Ep #39: TSP & Market Volatility: Part 2 – Buckets

You can spend. You can save. What is the right thing to do? Federal benefits, great savings plans too. You can save your own way, with help from Micah and Tammy. You can save your own way. Save your own way.

Micah Shilanski: Welcome to the Plan Your Federal Retirement Podcast. I’m your co-host, Micah Shilanski and we have a very special second episode.

If you listened to our previous podcast that we talked about, Tammy and I wanted to give you a special insight into questions that we were getting with regard to your TSP and market volatility. So, we had a great session one, where we were talking about market volatility, when they go up and your TSP goes down, what do you do?

We left with a bit of a cliff hanger of saying, great, you got to pay attention to the next episode when we talk about the secrets that we use with our clients and planning, called buckets of money. So, stay tuned for this episode, when Tammy and I chat about buckets and how to look at building a successful retirement plan with your TSP and other savings. How do we use buckets of money? And this is what it’s going to be. The first thing is, we decide when and how much money do you need earmarked for retirement? Then we start setting up…oh, perfect, thank you.

                  How to find buckets of money for short, mid and long-term from the TSP when the draws from the TSP are proportionate? Great question. I’m going to answer that in twofold, one, let’s talk about what buckets of money are and how they’re set up. Then we’re going to talk about how we need to blend the TSP to make this plan work. So, the big reason that I like buckets of money, and Tammy I’m going to make up some crazy scenario. Let’s say you go to retire, then all of a sudden the market has a hiccup, let’s say there’s a worldwide pandemic, the economies stop and the market falls several thousand points every single day. What are the odds of that happening, right? So, what we want to do with your buckets of money is, we never want to have it set up where you have to sell out when the market is going down. Because when the market is going down and you sell, this is when you’re hurt. This is what we talked about earlier, you got to let that money invest.

                  So, the way I look at it with my clients is, I want a five year clock, for the next five years, what are any monies that you want to take out of the market and they should not belong invested, they should be sitting on the sidelines. The first two years, so if we look in a retirement scenario, well, if she needs to pull out $1,600 a month, I want $40,000 when she goes to retirement, just sitting in cash. Now, doesn’t have to be under the mattress, right? I’d prefer if it wasn’t. Maybe it’s the G fund, maybe it’s a money market, maybe it’s something else, but I want cash, something that doesn’t go down in value. Because cash buys us time and time buys us options and that’s so important in retirement. So, our first bucket, we’re going to have cash set aside, our second bucket, I want three to five years of an income bucket. And an income bucket is something that, it’s going to go up and down a little bit over time but really not too much, maybe it’s bonds, maybe it’s CDs, maybe it’s structured notes.

                  There’s a whole bunch of things that could fit inside of there but I want to see, in this example, at least, $60,000 sitting in this income bucket, three years of distributions. Well, why do I want three years of distributions? Well, if I got two years in cash and three years in income, that’s five years of money needs. The next five years of money needs are taken care of. Let’s go back, I think, Larry asked in 2008, how long did it take the market to correct? Well, it’s 2008, ’09, ’10, ’11, right? We were getting past that fourth year, depending on contributions, let’s call it five to be safe. Four to five years to recover. Well, in this scenario, we have the next four to five years taken care of. She doesn’t have to sell, doesn’t have to come out of the stock market for anything for the next five years. This is really, really important to do because the stock market will go down more, it will go down again.

                  Now, once we have the first five years taken care of, we go to our last bucket, which is a growth bucket. And the growth bucket is our rollercoaster, that’s the C, S and I funds, right? That’s moving up and down and that’s going to be volatile over time. And what I like about this is, this gives you, as the retiree, flexibility in choosing where your money comes from. Because when the markets are really high and they’ve just skyrocketed, you could say, great, you could rebalance. You could take some out of that growth bucket, we could go put it in that cash bucket and rebuild that cash bucket up. But when the markets drop and they fall 20 to 30%, which is normal by the way, right? We all get a little worried about it but these are normal corrections that we see frequently.

                  When that market drops, you’re not selling out. We’re taking our money out of cash, it doesn’t affect, it allows your money to grow, it allows it to come back up. This is the most important part about the buckets, it helps stabilize your income and it allows your money to grow over time. Now, one of the things that’s with the buckets that are going to be there, which is a little bit more challenging, is how do we blend this with the TSP, right?

Tammy Flanagan:        That’s what I was going to ask.

Micah Shilanski: Oh, perfect. Well, Tammy, we have some… this is a future slide but let’s just talk about it right now. We have some limitations in the TSP distribution rules, right? The modernization act came out, which is great, it helped a lot but there’s still a little bit of limitations. So, would you walk us through, real fast, how those work?

Tammy Flanagan:        Yeah. So, on the TSP Modernization Act, which really did liberalize a lot of the withdrawal options from within the thrift. So, up until 2019, you really basically had to make a decision for all of your money within about two different time periods. So, now that we have this new law, we can now take partial withdrawals anytime we want to, once we’re separated from federal service. You can also change how much you receive in your monthly payment. So, if you tell the TSP, send me $1,000 a month, they’ll send you $1,000 a month until you tell them to change it. You can change it next month, you can change it next year, you could just leave it that way until the money runs out. So, you have a lot more control over how you take the money out, as far as the monthly payment distribution and whether or not you can peck the money and take lump sum distributions, in the meantime.

                  Now, the one thing that didn’t change and I still don’t quite understand why because I think this would’ve been a really significant change and really helpful to a lot of people is that, when you take a withdrawal and you’re invested, let’s say you’re 50% G and 50% C, just to make it easy. So, if I tell the TSP, send me $1,000 out of my G fund, they won’t do that. They’re going to send me $1,000 where 500 comes from G and 500 comes from C, because I was invested 50% in each. So, I can’t tell the TSP, I just want to withdraw from my cash bucket and leave my growth bucket alone for the next five to 10 years. So, one of the ways to compensate for that is that, the TSP does allow you to do multiple transfers out of the thrift.

                  So, if you wanted to move some money out, to either put it in your growth bucket or to put it in your cash bucket and leave your growth money in the thrift, you can do that. So, you can set up these buckets within and then, maybe some inside and outside of your TSP.

Micah Shilanski: And that’s, kind of, the blend that we need to have that, right? Because in going back to that question, how do we make this work in the TSP? And the answer with the bucket strategy is, we really can’t, just using the TSP, you got to blend the best. And this doesn’t make TSP bad, let’s be really clear. The TSP is a great tool for retirement, just like any tool, doesn’t fit every single occasion. Sometimes we need multiple tools to get a job done and this would be one of those cases where sometimes we’re going to blend that TSP. Maybe we’ll leave that income bucket, maybe we leave that cash bucket in the TSP because the G fund is great, right? Paying a solid interest rate, pretty high money market rate and it can’t go down in value based on how it’s set up. So, maybe that’s a great cash bucket or income bucket and maybe we put the growth in an IRA. Maybe we do a difference in there but you probably need to blend those to make them work.

Tammy Flanagan:        Right. And the other thing that did change also, some of you have money in the Roth TSP, we’re going to be talking more about Roth IRAs in a few minutes here. But if you had money in Roth, which is not going to be the majority because we’ve only had a Roth TSP for about eight years, but if you have Roth money and traditional pre-tax money, when you make your withdrawals you can designate, I just want to take it out of the pre-tax bucket, leave my Roth bucket, continue to grow tax free or move that Roth bucket into an IRA to keep that… I know your favorite bucket is the tax free bucket, mine too.

Micah Shilanski: How is it not, right? It’s great. Now, before we get into why do the buckets work, let me go back real fast. We have a decent amount of attendees that are several years from retirement. So, how does this apply to you? Same concept, right? Do you need money out of your investments, right? With IRA Roth, IRA TSP, I’m going to put them all in the same bucket, right? Do you need money out of those investments in the next five years? If the answer is no, then maybe you should really be looking at that growth fund that’s there. And I’m not recommending this to anyone, I know I talk with a lot of my clients that are five years from retirement or their TSP is allocated to be more than five years before we need that TSP money. Their contributions are going to the C, S and I fund, even when the market goes down, because we’re buying those dips.

                  Because in my theory, in five years, the market will be higher. My theory, right? We’re going to see if that’s true but I really think it’s going to be, so we’re buying when it goes down. So, even if we’re years from retirement, use the same methodology, do you need money within five years? And if you don’t, great, maybe it’s more in the growth fund. If you need money within the next five years, then stick it out. I have had several clients that need money to buy a house, their plan in the next couple years and they’re like, Micah, the market’s down, how about I put everything in? Absolutely not, right? We stick to our plan, have that if we need it in the next five years, it doesn’t belong in here.

                  So, let’s talk about why these strategies work. And we have a chart that’s called sequence of returns from BlackRock. And I’ll zoom in on this in just a minute so we can actually see it. The reason I chose BlackRock, if you’re not familiar with them, they’re actually the ones that manage the funds for the TSP. So, they’re the ones that, when you put money in, decide how it’s going to be allocated in the C, S and I funds, they do all the rebalancing, they put all that money to work. As the TSP office is really a service center, handling paperwork, et cetera, BlackRock is the money managers on the backend. So, I like to look at what they’re saying on how do you take money out. Let’s zoom in on this a little bit, Tammy. And what this chart says is, this is what’s called a sequence of returns.

                  It says, hey, we’re in our accumulation phase, right? We don’t need money, we’re saving money, we’re going to let it build and grow and we’re not going to. If we average a 7% rate of return over time, over the next 25 years, between 40 years young and 65, if we average a 7%, does it matter when we get a rate of return? Does it matter that, day one, the market goes up or what if the market goes down? What if we get a 7% constant? And what the show us in this scenario is, the red line is what happens when the market goes up right away, then it goes down. The yellow line is, what happens when the market goes down right away but then it recovers? You end up in the same spot, right?

Tammy Flanagan:        Markets are still going to go up over time, whether it’s up and down now or down and up now.

Micah Shilanski: Right. So, when we’re saving… our accumulators in the audience, right? When you’re saving money and that market dips, I’m not getting panicked about it, it’s a five year question. Do you need this money in the next five years? If yes, make a change, if no, great, probably stay invested, right? Yes, please—

Tammy Flanagan:        This might be a good time for Shauna’s question because it, kind of, ties into this, only from a little different angle, because she said, I’ve heard that the Roth is on sale. Well, actually, all stocks are on sale right now because they’re down, they’re low. It’s like buying shoes on sale, they’re at a lower price, you can buy more pairs of shoes. So, she says, can you talk about when to take advantage of the Roth options? So, whenever you’re doing this sequence of returns, is it really going to matter if you’re doing pre-tax money or after tax money? Because that’s really the difference between the Roth and the traditional.

Micah Shilanski: Absolutely. Now, I’m a huge Roth fan, I love Roth components that are out there. The TSP also made some positive changes with regard to the Roth and the TSP Modernization Act. Most of my client, I have them maximize a Roth IRA and we leave the TSP tax deferred, just because of the proportionate investment rules in the TSP. Everything has to be invested the exact same way, whether it’s Roth money or pre-tax money. So sometimes, depending on where you are in your career, you might want to separate those. If you’re very young in your career, maybe the TSP Roth might be a great thing for you.

                  It’s a tax question. If you’re putting all of your money in as a Roth, what a tax effect does that have today and if you can withstand that and you can, kind of, pair those taxes that are there. I’m a huge fan of funding those Roth IRAs, because that money’s going to grow and it’s going to be so valuable for you in the future. Because I think two things are going to happen, one, the stock more market will go up eventually and two, taxes will go up over time. We got $6 trillion we have to pay for, right? And that’s just in the CARES Act. So, all of these other things, the more tax free money you have, I am a huge fan of it personally.

Tammy Flanagan:        Right.

Micah Shilanski: All right. So, sequence of returns, put money in, let it grow, that’s wonderful on the accumulation. What about on the distribution? What happens if we change the scenario, we leave the rates of return the exact same but you started to take distributions, what’s going to take place? This is the full screen that’s going to be there, let me zoom in, if that’s all right, on just the chart. And this is saying, we started with a million dollar portfolio at 65 years young, you took out $60,000 a year from that portfolio and you had the same rate returns as we did in the previous chart.

                  Portfolio A, the red line started off really good, out of the gate, up and down over time but ended with $1.1 million. The green portfolio, portfolio B, as in bravo, that had a constant 7% and guess what? You ended up with $400,000 at your COD, right? At 90 years young. Which still worked out, you took out 60 grand every year. But what happens when you retire and that market drops? In this scenario, it was only 7%, only a 7% drop in the stock market and you ended up running out of money at 85 years young.

Tammy Flanagan:        So, let me summarize, Micah.

Micah Shilanski: Oh, please.

Tammy Flanagan:        This is what I’m getting out of what you’re saying. So, what I understand you to say is that, volatility is our friend while we’re accumulating money and we’re not taking any money out of our accounts. Volatility is, kind of, our enemy a little bit, whenever we’re taking distributions to live on and the market’s going up and down. So, we want more of a straight line when we’re living out our retirement years, maybe a little less volatility. Not complete safety but a little less.

Micah Shilanski: Well, how about, I’m going to jump back a few slides to our buckets of money.

Tammy Flanagan:        Right.

Micah Shilanski: How about we have the volatility in the right buckets?

Tammy Flanagan:        That’s right.

Micah Shilanski: How about we have our cash bucket where you don’t have that volatility, because it’s in the G fund? For example, money market, something of that nature. We have the income fund, which we don’t have a lot of volatility, you’re going to have a little bit, it’s going to move up and down, right? But over three years, you’re probably going to be ahead. But we save your volatility for our growth bucket, because that’s where it belongs. Because you still need your money to grow, we still need those C, S and I investments. You still need it but you need it in the right spot and that’s our growth bucket because that can stand the volatility because the market, at least over time, has always come back up.

Tammy Flanagan:        Right. We’ve got two questions right now that are very similar. This one from Greg says, he’s retired and he wants to transfer money from the G fund to the C or the I, for example, and he’s already retired. So, Greg, yes, you can do that, you can make interfund transfers, whether you’re working or retired. And then, I think the more important question is from Christina, she says, everything I have is in the G fund, should I move now to the other funds? What do I do about what’s happening right this minute? So, should either one of these people be making interfund transfers right now to, kind of, manage what’s happening with our down market that we’re in right now?

Micah Shilanski: Sure. The first thing that I would do and, of course, Greg and Christina, we’ll talk at ask your question, right? Because there’s so many other things about your personal situation we don’t know. Here’s what I—

Tammy Flanagan:        Or what other money you have.

Micah Shilanski: Yeah. What’s your income like, how much money do you need, all of these questions. Step one, do your retirement income timeline, right? And we’re going to have some tools that are available for you. In just a little bit, we’ll talk about to use this. Do your retirement income timeline. What money do you need for the next five years? That money I would want between my cash and my income bucket, right? Five years of distributions, that’s where I would want it. The rest of the money, I would be a little bit more growth leaning. I would say, and this is a scenario I took from a lady that was preparing to retire this year and she had moved all of her money as well to the G fund. And it was, when the markets are down, what do I do? My recommendation on her particular case, right? Was, we’re going to do five years here, we’re going to put the rest of the money back in the market and let it recover. Because it made sense for her.

                  Do that same analysis on you. Does it make sense? And can you stomach this growth bucket, which is right here? And Tammy, one of the things that I do a lot with my clients and it really helps with this, is why I don’t use the TSP for all of this solution, only a portion of it. Let’s say we’re using our TSP for the cash bucket, just to make it easy. Well, if I leave $40,000, in this case, in that cash bucket and then, I have another account which is an income bucket, then I have another account. So, three totally separate accounts, which is my growth bucket. I’m telling all my clients not to look at their growth bucket statement, right? It’s a little volatile, because it’s in the stock market.

Tammy Flanagan:        Right.

Micah Shilanski: But their cash bucket and income bucket, those are stable, that helps us make better decisions because we’re not seeing everything go down.

Tammy Flanagan:        Before you move on, Micah, this is a good question from Susan, because she doesn’t understand what you would put in the income bucket. Can you do that within the TSP? Is that the F fund, perhaps?

Micah Shilanski: You could, kind of, blend it inside of there. This would be a blend of a TSP and an IRA. Quite frankly, the F fund is the only investment which would fit in the income bucket. The G fund would be the cash, the F be fixed income, right? That would be inside of that. So, that would work a little bit, in that case. The F fund does move up and down, you can look at that historically, that’s going to be there. An F fund is a great example. Structured CDs, when the rates go back up, CDs would be good. Bonds, laddering, something that’s available. And what I’m looking for in my income bucket, something that’s going to pay higher than my cash bucket, right? So, if my cash bucket, I’m making up numbers, is 1.5% and the G fund, I forget what it’s at right now, then the income bucket—

Tammy Flanagan:        Not much better.

Micah Shilanski: Yeah. Not much better, right? My income bucket, I want something that’s not going to have volatility like the stock market but is going to do better than that 1.5. So, what are my bond funds? What are my CD options? Those types of things. That’s a good income bucket strategy. So, we talked about the sequence of returns, really important to understand how that works. And now let’s talk a little bit, and Tammy, maybe you just hit the highlights of this because you already went through the rules on just how the new rules of the TSP distributions.

Tammy Flanagan:        Yeah. So you can now, if you’re still employed, some of you are planning to retire but you’re not there yet and you’re wondering, can I take money out to move it into an IRA, perhaps while I’m still working? You can do four, they call them, age-based in-service withdrawals per year. So, you may not want to move a big chunk of money all at once. So, this is allowing you to do it at different timeframes. But the age-based means, you got to be 59 and a half or older to be able to do that. So, unless you’re at that age or unless you’re experiencing a financial hardship or unless the TSP does allow people of any age to take out that $100,000, under the new CARES Act, then you wouldn’t be able to do it. So, we’re going to watch the TSP website for the next few days, few weeks, to see if they’re going to implement that ability to take a lump sum distribution out, where you could invest in an IRA, if you wanted to.

                  After separation unlimited post withdrawal, lump sum payments and you can even take lump sum payments while you’re doing the installment payment plan, while you’re taking a monthly distribution. Once you are separated, I call this post-service because even if you’ve left government but you haven’t retired, you’re working in the private sector, you’re doing something else. So, after you’ve left federal service, even if you didn’t retire, if you just resigned from your federal career, you have options or access to all of these different withdrawal choices. So, lump sum just means a partial distribution. And as I said, you can do as many of those as you want or need to do. Just be careful, you don’t want to deplete your account too early by doing that. Installment payments, they used to call that monthly payments based on a specific dollar amount, now they’re calling it an installment payment. So, instead of paying the bank, you’re paying yourself.

                  So, you pay yourself a monthly payment out of your TSP account, either on a monthly basis, every month you get a check or quarterly, every three months they send you a check or once a year. So, that never was the case before, it was only monthly. So, today you can do a quarterly payment, an annual payment or monthly and change that anytime you need to make a change. Now, a question had come up a little earlier. Let’s see if I can find it real quick. They want to know, I’m just months out from retirement, I know I want monthly income from my thrift but I’m not sure if it’s best to use the MetLife option or just set up monthly payments from the government. Please advise and address security and interest on your account when you answer.

                  So, that’s a great question for this slide, because what they’re talking about is the annuity that is under contract with the TSP from MetLife. So, you do have an option, every TSP participant has the option to take some or all of their TSP money and convert it to a life annuity through this contract with MetLife. And likewise, I should say, you could take your money from the TSP and buy an annuity in the private market as well, if that meets your needs. Now, one of the concerns on this question was, what about security? So, there is a sense of security with an annuity, where you take that money, you give it to an insurance company, they invest it, they manage it, you don’t have to worry about the stock market anymore and you’re going to get a check every month for the rest of your life. That’s the concept of an annuity, a lifetime payment.

                  So, I guess, that does give you a sense of security but at what price? And the price you pay is, number one, right now the MetLife annuity option is paying a whopping 1.75% interest rate index. And by the way, that is locked in for the life of the annuity. So, if interest rates increased to 5% or 8% or even 9 or 10%, well, too bad, you locked your money in at 1.75% in 2020 and that’s what you’re stuck with for the rest of your life. So, there is zero flexibility, once your money’s over with MetLife, there’s no getting it back. And as you might imagine, this is not a very popular option right now. The TSP reports that, only 1% of the distributions that are coming out of the TSP in recent years have been in the form of the annuity option because interest rates have just been too low to make that a very wise decision at this point.

                  The reason why somebody might buy an annuity, whether it’s through the TSP or a private insurance company, is to give them that stream of income that they need for the next 30 or 40 years. And they’re worried about the fact that they’re not managing their investments well, that there’s volatility, but you can avoid that volatility, to some extent, by doing what we’re talking about with the bucket strategy, so that you’re not exposing all of your money to risk all at the same time. So, I think, in my opinion, anyway, the MetLife annuity right now would not be a good option for just about anybody because of the low interest rates and the fact you’ve given up your option to choose what you want to do with this money. You might need some of it later on in life and you want to be able to access it.

Micah Shilanski: Well, really hope you enjoyed that episode, as Tammy and I broke down how buckets worked, some TSP questions, sequence of returns, really important things to understand for longevity in retirement and getting an income stream that you don’t outlive. Now, one of the things we need to chat about too is what we call silver linings. So, there’s some good things that are coming out, there’s some great changes in the TSP that have already taken place and there’s still a lot of confusion about those. So, if you want to hear about those, make sure you stay tuned to our next episode and until then, happy planning.