By the time someone gets to the end of their career, they are generally really good at saving for retirement. In the finance world, we call this the accumulation phase.
But as people retire, they leave the accumulation phase and enter the distribution phase—the phase where they start using the money that they have saved. And this is where it often gets tricky. The distribution phase comes with new challenges.
Saving enough money for retirement is like climbing Mount Everest. Getting to the top is an incredible feat but once you get there the next challenge is getting down. And on the real Mount Everest, many say that the descent is actually the most dangerous part. The same could be said of the TSP withdrawal phase.
Here are some big TSP withdrawal mistakes.
Don’t Wait Too Long
A huge part of correctly navigating retirement is understanding how to manage taxes. For most retirees, the biggest component of their retirement savings is in the traditional TSP which will be taxed upon withdrawal.
Some people are in the fortunate position to not need much of their TSP during the early years of retirement because of other sources of income. One consequence, however, is that this might push them into higher tax brackets in later years when they are subject to required minimum distributions.
Required minimum distributions start at age 72 and are required for both the traditional and Roth TSP. They are required for traditional IRAs as well, but not for Roth IRAs.
Basically, RMDs require you to take out at least a certain portion of your retirement savings every year whether you need the money or not. This may push you into a higher tax bracket than you were in during the first part of your retirement.
One strategy you can use to level out your taxable income over your entire retirement is to do Roth conversions in lower tax years. This way there will be less pre-tax dollars subject to the required minimum distribution down the road.
And while the TSP does not allow you to move money from the traditional TSP to the Roth TSP, you can transfer your traditional TSP into a traditional IRA which can then be converted into a Roth IRA.
To be clear, I am not saying that you should distribute your TSP before age 72 just to avoid the required minimum distributions. But you will want to have a strategy to minimize the taxes you pay over the course of your entire retirement, not just during the first part.
Buy Low, Sell High
We have all heard the classic investment advice to buy low and sell high. In other words, you should buy stock-based investments when the market is low and then sell when it is high.
But we have a problem. When we take any amount of money out of the TSP, it comes out of each fund that you are invested in proportionally.
For example, if your money is divided equally between the the C Fund and G Fund, withdrawing $100 would mean pulling $50 out of the C Fund and $50 out of the G Fund. But what if the market is down and you don’t want to sell out of the C Fund until the market comes back up?
There are a number of ways to get around this but one strategy is to have a “cash bucket” outside the TSP that you can use as you wait out down markets. This way you don’t have to sell when the market is down.
The next question is how do we buy low in retirement when we are no longer contributing more money into the TSP?
A periodic rebalance of your TSP can be a great tool to do this. A rebalance is simply moving money around in your account to get your allocation back to where it should be.
For example, let’s say that you determine that the ideal allocation for your TSP in retirement is 50% C Fund and 50% G Fund. Overtime, because those two funds grow at different rates your account won’t stay at 50/50 for long. A rebalance is a combination of buying one fund and selling the other to get back to your ideal allocation percentages.
So when the market is down, your allocation may be 40% C Fund and 60% G Fund because the C Fund went down in price. In this case, a rebalance would mean selling some of the G Fund to buy some of the C Fund—buying when the market is low.
And when the market is up, a rebalance would be selling C Fund and buying G Fund—selling high.
Rebalances should occur on a regular schedule (annually often makes sense) to stay consistent regardless of what the market is doing.