Upon retiring from federal service, a TSP participant may choose a life annuity as one way of withdrawing his or her TSP account. A life annuity is purchased from a company (who the TSP calls the “annuity provider”) using some or all of a TSP participant’s account.
However, a TSP life annuity should not be confused with the CSRS or FERS annuity (either of which a retired federal employee receives throughout his or her retirement), or military retirement pay that retired members of the uniformed services receive.
In the first of two columns explaining a TSP life annuity, this column discusses what the TSP life annuity is, and how it can supplement a federal employee’s other guaranteed pension income.
A TSP participant should understand that a life annuity is not like one’s TSP account, an IRA, a certificate of deposit (CD), or a bank (checking or savings) account in which the TSP participant, IRA, CD or bank account owner has full control of his or her account. A TSP participant who purchases a life annuity does in fact give up control of his or her TSP money that went into the purchase of the life annuity. In exchange, the TSP participant – the TSP life annuity owner – is guaranteed lifetime monthly payments from the annuity provider. The TSP does not formally state in its Fact Sheet “Annuities” who the TSP annuity provider is. In past years, Metropolitan Life Insurance Company has been the TSP’s annuity provider.
The factors that affect the amount of a TSP participant monthly annuity payment include the following:
- the amount of a TSP participant’s account used to purchase the annuity. The higher the amount used, the higher the monthly annuity payment.
- the TSP participant’s age when the life annuity is purchased, and the age of the participant’s spouse or other joint annuitant, if a joint annuity is chosen. In general, the older the TSP participant when he or she purchases the TSP life annuity, the higher the monthly annuity payments. This factor will be examined in Part II of the discussion on TSP life annuities.
- the particular type of annuity option and additional annuity features the participant chooses. This factor will also be examined in Part II of the discussion on TSP life annuities; and
- the “interest rate index” at the time the annuity is purchased. The TSP does not explain in its Fact Sheet “Annuities”, what this “interest rate index” is tied to. However, in general the larger interest rates, the higher will be the monthly annuity payment.
Additional guidelines on purchasing a TSP life annuity
The minimum amount with which to purchase a TSP annuity is $3,500. This minimum applies separately to each balance of a traditional TSP account and a Roth TSP account. This means that if a TSP participant has money in both the traditional TSP and in the Roth TSP, and chooses not to have the money for the TSP life annuity come solely from one TSP account or the other, the TSP will take out the money for the TSP annuity “pro-rata” based on the relative balances in each account. This pro-rata distribution, together with the $3,500 minimum for a TSP annuity can cause some problems. In particular, if a TSP participant chooses to have money for a life annuity purchase taken from both the traditional TSP balance and the Roth TSP balance, then:
1. If the TSP participant desires his or her entire TSP balance (that is, using the combined traditional TSP and Roth TSP accounts) to purchase a life annuity and one account balance is less than $3,500 but the other account balance is not, then the TSP will purchase an annuity with the TSP account that has at least $3,500 and pay the balance in the other TSP account (less than $3,500) directly to the TSP participant as a cash payment.
2. If the TSP participant is using a portion of his or her traditional TSP and Roth TSP accounts to purchase a life annuity and either of the TSP account balances is less than $3,500, then the TSP will reject the TSP participant’s request to purchase a life annuity.
3. If the result of the pro-rata calculation results in either the Roth TSP portion or the traditional TSP portion of the TSP annuity portion being less than $3,500, then TSP will proceed as if the TSP participant does not have the minimum amount and reject the TSP participant’s application to purchase a TSP life annuity. The following example illustrates:
Janice has $75,000 in her traditional TSP account and $15,000 in her Roth TSP balance. Janice requests a TSP annuity purchase using $10,000 from her TSP accounts. Since $75,000/ $90,000, or 83 percent of $10,000 equals $8,300 is coming from Janice’s traditional TSP account and $15,000/$90,000, or 17 percent of $10,000 equals $1,700 (less than $3,500), would be coming from Janice’s Roth TSP will be used in purchasing Janice’s TSP life annuity, the TSP reject Janice’s request to purchase a TSP annuity.
How a TSP life annuity is purchased
A TSP participant who wishes to purchase a TSP life annuity must go online to his or her account. Form TSP-99 (Withdrawal Request for Separated and Beneficiary Participants) is used to request a TSP life annuity. The TSP participant will be asked if he or she wants to use all or a part of his or her TSP account to purchase the annuity. The TSP participant is then asked if he or she wants to use the TSP Payment and Annuity Calculator. The participant is encouraged to use the annuity calculator in order find out what the annuity monthly payments will be given the various annuity options and features the TSP participant has selected. The next column will discuss in detail these annuity options.
Like other TSP withdrawal options, a TSP participant who is married and chooses the TSP life annuity must first provide information about his or her spouse. If the TSP participant is covered by CSRS or CSRS Offset, then the TSP participant’s spouse will be notified of the participant’s decision to purchase a TSP life annuity. If the TSP participant is covered by FERS, then the TSP participant’s spouse will not only be notified of the participant’s decision to purchase a TSP life annuity but the spouse must give his or her written consent.
Upon receiving the TSP participant’s documentation to purchase the annuity, the TSP will process the annuity request and disburse the funds to the annuity provider withing 10 business days. Once the funds for the annuity have been disbursed, the TSP participant cannot cancel the life annuity application, change any of the life annuity options, or, if applicable, change the joint annuitant.
All communication concerning a TSP participant’s annuity should be directed to the annuity provider. The annuity provider will send the participant a package of information and an annuity contract. The monthly annuity payments will begin approximately one month after the annuity is purchased.
How TSP life annuities are taxed
There are no tax consequences upon the purchase of a TSP life annuity. A TSP annuitant who purchases a TSP annuity will only be taxed when the TSP participant receives TSP life annuity monthly payments.
A TSP life annuity purchased with traditional (non-Roth) money will be fully taxable as it is paid out. This is because a traditional TSP annuity payment consists of (1) traditional TSP contributions and traditional TSP accrued earnings, all of which have never been taxed, and (2) TSP life annuity interest that started to accrue and grew tax-deferred once the traditional TSP annuity was purchased. Traditional TSP annuity payments are taxed as ordinary income in the years when the TSP annuity owner receives the payments.
If a TSP annuity is purchased with Roth TSP funds, then the portion of the Roth TSP annuity payments comprising Roth TSP contributions will not be taxed. This is because Roth TSP contributions coming an employee’s paycheck are federal and state taxed before they are contributed to the Roth TSP participant’s account. Whether the Roth TSP accrued earnings portion of the Roth TSP that comprise a TSP life annuity will be taxed as part of Roth TSP life annuity payment depends on whether the accrued earnings coming from the Roth TSP meets the IRS rules for “qualified” earnings.
Roth TSP earnings (interest, dividends, capital gains) become qualified (withdrawn tax-free) when the following two conditions are met:
(1) five years have passed since January 1st of the calendar year in which a TSP participant made his or her first Roth TSP contributions, and
(2) the TSP participant has reached age 59.5 or has a permanent disability or has died.
However, once the Roth TSP annuity is purchased, then the interest paid on the annuity will be taxable in the year received. The TSP annuity provider will send the Roth TSP annuity owner a Form 1099-R (Distributions from Pensions, Annuities, Retirement and Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) in January of every year, showing the TSP annuity payments from the previous calendar year.
There are several boxes on the Form 1099-R. One of the boxes is the “gross distribution” and another box is the “taxable amount”. For a traditional TSP annuity, the two boxes show the same amount because the “gross distribution” of the traditional TSP life annuity and the “taxable amount” of the traditional TSP life annuity are, in fact, the same. On the other hand, the amounts shown on the Form 1099–R associated with the reported payments from a Roth TSP annuity, in the box “gross distribution” and shown in the box “taxable amount” are not the same. This is because the amount shown in the box “taxable distribution” consists only of interest income.
TSP participants are advised to never use any portion of their Roth TSP account to purchase a TSP life annuity
Given the above discussion that the withdrawals from a Roth TSP account are tax-free assuming that Roth TSP earnings are qualified, why would a Roth TSP participant want to purchase a Roth TSP annuity in which the accrued interest earnings in the TSP annuity will be taxed when they are withdrawn? Instead, the Roth TSP participant should either:
(1) keep the funds in the Roth TSP account and let the account continue to grow tax-free; or
(2) directly transfer the Roth TSP account or a portion of it to a rollover Roth IRA in which the accrued earnings will also grow tax-free and be withdrawn tax-free.
TSP participants interested in purchasing a TSP annuity should therefore be vigilant in making sure that the funds from a TSP being used to purchase the TSP annuity are coming only from the traditional TSP account.