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TSP Withdrawals | TSP Fixed Monthly Payments or TSP Annuity: Which Withdrawal Option Should TSP Participants Choose?
TSP Fixed Monthly Payments or TSP Annuity:
Which Withdrawal Option Should TSP Participants Choose?
Federal employees with Thrift Savings Plan (TSP) accounts face the following
decision upon retiring from federal service: What should they do with their TSP
Among the various withdrawal options are:
- Request a full withdrawal using fixed monthly payments for life that are
withdrawn from their TSP account balance; or
- 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
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:
- Single life annuity;
- Single life annuity with a cash refund to a beneficiary;
- Joint life annuity with a 50 percent survivor annuity going to a spouse;
- Joint life annuity with a 50 percent survivor annuity going to a spouse with
a cash refund to a beneficiary;
- Joint life annuity with a 100 percent survivor annuity going to a spouse:
- 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
• 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.
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.
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.
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.
About the Author
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Financial
Consultant, Chartered Life Underwriter, Registered Health Underwriter,
Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD
-- and the owner of EZ Accounting and Financial Services, an accounting,
tax preparation and financial planning firm also located in Silver Spring,
MD. Zurndorfer is also is an instructor at federal employee
retirement seminars throughout the country and writes numerous columns and books
on federal employee benefits.