Are You Afraid of Outliving Your Money?
One of the concerns I hear in my seminars over and over again is not having enough money to live on in retirement. During the first part of my seminars, we discuss the value of the government retirement benefit under either the Civil Service Retirement System or the Federal Employees Retirement System, and then most people feel somewhat better—especially the people who didn’t know they had a government retirement benefit.
Yes, it is true; I meet federal employees every week who are covered by FERS who don’t understand the value of the retirement withholding for FERS from their biweekly salary.Those employees have a fresh outlook when they realize the amount of FERS retirement benefit that they will be receiving.
Most CSRS employees know they have a retirement benefit. Under CSRS, employees are exempt from paying Federal Insurance Contributions Act taxes and therefore, Social Security retirement is not accumulating. CSRS was designed as a single benefit plan that stands alone without the Social Security benefit or an employer-sponsored savings plan. FERS employees have paid FICA taxes throughout their federal career, so they will also receive a percentage of income replacement from the Social Security retirement benefit.
There is a third source of retirement income for federal employees besides CSRS or FERS and Social Security. That is the Thrift Savings Plan. The TSP also offers a life annuity option for separated employees.
I recently listened to a video discussion of Mark Warshawsky’s book, Retirement Income: Risks and Strategies, which explores the reasons for using your retirement savings to purchase a life annuity. Mark Warshawsky is president of ReLIAS LLC, a retirement solutions design firm. He has held senior positions at the Federal Reserve Board, the Internal Revenue Service and TIAA-CREF, and was assistant secretary for economic policy at the Treasury Department. The discussion, moderated by David Littell of The American College of Financial Services, provided sound information regarding the decision of whether or not to use your retirement savings to purchase a life annuity.
The TSP provides single life and joint life annuity options with fixed or increasing payments. There are additional features available to protect your beneficiaries, including a 10-year certain payout option, a cash refund option, and 50 percent and 100 percent joint annuities. In most discussions about the TSP annuity, this method of investing your retirement savings raises red flags. Here is a summary of the reasons that support using some or all of your TSP account to purchase a life annuity, followed by reasons that you should be cautious about this decision:
Reasons to Consider a TSP Annuity
- The income streams from your other retirement benefits (CSRS or FERS and Social Security and any other pensions) are not enough to cover your monthly living expenses.
- You are risk averse and reluctant to move your money out of the G Fund, which will never have a negative return, and into the C, S, I or F Funds, which may have higher returns but also could lose value.
- You have looked at your health, family history and other factors that influence your life expectancy and realize you could live a long time.
- You are not concerned about leaving a large inheritance for your children, a favorite charity or some other bequest.
- You are worried about running out of money.
- You understand that the risk of an annuity is that you will be pooling your money in the same way you do when purchasing insurance. With any insurance, some people get their money’s worth and some don’t. If you live a long time, you will have the security of never running out of money, but if you die early the annuity dies with you (with the exception of the survivor options). The purpose of insurance is to manage risk, which in this case involves outliving your money.
Reasons Not to Purchase a TSP Annuity
- Your retirement income from CSRS or FERS and Social Security (and any other lifetime benefits) is enough to cover your living expenses and will be modified by adequate inflation adjustments.
- You have a higher risk tolerance and understand that if you manage the money in your TSP yourself, you are taking a chance that you could outlive the money and that you could make decisions that could cause your investment to lose value.
- You have confidence that you can make investment decisions to protect your money and financial security during your retirement years, or you are working with a financial adviser who can assist you in managing your money to achieve lifetime financial goals and objectives.
- There are no tax incentives and little competition to make an annuity purchase more favorable. A point made in the video presentation was that the government could make purchasing annuities a more favorable option if they would make a portion of the payout tax-free or if they created exchanges (i.e., health care) that would allow for better competition in the marketplace.
- It is important to you that you leave a legacy to your children or others who might benefit from the wealth you’ve accumulated.
- There are reasons to believe your life expectancy may be shorter due to illness or other factors that might influence your longevity.
- The purchase of an annuity is irreversible. This means that the money you use to make the purchase is no longer available to you as a lump sum.
- The interest rate index is unfavorable. The current interest rate index for annuities purchased in July 2014 is 2.625 percent. Once the annuity is purchased, the interest rate index is fixed. If rates increase in the future, too bad, you bought your annuity at 2.625 percent. Caution: If you wait for more favorable rates to purchase annuities, this could also be a time when the earnings on your investments might be lower and you would be using less money to purchase an annuity at a better rate. Here is an example:
- Sally is 62 years old and has $200,000 in her TSP account that she wants to use to purchase a single life annuity with a 10-year certain feature and increasing payments. At the current interest rate index, her annuity payments would begin at $737 per month (and they would increase up to 3 percent per year with inflation adjustments). If the interest rate index were 5 percent, those payments would begin at $1,038 per month.
- If Sally waited five more years to get a 5 percent interest rate on the annuity, but the value of her investment fell to $150,000, then she would start payments at $823 per month (at age 67 instead of 62). In addition, she would have missed out on receiving the payments of $737 per month for the last 60 months.
- You don’t understand how they work and you need more education.
If you purchase annuities outside of the TSP, you have the option of purchasing more than one. You could use some money to purchase a TSP annuity at your current age and at current interest rates. You could elect a portion of your TSP to purchase a life annuity and a portion of your TSP balance that you may wish to transfer to an individual retirement account for later use. You also could designate a portion of your TSP to provide a stream of monthly payments directly from your TSP account that will allow the remaining account balance to be invested in the C, S, F, G and I Funds. Later, you could purchase another annuity (outside of the TSP) at possibly more favorable interest rates and at a later age using the money that you’ve transferred to an IRA.
It pays to learn about all of the options available for using the money you’ve saved for your retirement. Here are some resources from the TSP to get you started:
- Withdrawing your TSP Account After Leaving Federal Service
- Withdrawal Strategies
- Important Tax Information About Your TSP Withdrawal and Required Minimum Distributions
- Important Tax Information About Payments From Your TSP Account