Should You Get the TSP Annuity?

Here are some important points to consider about the TSP Annuity.  If you know someone considering the TSP annuity, or any other annuity, they’d probably appreciate this.

What is an annuity?
An annuity is an insurance product (not an investment vehicle) that converts the money you place into the annuity into a guaranteed stream of income payments that will last the rest of your life.

Why would someone get annuity?
Ideally, we’d like to have all our expenses covered by our federal pension and social security income, with no need to rely on our investments.

But for many, that’s not the case.  Their federal pension and social security income may not be enough.  They have an income shortfall, and they need their TSP (or their other investments) to fill in the gap throughout their retirement.

Do you need an annuity to fill in the income shortfall?
If you think about it, the “need” for an annuity is only if your income shortfall needs exceed a certain percentage of your overall TSP (or retirement portfolio).   Let me illustrate:

• If your income shortfall is 1% of your portfolio, well theoretically you could draw 1% from your portfolio for 100 years.  Were you planning on being retired for 100 years?
• If your income shortfall is 2% of your portfolio, theoretically you could draw 2% from your portfolio for 50 years.  Again, were you planning on being retired for 50 years?
• If your income shortfall is 3% of your portfolio, theoretically you could draw 3% from your portfolio for 33.33 years.  So here we start getting closer to a common retirement time horizon.  But this is assuming you didn’t even bother growing your money at all!  Had you even gotten a small interest growth on your money, it could last longer than 33 years.
• If your income shortfall is 4% of your portfolio, theoretically you could draw 4% from your portfolio for 25 years.  This is a very common retirement time span.

As you can see, if your income need is 3% or below, you may not need an annuity to guarantee your income.   But when your income need gets closer or above 4%, that’s when you may start feeling uncertain that your assets will provide income for the rest of your life.  You could attempt to invest your money to yield 4% or more, but such investments may expose you to losses which, in turn, will reduce the amount of years you can generate income from your portfolio.  Some people are uncomfortable with managing their investments to produce the necessary income, so instead they look to annuities.  Annuities provide a guaranteed income stream for the rest of a person’s life.  You won’t run out of money as long as you live.

TSP Annuity Options:
The TSP offers an annuity with a few different payout options.  They are:

• Life Only – A payout that lasts only as long as you live.
• Cash Refund – A payout that lasts only as long as you live, and pays the remaining balance to your beneficiaries.
• 10 year certain – A payout that will pay for at least 10 years.  Should you die before 10 years, the monthly payment will continue until the end of the 10^th year.
• Joint 50% – A payout that lasts for your life and life of survivor, but which gets reduced by half when the 1^st person dies.
• Joint 100% – A payout that lasts for your life and life of survivor, and which doesn’t get reduced when the 1^st person dies.
• COLAs – A payout with monthly payments that rise with an annual COLA (cost of living adjustment)

The largest monthly payout is with the life only.  Any other form of payout has a reduced monthly payout.

Is the TSP Annuity “Good” or “Bad”?
Before you commit your money to the TSP annuity, you will want to consider the following:

1. Irrevocable: Once your annuity starts, there’s no way out.  Here are the words from TSP.gov:  “Once the funds for your annuity have been disbursed, you cannot cancel your annuity, change your annuity option, or change your joint annuitant.”

2. Fixed growth at the current G Fund rate: This may not be a problem if the current G fund yield was high, like it was in the mid-80s.  But the yield in 2014 is almost a historical low.  If you annuitize now, your money will never again benefit from higher rates.  Even when interest rates rise and even when the stock market yields double-digit returns, you will be stuck in the current low yield of the G fund.  In the private sector you can find “flexible” fixed annuities or variable annuities – both will allow you to benefit from rising interest rates or higher market returns.

3. Lower payout rates than private annuities:   If you want your TSP annuity to cover your survivor, the TSP payout will drop significantly.  The payout rate in such a case will usually be 20% less than what you can get in the private sector.

4. Your payments will never increase (unless you elect a COLA – see below):  Whatever your payout amount is, that is what you will receive for the rest of your life.  This may bother you in 5 years from now, and certainly in 10, 20 or 30 years from now.

5. Snoopy keeps your money: What happens to your remaining money after you die?  Snoopy (MetLife) keeps it!  The only way to avoid that is by electing a beneficiary option – but that will lower your monthly payout rate (as mentioned above).

6. 50% survivor can be YOU:  If you choose the Joint 50% survivor benefit, that means that the survivor will receive 50% of your original payout amount.  Most people assume that this survivor benefit only kicks in when THEY (meaning the owner of the TSP account) passes away.  But that’s not the case.  The 50% payments start when either the account owner or their beneficiary passes away!  So if your beneficiary passes before you do, YOU will suffer a 50% loss, even though it’s YOUR TSP!

7. Cola capped at 3%:  The only way to get keep up with inflation is to elect a COLA (cost of living adjustment).  The TSP COLA is equal to CPI (the Consumer Price Index), but can never exceed 3%.  So even if CPI is 3.5% or 4% or higher, you will only get a COLA of 3%.

8. No COLA for non-spouse survivor:  The above COLA is not available for a non-spouse survivor.

If you were considering an annuity, you should compare what you have thru the TSP with what you can get outside the TSP.  Most of the newer annuities will not have the above problems, and they offer a wider range of benefits.

Two important points to note:
1. The TSP annuity is NOT the same as your FERS or CSRS annuity. 

2. CSRS employees have an extremely valuable annuity option called the Voluntary Contributions Program (VC). 

As always, I wish you success!

Stephen Zelcer is part of the GovLoop Featured Blogger program, where we feature blog posts by government voices from all across the country (and world!). To see more Featured Blogger posts, click here.