TSP Fixed Monthly Payments or TSP Annuity: Which Withdrawal Option Should TSP Participants Choose? Edward A. Zurndorfer, Certified Financial Planner Federal employees with Thrift Savings Plan (TSP) accounts face the following decision upon retiring from federal service: What should they do with their TSP accounts? Among the various withdrawal options are: 1. Request a full withdrawal using fixed monthly payments for life that are withdrawn from their TSP account balance; or 2. Request a full withdrawal to purchase a fixed annuity from Metropolitan Life Insurance Company that pays a guaranteed monthly payment for the rest of the TSP participant's life. This column discusses these two options and which option may be better for a TSP participant. The decision of whether to buy a TSP annuity becomes even more challenging when one considers all of the TSP annuity options, including: 1. Single life annuity; 2. Single life annuity with a cash refund to a beneficiary; 3. Joint life annuity with a 50 percent survivor annuity going to a spouse; 4. Joint life annuity with a 50 percent survivor annuity going to a spouse with a cash refund to a beneficiary; 5. Joint life annuity with a 100 percent survivor annuity going to a spouse: and 6. Joint life annuity with a 100 percent survivor annuity going to a spouse with a cash refund to a beneficiary. A single life annuity pays the highest monthly amount to the TSP annuitant. But the downside to choosing a single life annuity is that at the death of the TSP annuitant, any remaining funds in the TSP annuity will be kept by Metropolitan Life Insurance Company with no remaining TSP funds paid to a beneficiary. If, on the other hand, a TSP annuitant chooses the single life annuity with a cash refund, then at the death of the TSP annuitant any remaining funds in the TSP annuity will go to a named beneficiary. But electing the single life annuity
along with a cash refund option will result in the TSP annuitant receiving lower monthly payments. When a TSP participant chooses withdrawals in the form of fixed monthly payments, the participant will receive a monthly check. While the monthly amount can change from year to year, for the purpose of comparison in this column it will be assumed that payments will be fixed and not change throughout the life of the participant. One important advantage of TSP monthly payments is that at the death of the participant, any remaining funds will go to a named TSP beneficiary -- for example, a spouse, child or other relative -- at no "cost" to the participant. In other words, with monthly TSP payments there is no reduction in the participant's monthly payment when a beneficiary is named. The following are some important factors to consider when deciding between a TSP monthly annuity or fixed monthly payments: Life expectancy. Perhaps the easiest analysis compares the fixed monthly annuity selected to what a TSP could receive by receiving a fixed payment (that the TSP participant chooses) each month for life. But the key to the life expectancy analysis is an assumption about one's life expectancy. In general, those individuals who strongly believe that they will not live beyond their life expectancy will find that the fixed monthly payments are more attractive. Consider the following example. A TSP participant, age 65 and retired, has a $500,000 TSP account balance. The participant requests fixed monthly payments of $2,500 per month ($30,000 per year) or six percent of the original account balance. Note that the $2,500 monthly payment will result in the participant fulfilling the minimum required distribution (MRD) rules starting when the participant is age 70.5. If one assumes a life expectancy of 18 years at age 65, and with a $2,500 monthly payment for 18 years, then in order to not deplete the account before the end of the 18 years any funds remaining in the TSP account would require an internal rate of return of 0.82 percent. Given the long term performance of the TSP C, S, I, F and G funds, this is certainly "doable". In fact, a $2,500 monthly payment could be sustained for 16.67 years, even with a zero percent internal rate of return. If the
investment performance of the funds remaining in one's TSP account exceeds 0.82 percent, then the monthly payments can continue longer. For example, if the internal rate of return is 1.80 percent, then a monthly payment of $2,500 starting at age 65 can be sustained for 20 years. Or if the internal rate of return is 3.4 percent, the monthly payment of $2,500 can be sustained for 25 years until the participant becomes age 90. Now consider the TSP monthly annuity using one of the six annuity options discussed above. The TSP has on its Web site, www.tsp.gov, a TSP "annuity calculator" that will generate the monthly annuity payment that depends on: (1) The ages of the annuitant and joint life annuitant spouse (if a joint life annuity with a spouse is chosen) at the time of purchase; (2) The annuity option chosen; (3) The amount used to purchase the annuity; and (4) The annuity interest rate which is the TSP G fund rate at the time the annuity is purchased. For this comparison, the monthly payments shown in the following table assume $500,000 is used to purchase the annuity with an interest rate of 1.75 percent, the G fund interest rate as of 12/26/2012. Note that only the single life annuity results in a monthly payment that exceeds the fixed monthly payment of $2,500. Of course, the longer a TSP annuitant lives beyond life expectancy, the more attractive the monthly annuity becomes. For example, if the annuitant lives to age 90, the annuity compounded rate of return (or yield to maturity) would be 3.63 percent. If the annuitant lives to age 95, the annuity yield to maturity would be 4.52 percent. These yields to maturity are not bad when compared to current high-qualify bond yields of similar maturity. Moreover, it is obvious that if a TSP participant chooses a single life annuity with no survivor benefits and died within the first 15 years of
receiving monthly payments, then it would be a "great deal" for Metropolitan Life Insurance Company who owns the TSP annuity. Other factors to consider: Current income needs. A TSP annuity may be less attractive because federal annuitants already own a fixed annuity - a CSRS annuity and/or a FERS annuity - and some annuitants receive or will receive military retirement pay. A CSRS or FERS annuity and military retirement pay is a guaranteed form of payment with some inflation protection and most CSRS and FERS annuitants use their CSRS and FERS annuities to pay their monthly expenses. Moreover, since most federal annuitants will not necessarily need to initially tap into their TSP account in order to pay current expenses, they can leave the majority of their TSP account alone during at least the first few years of their retirement resulting in additional tax-deferred (traditional TSP) or tax-free (Roth TSP) growth. Health. The longer a TSP participant lives, the more attractive the TSP annuity. If a participant believes their life expectancy may be below average, then fixed monthly payments become more attractive. By choosing a TSP annuity, a TSP participant trades an asset for the promise of lifetime cash flow. By choosing fixed monthly payments, the participant retains both the asset and the ability to generate income. Inflation. Unless the TSP annuity payments have a cost-of-living adjustment which in turn results in a decreased monthly payment, the TSP annuitant will lose purchasing power over time. On the other hand, TSP monthly payments can be increased from year to year, or the monthly payments once paid can be reinvested in a prudent allocation of equities in order to hedge against inflation. Convenience. With a TSP annuity, monthly checks are issued to the TSP account owner for life. With fixed monthly payments, the TSP participant must make sure that whatever remains in the TSP account continues to grow at a sufficient rate in order to make sure TSP monthly payments will continue for life. Keep in mind that managing a TSP account throughout retirement takes careful planning, budgeting and discipline.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Financial Consultant, Chartered Life Underwriter, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent Addendum from Todd Ensing: The numbers below are the GUARANTEED worst case LIFETIME income numbers if an Income Rider is added to a National Western Indexed Annuity. The income gets larger the longer you wait until starting benefits but even in one year the income essentially matches the highest payouts outlined in the above article. The important difference being that the Indexed Annuity guarantees income for life without risk of disinheriting survivors. Plus, the payout scale below is on top of the underlying balance that is linked to a stock market index for part of those gains and NONE of the losses for better protection against inflation: Annual Detail for NWL's Withdrawal Benefit Calculator Accumulation Guaranteed Maximum Period Withdrawal Guaranteed End-of-Year Attained Age Payment Base Percentage Withdrawal Issue 65 525,000.00 n/a n/a 1 66 546,000.00 5.50% 30,030.00 2 67 567,840.00 5.50% 31,231.20 3 68 590,553.60 5.50% 32,480.45 4 69 614,175.74 5.50% 33,779.67 5 70 638,742.77 6.00% 38,324.57 6 71 664,292.48 6.00% 39,857.55 7 72 690,864.18 6.00% 41,451.85 8 73 718,498.75 6.00% 43,109.93 9 74 747,238.70 6.00% 44,834.32 10 75 777,128.25 6.50% 50,513.34 11 76 808,213.38 6.50% 52,533.87 12 77 840,541.91 6.50% 54,635.22 13 78 874,163.59 6.50% 56,820.63 14 79 909,130.13 6.50% 59,093.46 15 80 945,495.34 7.00% 66,184.67