You may have heard of the so-called “4% Rule”, which, like all rules that have to have quotation marks around them, are not hard and fast. Basically, the rule says that, if you begin withdrawing from a lump sum of money (say, your TSP account) at a 4% rate, you will be able to take annual inflation adjustments and have a better than 90% chance of not running out of money in a 30 year period.
Financial experts came up with this number by using “Monte Carlo Simulations”, which are designed to give the odds of running out of money in a specified period of time. Most of the calculations used a portfolio that was balanced between equities and fixed income. They looked at market returns over a long period of time (often back to the 1920s) and mixed them up in random return scenarios. Imagine a giant bingo ball that, instead of giving you B11, O36 and so on, gave you 1952, 2014, and so on. Some of the calculations ran thousands of scenarios and in over 90% of them, there was money remaining at the end of 30 years. In close to half of the scenarios, there was as much, or more, money remaining at the end of the time period.
Using this rule, if one wanted to have $20,000 of annual income that could be adjusted for inflation; they should shoot for a balance of $500,000 in their TSP account.
Let’s now turn the 4% rule upside down to show the value of a FERS pension. In other words, how much would one have to have saved to create the same stream of income that is created by our inflation-indexed FERS pension? For an example, we will have a FERS employee who retires with a high-three of $100,000 at the age of 60 with 30 years of service. The FERS computation factor that would be used in this situation would be 1% per year of service multiplied by the high-three average annual salary. Upon retirement, they will be entitled to a FERS pension of $30,000. The pension would not begin to receive a cost of living adjustment until the individual turns age 62. In order to generate $30,000 of inflation indexed annual income, the 4% rule tells us that the person in question would have had to have saved $750,000.