Another Look at Annuities
Last year, I wrote a pair of columns on TSP annuities:
This week, I'd like to revisit the issue, addressing questions submitted by readers after those columns on annuities. I have my TSP in the 2020 life-cycle fund because that's about when I planned to retire. I'm wondering if I should move it to the 2030 life-cycle fund to gain a higher return and because I'll be 74 at that time.
I'm not a financial adviser, but I do know a few things about investing in the TSP. First of all, there is a lot that can happen between now and 2020, so continue to modify your investments and strategies as your plans change.
The L 2030 Fund will not always have a higher interest rate than the L 2020 Fund. The rates of return for the investments held in each fund will fluctuate based on the holdings within that fund.
The idea behind the life-cycle funds is to reduce the volatility of your investments as you approach retirement. The question is, when will you need to start withdrawing from the TSP? When you retire, what other sources of income will you have? Since you will be 74 at the time you are planning to retire, you will be facing required minimum distributions from the TSP after you leave federal service, so you won't have the option to leave the money in the TSP untouched. You will be required to begin taking payments, or transfer the money to an IRA to receive your required minimum distributions through a different method.
You are to be congratulated for diversifying your TSP to take advantage of the different performance results of the various funds it includes. You could choose a combination of L 2020 and L 2030 to further allow for diversification of your investments.
I recently retired under the Civil Service Retirement System. I net $3,652 monthly and have $90,000 in my TSP. My wife is 58 and under FERS, with 20 years' service and a base annual salary of $50,000. She has $100,000 in her TSP. I am 62 and have been told I am ineligible for Social Security even though I have the required 40 quarters of Social Security earnings. The retirement income for my wife will be pretty small. What do you recommend I do with my TSP now?
Again, I will preface my comments by saying you may wish to consult a financial adviser rather than a benefits specialist. But since you asked, here are my thoughts. First, if you have 40 credits of coverage under Social Security and you are age 62, you are eligible for Social Security retirement benefits even if you are receiving a CSRS annuity. You will be subject to the Windfall Elimination Provision since you retired under CSRS, but this only reduces your SSA benefit, not eliminates it.
The one thing that might prevent you from collecting your own Social Security benefit at age 62 is if you are still working and have earned income higher than the current limit of $14,160. Until you reach your full Social Security retirement age, there is a $1 offset to your SSA benefit for every $2 of earned income above the earnings limit. The limit applies only to wages, salaries and self-employment income. The earnings limit is not affected by pensions, annuities or other forms of unearned income.
As to the issue of what to do with the $190,000 total in you and your wife's TSP accounts, here are a couple of things to think about. First, when does your wife plan to retire? She won't be able to withdraw from her TSP until after she is separated, with the exception of a one-time in-service withdrawal (age-based withdrawals are available to employees who are still working past age 59 1/2).
Second, you say your CSRS retirement is $3,652 a month, but you don't say what your monthly expenses are. You have to determine how much income you will need to withdraw from your investments each month to supplement you and your wife's federal pensions and Social Security benefits. Then, you can compute a series of monthly payments from the TSP to determine if you will be able to provide the income you need for a long enough period of time so that you won't run out of money. Here's a link to a user-friendly calculator to help you out.
It's all in the timing. I retired on June 1, 2007. If I'd left the balance in my account in the C Fund instead of buying an annuity from MetLife, my balance today would be down about 25 percent. Plus, instead of locking in an annuity at the 5.5 percent index rate I got back in 2007, I'd only get a current index rate of 3.5 percent. Not to mention I would have missed out on three full years of payments received. I got lucky!
Luck is in the eye of the beholder. I don't mean to burst your bubble, but if you had left your balance in the C Fund, you would have almost recovered from your losses. Here are the returns on the C Fund in recent years:
- 2008: -36.99%
- 2009: +26.68%
- 2010: +15.06%
- 2011: (through May): +7.81%
If you had $1,000 in the C Fund in 2008, you'd have $984.36 as of May 31, 2011.
When you purchased your annuity, you took the money that you had in the TSP and gave it to MetLife in exchange for a life annuity (for which you are currently paying taxes on the payments). Depending on your age in 2007 and the features you added to your annuity, it will take many years to recover your initial investment in the form of monthly annuity payments. For example, if you used the $1,000 to purchase a life annuity at age 60, payable during your lifetime, with no additional features, the payments would be $5.54 a month. It would take 15 years to get back your $1,000 at the current annuity interest rate of 3.375 percent. Even if that rate were to double, it would still take a minimum of seven and a half years just to get back your original investment.
If you began taking out payments of $5.54 month (or $66.48 a year) in 2008, you would currently have less money, but your balance would continue to compound. Based on a simple withdrawal of $66.48 a year (ignoring monthly and daily investment fluctuations), you currently would have $764 left in your account.
The benefit to the life annuity is that you will receive payments for the rest of your life, regardless of how the stock and bond markets perform. If you die early, you may not receive as much as you gave to MetLife in 2007 (unless you added a survivor annuity, cash refund feature or 10-year certain feature). If you added features to protect your annuity, your monthly payment would be lower and it would take even longer to recover your initial investment. Remember that you can shop around for other annuities besides the one offered through the TSP. The TSP annuity provides a payment for life with 18 options to protect the money you have invested. The interest rate is competitive. By transferring some or all of the TSP to an IRA, you could purchase an annuity other than the one available through the TSP. But do your homework first and make sure the IRA recipient will provide the annuity of your choice.
I'm under CSRS. I get about $4,400 a month. My wife works part time and brings in about $15,000 a year. We have no problems paying our debts. I recently retired. I have $40,000 in my TSP, and I owe $24,000 on my house. I'm thinking that I should pull out the money in my TSP to pay off my house. The house interest is 6 percent, and my TSP G Fund is making 3 percent. What is your take on our situation? My wife also has a 401(k) with $100,000, which she can't touch until she is 59 1/2, which is four years from now.
I asked my friend and colleague, Bob Leins, who is a certified public accountant, for his input on this one. Here's what he said: "Often the decision to take a full or large distribution from the TSP to pay off an outstanding mortgage is driven by psychology. I suggest that they consider taking monthly payments from the TSP and depositing it in their checking account. Then have monthly mortgage payments come out of that same account. By doing this they don't have the monthly reminder of depositing money to pay the mortgage. A small problem with this is the TSP will have 20 percent withholding, and that may not be enough to pay the mortgage. In that case they have to boost the TSP monthly withdrawal. The thrust of doing this is to potentially earn a greater return than the mortgage is costing."
Here's what I would add regarding your situation. If you have $40,000 in your TSP and you withdraw it all at once, it will be subject to income tax. What will be left after taxes depends on your tax bracket, both federal and state. It's likely, unless you are in a high tax bracket, that you'd still have enough to pay off your mortgage. But since you're not currently having any trouble paying your bills, I would vote for leaving the nest egg in the TSP for a while.
You didn't mention other investments or savings besides your wife's 401(k), so I'm concerned you might not have money available for emergency needs that might come up. It's much harder to get a home equity loan if you're retired, so it is important for retirees to have some cash available. You might want to check into refinancing your mortgage at a lower interest rate and extending the mortgage for another 30 years. This might make the monthly payments more affordable and allow you to keep your savings intact.
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.
For more retirement planning help, tune in to "For Your Benefit," presented by the National Institute of Transition Planning Inc. live on Monday mornings at 10 a.m. ET on federalnewsradio.com or on WFED AM 1500 in the Washington metro area.