Income for Life
February 19, 2010
The topic of withdrawing funds from the Thrift Savings Plan is always a subject of great interest at my pre-retirement seminar presentations. The March issue of Money magazine, contains a short article claiming that one of the best ways to ensure your retirement savings last is to buy an immediate annuity, which provides a monthly payment for life.
So what options does a federal retiree have with a TSP annuity?
What Is a TSP Annuity?
The options to withdraw your investment from the TSP after you retire include taking a lump-sum payment, electing a series of monthly payments and purchasing an annuity. Keep in mind you can do a combination of all three options. For example, you can choose to receive 30 percent of your balance as a lump sum (you can transfer some or all of it to an IRA); 30 percent as a series of monthly payments (either a set dollar amount or payments computed based on your life expectancy); and the remaining 40 percent can be used to purchase an annuity.
The lump-sum option to transfer some or all your TSP funds to an IRA and the series of payments option both require you to continue to manage the balance in your investment to receive payments. Once purchased, the annuity provides a steady stream of income for life. To read more about the TSP withdrawal options, click here.
Whether you use some or all your plan investments to purchase a life annuity, this choice boils down to removing money from your TSP account and allowing the TSP to purchase a life annuity for you from MetLife Insurance Co. MetLife has been the provider for the TSP annuity program since it began in January 1988; the insurance company has assets of more than $120 billion, with more than 320 million individual annuity contracts and group pension certificates in force. In exchange for your money, MetLife pledges to send you a check every month for the rest of your life.
The advantage of this option is you'll have no more worries about the stock market and no fear of running out of money. Ironically, those are the two reasons why many people don't pursue this option because they think they can make more money by keeping their funds invested and diversified. And looking at a lump sum of $250,000 or more, it is tempting to think that it would be hard to spend that much money over your remaining lifetime.
How Does It Work?
The insurance company will compute your monthly payment based on the answers to the following questions:
- How much money are you using to purchase the annuity?
- How old are you (how long do they expect you to live)?
- Which features do you want the annuity to have? A cash refund to protect your principal in case you die early? A 10-year certain option that pays the monthly benefit whether you are alive or not? A survivor benefit option that will pay either 100 percent of the monthly payment over two lifetimes, or one that will pay 100 percent while you and your beneficiary are alive and then 50 percent to the survivor? Increasing payments to offset inflation?
- The current interest rate index, which is a fixed rate used to calculate your monthly payment. For for TSP annuities purchased in February, the rate is 3.75 percent. Since 2006, this rate has been as high as 5.75 percent and as low as 2.63 percent. Once purchased, this rate is fixed for the life of the annuity.
Let's look at some examples. The following case studies were calculated using the annuity calculator on the TSP Web site.
- Henry recently retired and purchased a single life annuity at age 60 using $250,000. He chose to receive increasing payments to help offset inflation. That decision will allow his annuity payments to increase as much as 3 percent, depending on the actual rate of inflation. In the event he dies unexpectedly, he also added a cash refund so his beneficiary can receive the amount of his original investment should he not live long enough to recover his investment through his monthly payments. Henry's initial monthly payment using the 3.75 percent interest rate index will be $900 per month. If he receives a 3 percent increase annually, his payment will increase to $1,174 per month in 10 years. If Henry waited until age 65 to purchase this same annuity (using the same amount of money), his monthly payment would be $1,030 per month and would jump to $1,344 after 10 years.
- Harriet purchased a joint life annuity with 100 percent payment to the survivor (her husband). She and her husband are both 70 years old. She also added the cash refund feature in the event she and her husband die before the $250,000 is recovered in monthly payments. Harriet chose a level payment since she reasoned that her monthly Federal Employees Retirement System benefit and her Social Security retirement benefit both receive an annual cost-of-living adjustment. She also used $250,000 to purchase this annuity at the current 3.75 percent interest rate index. Her monthly payment will be $1,478 per month, which will remain the same during both her and her husband's life times, regardless of whether one or both of them are still living. At this rate, Harriet and her husband will receive $250,000 worth of payments after 14 years. If they live past age 84, they will continue to receive the monthly payment of $1,478 each month. I checked with MetLife and found out that at age 70, Harriet has a life expectancy of 85, while her husband's life expectancy is 83. It seems as though if they live according to these expectations, they will simply break even. Based on Social Security's periodic life tables, at least one of them has a 50 percent chance of living beyond age 88 and a 25 percent chance of living past age 92. I used this calculator for the projection.
The advantages of purchasing a TSP annuity include:
- Receiving a lifetime income without fear of running out of money.
- If the interest rate index is high, you will lock in this rate for the life of the annuity. In the 1980s, interest rates on fixed annuities were as high as 18 percent.
- You can add features to the annuity at the time of purchase to protect your principal and allow an increase to offset inflation.
- An annuity simplifies your efforts to manage your retirement income.
The disadvantages of purchasing an annuity include:
- Once purchased, you cannot make changes to the annuity.
- Income from the annuity is taxable. You cannot halt annuity payments if you return to work or receive other income.
- There could be little or no money left for your beneficiaries.
- You already have at least two annuities -- your federal retirement benefit and Social Security retirement. Do you really need a third source of monthly income to meet your expenses, or would you rather have a lump sum of money available to meet unexpected expenses that crop up periodically?
- If you don't add the inflation option, your income can erode in value over time.
- You will be unable to withdraw funds to meet unexpected needs.
If you have additional questions about the annuity option or the TSP in general, tune in to "For Your Benefit" on Monday, Feb. 22 at 10 a.m. on www.federalnewsradio.com. Bob Leins and I are hosting the show with our guests from the Federal Retirement Thrift Investment Board, Executive Director Greg Long and Thomas Trabucco, director of external affairs. E-mail email@example.com or call 877-936-9333 to get answers to your questions. If you miss Monday's segment, the show will be archived so you can listen to it anytime, or download it to a portable device.
Tammy Flanagan is the senior benefits director for the National Institute of Transition Planning Inc., which conducts federal retirement planning workshops and seminars. She has spent 25 years helping federal employees take charge of their retirement by understanding their benefits.
February 19, 2010