There are a lot of misconceptions about retirement. Here are the three most common ones every federal employee should know.
1. Cost of Living and Leisure Spending Will be Lower in Retirement
Everyone plans to be debt-free before retirement. We all hope to have paid off our mortgage, car, credit cards, and other debts. The possibility of paying off debts is why most people believe they’ll spend less in retirement. But while being debt-free may lower your monthly expenses, several unexpected expenses may arise, including the following:
Children/grandchildren: Many retirees may retire early and find themselves paying for their children’s education or grandchildren’s living expenses.
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Federal Employee Health Benefits: FEHB increased by 4% in 2020, while federal employees received only 1.6% COLA on their annuity. Also, bear in mind that federal employees pay their healthcare costs before taxes, while retirees pay after taxes.
Travel expenses: Retirement provides you with a lot of time to embark on all the trips you’ve been postponing. Increased traveling would result in increased travel expenses.
Inflation: While federal retirement benefits receive Cost-of-Living Adjustments (COLAs), which help reduce the impact of inflation on your income, it rarely eliminates it entirely.
When planning for retirement, it’s important to consider your current lifestyle. Do you currently live below your means and save part of your income, or are you spending it all every month? Answering this question would help dictate the direction in which you should plan your retirement.
Don’t just expect your cost of living to reduce when you retire. It’s wise to plan for unexpected expenses.
2. You’ll Fall Into a Lower Tax Bracket in Retirement Since Your Income Has Decreased
Depending on the years of service and retirement age, most federal employees often receive within 40% to 80% of their salary in retirement. This typically is supposed to trigger a lower tax bracket, but that’s not often the case.
Total income: To fulfill the standard of life they want in retirement, employees typically get income from various sources like Social Security, retirement supplement benefits, and their contributions to Thrift Savings Plans. Savings to traditional TSPs are tax-deferred and taxed upon withdrawal in retirement. Considering increasing national debts, it’s possible that the tax bracket may change in the future. So you have to decide whether it’s best to pay taxes on your retirement contributions now or later.
To avoid unpredictability, consider investing in a Roth account. Contributions to Roth accounts are made after-tax, which means you get to withdraw your money tax-free in retirement.
3. You Should Stop Saving and Investing in Retirement
Your working years are a saving period to enjoy a comfortable retirement. Your goal should be to eliminate your debts and save to your TSP accounts and other retirement plans.
Retirement, on the other hand, is a period of spending. Typically, the expectation is to stop saving for your nest egg when you retire. But that will depend on how much you have saved up and the number of years you’ll spend in retirement.
Currently, there’s a 50% chance of a man reaching age 86 and a woman getting to 88. So we are looking at twenty-five to thirty-five years in retirement. What determines whether you should stop saving is whether you have enough funds to live on in thirty-five years comfortably.
If you don’t, then there’s a need to save and invest part of your income in retirement so it can grow and last for more years. Consider investing in a Roth TSP/IRA account (which is tax-free in retirement) to give you more control of your income.
