Switching from Accumulation to Withdrawal
During most of your working career you will be adding money to your Thrift Savings Plan (TSP) account in hopes that you can accumulate enough funds to adequately supplement your retirement income when that time comes. When retirement does arrive, you can finally start withdrawing money from your TSP to help fund your retirement. Two important questions will arise as you transition to retirement. First, how should you invest your funds during retirement to maximize your return on investment while still protecting yourself from inevitable market fluctuations? Second, what investments should I sell in any given year to improve my long-term return on investment (ROI)?
How to Invest Your Funds During Retirement
Let’s consider the first question of how to invest your funds during retirement. In the world of finance, risk is measured by the amount your investment normally fluctuates in value over a period of time. An investment that fluctuates greatly in value is defined as riskier than an investment that fluctuates very little. To compensate for the additional risk, riskier investments usually provide a higher ROI over the long term (many years). For example, stocks fluctuate in value more than bonds in the short term, but also provide a higher ROI than bonds over the long term. In order to protect retirees from stock market downturns, most financial planners recommend that retirees diversify their investments and allocate some funds to stocks and some funds to bonds. For the TSP, you could do this by investing in a TSP Lifecycle fund. The Lifecycle funds maintain a mix of stocks and bonds with the bond allocation growing as you get closer to retirement and then retire. Many financial planners think that the allocation to bonds in the Lifecycle funds are too high compared to the allocation to stocks and instead recommend a 60/40 mix during retirement (60% of your funds in stocks and 40% in bonds). To achieve a 60/40 mix, you can invest your funds directly in TSP bonds funds and stock funds. This will maintain a higher amount in stocks than the Lifestyle funds and should improve your long-term ROI. For the TSP, you can achieve a diversified 60/40 portfolio by investing 60% of your funds in the C fund and 40% in the G fund. The risk with this approach is that the value of the C fund can drop dramatically from one year to the next, but some of this risk can be mitigated by adjusting your withdrawal allocations as discussed next.
Adjusting Withdrawal Allocations to Improve Long-Term ROI
Now let’s consider the second question of selling your investments to meet your retirement needs. When you request a withdrawal from the TSP, the withdrawal will be prorated according to your investment balances. If your TSP allocation is 60% C funds and 40% G funds, your withdrawal will be apportioned 60/40 from the C fund and the G fund. However, it might be better to pull more funds from the C fund after a year in which the stock market has done well and to pull more from the G fund after a year when the stock market has done poorly. As a specific example, let’s assume you make a yearly withdrawal from the TSP to help fund your retirement and you use a 60/40 allocation between the C fund and the G fund, you could follow the following rules for your withdrawals:
When the C fund increases at least 20% in the previous 12 months, you withdraw 100% from the C fund and none from the G fund. Since the TSP will automatically allocate your withdrawal according to your fund percentages, you will need to do an interfund transfer of 40% of your withdrawal amount from your C fund to your G fund.
When the C fund decreases at least 10% in the previous 12 months, you withdraw 100% from the G fund and none from the C fund. Since the TSP will automatically allocate your withdrawal according to your fund percentages, you will need to do an interfund transfer of 60% of your withdrawal amount from your G fund to your C fund.
For all other years you first rebalance your portfolio allocation to 60% stocks and 40% bonds and then you withdraw 60% from the C fund and 40% from the G fund.
Higher ROI for Some Effort Once a Year
The advantage of this type of withdrawal method is that the C fund will fund your withdrawals when the C fund has very high returns and the G fund will fund your withdrawals when the C fund has suffered large losses. This will give the C fund a chance to recover before withdrawing funds from the C fund. This type of method will require some of your time each year. However, if you are willing to make the effort, you should achieve a higher ROI compared to using a Lifestyle fund or trying to strictly maintain a 60/40 investment mix and withdrawal allocation.
