Mind the Gap
If you’ve ever been on the London subway (Brits call it “the Tube”), you’ve seen the signs and heard the recorded announcement to “Mind the Gap.”
The “Gap” is that 10-12” space between a subway platform and whatever train is paused there, waiting for passengers to get on and off.
The announcement is basically a warning. It’s shorthand for, “Hey, watch where you’re stepping! Don’t slip down into the crack! Getting smushed by a train is NOT something you want.”
“Mind the Gap” also happens to be a great phrase for Americans to heed when contemplating their income gap in retirement.
The Gap Between Paychecks Amounts
Many retirees are shocked when they realize their retirement checks are not as large as the paychecks they used to get. Suddenly there’s a gap between the money they’re receiving from their pension and/or Social Security and their monthly expenses. They’ve suddenly got to figure out a way to navigate that money gap. Otherwise, they’re going to end up in trouble.
At Christy Capital Management, that’s one of the services we provide our clients. We help them “mind the (retirement income) gap.” And we prefer to do that in advance, before they retire, so that there’s no shock.
Here, in a nutshell, is how that process works:
First, we help you determine your employment income gaps. Obviously, this is only an illustration. These are not your numbers. But they’re typical or similar to what we’ve seen in our work with thousands of workers over the years.
Let’s start with a pre-retirement income figure.
Let’s say you currently live on $6,000 a month (after taxes and retirement savings, etc.) You take home $6,000 a month to spend on housing, food, entertainment, clothing, etc.
Let’s say that when you retire, your pension amounts to $3,000 a month. And you can draw Social Security for an additional $1,500 a month. That creates a total income of $4,500 a month.
Do you see the gap?
In your working life, you have $6,000 to spend. But in retirement, you’re only getting $4,500. Assuming no changes in your lifestyle, you now have a “budget” that’s $1,500 a month more than your income.
How are you going to “mind that gap”?
Here’s how some people do it:
- They use outside assets. This would be money saved and/or put into some kind of IRA or annuity.
- They withdraw from their TSP. Federal employees have the opportunity to withdraw money from a Thrift Savings Plan.
- They reduce their expenses. This is not a fun option. And, truthfully, most people find it difficult to find expenses they can eliminate altogether. They say things like, “Since I won’t be commuting, I’ll save a lot of money on gas, tires, and oil changes.” Then, in the next breath, they talk about all the trips they want to take! Can people save a few hundred dollars a month by tightening their belts? Some can. But a thousand or more? You’d have to be really spartan to achieve that.
- They get a part-time job and work in retirement. This is a bit of an oxymoron, don’t you think? Working in retirement? Sounds even less fun than the previous option!
Let’s focus on that second option:
Withdrawing money from your TSP. How would that work?
Let’s say you’re officially retired, and you have $560,000 in your TSP. You want to fully withdraw that money and do three things with it. Here’s how that could look (I’ll try to keep this simple.)
- You want monthly income. Let’s say you need $2,300 a month (to “mind the gap”), and you want it to come from the TSP for the next two and a half years (i.e., 30 months). You can tell your TSP to send you $2,300 a month for the next two and a half years, which would be a total of $69,000.
- You want some cash. Maybe you have some debt you want to pay off. Or you want to take a trip, or get a new car for this next chapter in life. You can go to the TSP and say send me X amount of cash. (Remember, you have to request a percentage of the balance of the account.) But for this example, let’s say you request $10,000. That cash request would be subject to a 20% mandatory withholding. So, after taxes, you’d get a check from your TSP for $8,000.
- You want to move your TSP money. You started with $560,000 in your TSP. You requested $69,000 in monthly payments. Then you took $10,000 more in a lump sum for debt repayment or a big splurge. That leaves $481,000 in your TSP that you could rollover into an IRA. I’m not recommending you leave the TSP to go an IRA, I’m simply illustrating how it can work. You have to determine the best course of action for you by meeting with a financial advisor.
If you move money from a traditional TSP to an IRA, there are no tax implications for doing that, as long as it’s done appropriately. You would need to be concerned about certain fees about certain fees and how such a move fits with your overall financial goals and plan.
To recap: In this full withdrawal example, you’ve utilized your TSP to get a monthly check to “mind the gap.” You’ve taken some money for enjoyment or paying off debts. And you’ve decided to roll the rest into an IRA, that would then be there for you to use at some later date.
You should know there are savvy moves you can make to avoid early withdrawal penalties. These involve the age at which you retire, the always-changing U.S. tax code, withdrawal rates, and where you’re pulling money from. As you might guess, all this can get quite complicated. It would be hard to explain or follow in a short blog post. We’d be glad however to discuss specific details and options in person.
Here’s a second example of how you could do a gradual withdrawal of TSP funds to close the gap…
Let’s say you have $500,000 in your TSP. And you want to withdraw money from it at a rate of 4% year after year. (NOTE: I’m not saying 4% is the ideal amount for you to withdraw. It may be 3% or 6%. That will depend on various factors: your life expectancy, your plans, etc.)
But for our purposes here, I’ll use the 4% figure. Do the math and you’ll see that 4% of $500,000 is $20,000.
Assuming a 20% federal tax rate and a 6% state income tax rate that means when you take a $20,000 distribution, you actually only pocket $14,800.
That’s the bad news. The $500,000 in “your” TSP is not all your money–if you’ve been saving it in a tax deferred vehicle. The government is going to demand its share. That means you’ll end up with a net of $14,800 annually, or $1,233 per month.
Put all these pieces together, and here’s what you’ve got. You’re accustomed to living on $6,000 a month. Add your $3,000 federal annuity, to the $1,500 you get from Social Security. Factor in the $1,233 withdrawal from your TSP. That comes to $5,733. That leaves a $267 a month shortfall. We had a big gap and we made it a lot smaller.
However, we didn’t completely close it. So now we have to look at other assets, or reducing expenses, or working in retirement.
If this were your situation, and you and I were having this conversation, I would say, “Before you retire, you need to figure out how to live on $267 less a month. Or you’ve got to figure out where you’re going to find an extra $267.”
And my encouragement would be to do it now. If you say you can reduce your expenses and live on less in retirement, then do it for a six month window before you retire. This will prove if you really can or if you just thought you could. That experiment will make the adjustment easier once you retire.
I’ve had clients do this and decide, “I don’t like having to rein in my lifestyle. I’m gonna work another year so I can close the gap by having more assets..”
Often, during discussions about “the gap,” clients will mention their mortgage. Some say, “When I retire, I’ll take $100,000 out of my TSP and pay off my mortgage. That’ll cut my monthly expenses.” However, remember there are tax considerations. To end up with 100k to pay off a mortgage, you’ll have to withdraw 140k (because Uncle Sam will want his share).
There’s also this: A large withdrawal from your TSP can potentially throw you into a higher tax bracket!
Bottom-line? There’s a lot to consider when thinking about the “retirement income gap.” That’s why we love helping people sort through all these complicated decisions.
If you need help, we would love to help.
In our menu above–you’ll see a green TALK WITH AN ADVISOR button. Click it, and leave us a short message. We’ll be in touch right away.
At Christy Capital Management, we help folks take the mystery out of retirement. We’d love to help you too.
