on the time horizon (short, middle, and long-term) and provides an alternative to selling your shares at a loss during a market crash.
Thus, when there is a 50% decline in your TSP, you can rely on your short and mid-term buckets and allow your stocks (long-term bucket) to recover.
Read this article to learn more about the bucket system.
Lastly, utilizing a reverse mortgage as a buffer asset is similar to the bucket system. But instead of pulling funds from your cash and bonds (short and mid-term buckets), you’re pulling cash from a line of credit. This strategy allows federal retirees to use their home equity to provide income while giving their TSP time to recover from a significant decline.
Like a conventional mortgage, there are fees involved with this approach; however, those fees would likely pale compared to the losses sustained if you had to sell stocks in a significant market downturn.
For many federal employees, retirement can be a fulfilling new chapter in life – but it’s also a time of uncertainty and limited ability to adjust when disaster strikes, which is why sound preparation is needed.
While planning for the risks outlined above can be difficult, adjusting when living on a fixed income can be incredibly more challenging since you have less time and fewer opportunities to increase your resources.
I highly recommend that federal employees work with a fee-only Certified Financial Planner™ to explore the different strategies discussed in this article. By addressing the risks now, you’ll be in the best position to eventually enjoy the rewards of a well-planned retirement.
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