The Biggest Risk Federal Employees Face As They Near Retirement

The years immediately before and after retirement are often referred to as the fragile decade for your Thrift Savings Plan (TSP) because of the disproportionate impact that investment returns during this period have on your TSP’s longevity.

This disproportionate impact of investment returns is called the sequence of return risk, and it’s the greatest risk that federal employees face as they near retirement. So, this week we’re going to review why and how you might be able to mitigate this retirement killer.

What Is Sequence Of Return Risk?

Any federal employee who has paid attention to their TSP balance over the years knows that stock market swings are normal and are the price paid for a growing account balance. However, sequence of return risk (or sequence risk) amplifies the impact of these swings on your TSP as you near retirement.

Stock market ups and downs become more important in retirement because they are paired with ongoing withdrawals. Whereas before retirement, you could “buy the dip” or “dollar cost average” and benefit from drops in the stock market, in retirement, money is being withdrawn, and losses are realized. When you experience these realized losses early in retirement, you see the destruction of sequence risk.

For instance, imagine retiring right before the 2008-2009 recession and experiencing a drop in your TSP of 50%. Your one-million-dollar portfolio has just been cut in half, and now you need to sell double the number of shares to produce the same retirement income. Here’s the kicker, after selling your shares at a loss, those additional shares sold will not benefit from the subsequent market recovery.

In this scenario, such a drastic decline in your TSP early in retirement, even with subsequent years of great average returns, could mean a significant reduction of income and eventual TSP depletion.

Had the portfolio experience this decline ten or more years before retirement, you could have increased your savings rate or postponed retirement to ensure an adequate TSP balance. Had it occurred ten or more years later in retirement, the account would have been given more time to experience growth and thus have a larger cushion to absorb the hit. Equally important, a significant drop later in retirement would also mean fewer years of income left to provide from the account.

How To Mitigate

When developing a plan for addressing sequence risk, you’ll want an approach that helps you avoid the need to sell your stocks during a market decline. Two such strategies utilize “buffer assets” to avoid selling stocks in a bear market; one method uses a cash reserve while the other uses a reverse mortgage.

Cash Reserve (The Bucket Strategy)
The bucket or time-based segmentation strategy effectively mitigates sequence risk and is the approach I use when creating a retirement income plan for clients. This method divides assets into different “buckets” based on the time horizon.

For example, the short-term bucket would consist of cash (G fund) and provide 2-3 years’ worth of living expenses. In contrast, the mid-term bucket consists of assets with some volatility but also a greater return than cash, such as bonds or real estate. Lastly, the long-term bucket would hold high volatility and high growth assets, such as stocks.

This strategy effectively mitigates sequence risk by providing an alternative to selling your shares at a loss during a market crash. Thus, when there is a 50% decline in your TSP, you can rely on your short and mid-term buckets and allow your stocks (long-term bucket) to recover.

Read this article to learn more about the bucket system.

Reverse Mortgage
Utilizing a reverse mortgage as a buffer asset is similar to the bucket system. But instead of pulling funds from your cash and bonds (short and mid-term buckets), you’re pulling cash from a line of credit. This strategy gives federal retirees the ability to use their home equity to provide income while giving their TSP time to recover from a significant decline.

A reverse mortgage is like a conventional mortgage in that there are costs (origination fees, closing costs, etc.), and the initial loan is based on the appraised value of your primary residence.

However, there are significant differences, like age and FHA building requirements. While a complete overview of reverse mortgages is beyond the scope of this article, you can find more details on

Final Thoughts

The damage caused when a TSP account experiences negative returns right before or after retirement is sequence risk. This early reduction means that less money is available to benefit from subsequent growth, and thus, less is available to support the remaining years of retirement.

While many federal employees approaching retirement know that they’ll have to mitigate the risks of high inflation, spending shocks, and longevity, few have sequence risk on their radar.

However, now that you’re aware of this risk’s damage, you can prepare. Ideally, you’ll implement your plan five or so years before you retire so that a sudden market crash doesn’t catch you off guard.

Lastly, consult a fee-only Certified Financial Planner™ if you need help or aren’t confident in creating your retirement plan.

Get Tips On Maximizing Your Federal Employee Benefits!

Start on your path to financial freedom by getting our weekly articles full of tips on maximizing your benefits and the occasional freebie.

Privacy Policy: We do not sell or share your information with anyone.

2023 Legislative Change Notice

The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.

Author: Jose Armenta, MsBA, CFP®, ChFC®, EA

Hi, I’m Jose Armenta, a Certified Financial Planner practitioner. For over 14 years, I have worked with or among federal employees, from serving in the Marine Corps to my stint as a police dispatcher and now as a financial planner specializing in helping FERS federal employees. In that time, I have spoken to hundreds of federal employees about their benefits and retirement. Helping federal employees maximize their benefits, reduce taxes, and live confidently is a passion of mine. When I am not perfecting financial plans, you’ll find me at the shooting range, playing the drums, or breaching blanket forts with my three little ones.