One of the best rewards for working in the public sector is the healthy benefits package available to you upon retirement. Federal employees are entitled to a pension, Social Security, and tax-deferred investing through a Thrift Savings Account (TSP), along with other perks like healthcare and life insurance programs.
But despite the plentiful benefits, federal employees still need a detailed retirement strategy to maximize their income while minimizing taxes and commissions/fees. It’s not the same script as retirement planning for private sector workers either, who usually lack access to pensions. You’ll need a unique game plan if you’re a federal employee, since you’ll be encountering a different set of roadblocks than your private sector peers. In this post, we’ll walk you through the top five mistakes federal employees make with their finances so you can learn to avoid them.
If you’re looking for assistance in creating a personalized financial plan, speak with a CERTIFIED FINANCIAL PLANNER™ professional at Good Life Financial Advisors of NOVA today!
1. Retirement Rich, But Cash Poor
Tax-advantaged investing through a TSP is one of the best ways for federal workers to build a nest egg. Like a 401(k) or IRA, contributions made to a TSP are tax-deferred. This means that you get a tax break now and pay taxes on your distributions later. But one thing many federal workers underestimate is their actual income in retirement, which may not put them in a lower tax bracket as anticipated.
Additionally, TSP funds are subject to required mandatory distributions (RMDs) beginning at age 72. If your RMDs are too large, you may not only hit a new tax bracket, but you could also subject yourself to an Income Related Monthly Adjustment Amount (IRMAA) through your Medicare Part B (see income table here).
Another ding to TSP accounts came through the SECURE Act. Beneficiaries now only have ten years to spend down inherited TSP accounts, where before there was no limit. Federal workers should consider putting some retirement funds into a Non-Qualified account or the Roth portion of their TSP to avoid these tax issues.
2. Taking Social Security at Age 62
You can begin collecting Social Security when you turn 62, but it can be better to wait. As difficult as it is to turn down a free monthly check from Uncle Sam, taking Social Security as soon as you're allowed has serious life-long consequences.
Here’s one thing private and public sector workers can both do to extend retirement income: wait as long as possible before collecting Social Security. That’s because Social Security doesn’t kick in 100% until you reach Full Retirement Age (between age 66 to 67 depending on your birth date). You can delay further until age 70, adding an extra 8% to your monthly benefit for each year you delay. Yes, the additional cash flow would be nice, but taking Social Security at age 62 could mean a 30% or more permanent reduction in your monthly payments. This goes double if you’re collecting spousal benefits, where the spouse would see a reduction if claimed at age 62 as well.
Early claiming will also affect survivor’s benefits. If you perish before your spouse, they’ll be entitled to your benefit if it’s higher than theirs. If you didn’t claim until age 70, your spouse will also reap the benefits of waiting. Unless you’re in ill health or need cash for bills and expenses, it can be better to wait a little longer to claim Social Security.
3. Living Too Frugally
Living on a fixed income can be scary, because the threat of running out of cash before death always looms large. But if you’re a federal worker, you don’t need to be as concerned about dwindling cash as someone who spent a career in the private sector—thanks to your pension.
Many retirees worry incessantly about running out of cash, which prevents them from living the kind of life in retirement they’d prefer. With a pension, Social Security, and a TSP to fall back on, federal retirees can be less frugal and focus more on achieving retirement goals, such as traveling or spending time with family. Gross income may be lower in retirement, but proper retirement planning can help to make up the slack.
4. Annuitizing Thrift Savings Plans (TSPs)
One option that federal retirees have is to annuitize their TSP. In theory, annuitizing the TSP may eliminate investment risk in retirement by exchanging your funds for a guaranteed income stream. But this can be a terrible mistake. A life-long income stream may sound like a great perk, but there’s a reason that annuities are sometimes looked down upon. To annuitize your TSP, you’ll need to surrender ALL of your contributions to the annuity provider. You’ll get to select from a range of payout options, but you’ll have no control over the money you spent a lifetime accumulating.
5. Missing Unique Opportunities
The pension may be the key selling point for federal workers in retirement, but be sure to explore all avenues when discussing your benefits package. Here are a few decisions unique to federal workers who are preparing for retirement:
- Private Life Insurance vs Federal Employee Group Life Insurance (FEGLI). If you have a pre-existing condition, FEGLI won’t turn you down. However, private life insurance might be cheaper for some retirees than continuing with FEGLI.
- Rolling to IRA vs Staying in TSP. If you want to expand your investment opportunities, you can roll your TSP into a traditional or Roth IRA. You should discuss with your financial advisor the benefits and drawbacks of doing a rollover.
- Taking Early Distributions from TSP. Required minimum distributions for TSP account holders begin at age 72, but the account can be tapped beginning at age 59 ½ without penalty. If you have a large balance, taking distributions before age 72 could reduce your RMD amount, which with careful planning could help you avoid higher Medicare premiums as a result of IRMAA.
There are many options out there for federal employees. Having so many choices can create uncertainty and have you worrying about how to plan for your retirement. If you want to work toward your long-term goals, a knowledgeable financial advisor can help you understand and leverage the benefit options for your unique needs. It’s important to work with an advisor who understands the complexities of federal retirement benefits.
Good Life Financial Advisors of NOVA Specializes in Federal Retirement Planning
It’s important to avoid these top five mistakes federal employees make with their finances. If you have any questions, a financial advisor from Good Life Financial Advisors of NOVA can assist you. We specialize in working with federal employees, government contractors, and military personnel. Contact us today!