Upon retiring from federal service, a TSP participant can choose a TSP life annuity as one way of withdrawing his or her TSP account. A TSP life annuity is purchased using all, or part, of a participant’s TSP account from a company that the TSP calls the “annuity provider.”
This is the second of two columns discussing TSP life annuities. In this column, the various options and features that are available with a TSP life annuity are presented and discussed.
Before presenting and discussing the various options and features, it is important to first explain what in general a “life annuity” is, including why an individual would want to purchase a life annuity and its advantages and disadvantages.
A life annuity is a contract between an individual and an insurance company in which the individual makes a lump-sum payment to an insurance company. In return, the insurance company makes guaranteed payments including interest to the individual for the rest of the individual’s life. These annuity payments may begin immediately (an “immediate” annuity) or at some time in the future (a “deferred” annuity).
An individual’s real purpose in buying a life annuity is to provide for himself or herself a steady stream of income, typically during retirement.
In a sense, a life annuity can be considered as “upside down” life insurance. When someone (the life insurance “policyowner”) buys a life insurance policy of a certain face amount (for example, $300,000) the life insurance policyowner pays the life insurance policy premiums (annually, semi-annually, quarterly or monthly) to the insurance company.
Upon the death of the policyowner, the insurance company pays the face amount of the life insurance policy in a lump-sum payment to the beneficiary (for example, $300,000). With a life annuity, the individual buying the life annuity (the annuity owner or annuitant) pays the insurance company a lump sum amount of money. The insurance company then regularly pays the annuity owner annually, semi-annually, quarterly or monthly for the rest of the annuity owner’s life.
It is important to understand that the annuity payments to the annuity owner are guaranteed by the insurance company, no matter how long the annuity owner lives. There is absolutely no risk to the annuity owner that he or she will outlive his or her annuity account. But there is the risk that if the annuity owner dies before he or she receives all of the money that he or she contributed to the annuity. In that case, then any funds that are left over in the annuity account are kept by the insurance company.
There is a way around this risk to the annuity owner but, as will be explained below, the annuity owner will “pay for this” in the form of reduced annuity payments. There are other risks associated with pure life annuities, such as level payments that do not keep up with the cost-of-living, that are also discussed below.
With this background information on annuities, a discussion of TSP life annuity options is now presented.
Types of TSP Annuity Options
The TSP mentions in its Fact Sheet “Annuities” that the TSP offers a life annuity through its annuity provider. The TSP Fact Sheet does not formally mention who the annuity provider is. In past years, the annuity provider has been Metropolitan Life Insurance Company.
The following are types of TSP annuity options are offered:
1. Single life annuity. An annuity that provides monthly payments only to the annuitant (that is, the TSP participant who purchases the annuity) as long as the annuitant lives. This means that upon the death of the annuitant, annuity payments cease. Unless a “cash refund” benefit (see below) was selected by the annuitant at the time of purchase, the annuity provider keeps any remaining funds left in the annuity following the death of the annuitant.
2. Joint life annuity with the annuitant’s spouse. An annuity that provides monthly payments to the annuitant and to the annuitant’s spouse (the “joint annuitant”). When the annuitant or the spouse dies, monthly annuity payments will continue to be made to the surviving spouse for his or her lifetime. Upon the death of the second spouse, annuity payments stop. Any remaining money in the joint life annuity at that time will be kept by the annuity provider (unless the cash refund option was selected by the annuitant at the time of purchase). Also, the amount of the payment while the annuitant and joint annuitant are alive depends on whether the annuitant chooses a 100 percent or a 50 percent survivor annuity.
3. Joint life annuity with someone other than annuitant’s spouse. The joint annuitant must be either a former spouse or someone with an “insurable interest” in the annuitant. “Insurable interest” means that the joint annuitant is financially dependent on the annuitant and could reasonably expect to derive financial benefit from the annuitant’s continued life. Blood relatives or adopted relatives, but not relatives by marriage, who are closer than first cousins are considered to have an insurable interest in the annuitant. Proof of the joint annuitant’s age will have to be submitted to the annuity provider.
Additional Information on TSP Joint Annuities
1. 100 percent survivor annuity benefit. The amount of the monthly annuity payment to the survivor is the same amount of the payment to the annuitant while the annuitant and joint annuitant are both alive. But the amount that is paid to the annuitant is generally less while the two are alive compared to what the payment would be to the annuitant had the 50 percent survivor benefit been paid.
2. 50 percent survivor annuity benefit. The amount of the monthly annuity payment made to the survivor – whether the survivor is the annuitant or the joint annuitant – is cut in half to 50 percent, of the annuity payment while both the annuitant and joint annuitant are alive.
Note: If an annuitant names a joint annuitant other than a spouse who is more than 10 years younger than the annuitant, then the annuitant must choose a joint life annuity with a 50 percent survivor benefit (a 100 percent survivor benefit is not permitted). The only exception is for a former spouse to whom all or a portion of the annuitant’s TSP account is payable under a retirement benefits court order.
Level and Increasing Payment Annuities
Upon deciding a single life or a joint life annuity, the annuitant must decide on whether the annuitant wants to receive level payments or increasing payments, both of which are now discussed:
1. Level payments. The amount of the monthly annuity payments remains the same from year to year. Therefore, with a single life annuity the annuitant receives the same monthly payment as the annuitant gets older until the annuitant dies. With a joint life annuity, the annuitant receives the same monthly payment for as long as the annuitant and joint annuitant are alive. The monthly payment to the survivor (either the annuitant or the joint annuitant) will depend on whether the annuitant has chosen a 100 percent survivor annuity or a 50 percent survivor annuity, but it will remain at the same amount for the life of the survivor.
2. Increasing payments. The amount of the payment can change each year on the anniversary date of the first payment. The amount of the change is based on the change in inflation as measured by the consumer price index (CPI). Increases cannot exceed 3 percent per year, but monthly annuity payments cannot decrease. It is important to note that when annuity payments start, they are smaller than they would have been had the annuitant selected level payments. But monthly payments may increase each year depending on the CPI. Increasing payments can be combined with either the single life annuity or the joint life annuity with a spouse. Increasing payments cannot be chosen with a joint annuity when the joint annuitant is not the annuitant’s spouse.
Additional Annuity Features That Provide for Beneficiaries
There are two additional annuity features available for annuitants who would like beneficiaries to receive any of the annuity funds remaining upon the death of the annuitant and the joint annuitant in the case of a joint annuity. It is important to note that if either of these features are selected by the annuitant, the annuity’s monthly payments will be less than the payments would have been had the annuitant chosen an annuity without either of these features.
1. Cash refund. If the annuitant (and the joint annuitant, if applicable) die before the amount used to purchase the annuity has been paid out, the remaining amount of the TSP funds used to purchase the annuity will be paid to the annuitant’s beneficiary(ies) in a lump-sum. For example, if the annuitant purchases a joint life annuity for $100,000 and the annuitant and joint annuitant both die after receiving together a total of $80,000 in annuity payments, then the named beneficiary(ies) will receive a lump sum payment of $20,000 from the annuity provider. This feature can be combined with either a single life, or a joint life annuity, and with level or increasing payments.
2. Ten-year certain. If the annuitant dies before receiving annuity payments for the 10-year period, annuity payments will continue to a beneficiary for the remainder of the 10-year period. If the annuitant lives beyond the 10-year period, then no payment will be made to a beneficiary when the annuitant dies. This feature can be combined with a single life annuity with either level or increasing payment. It cannot be combined with a joint life annuity.
The table below summarizes the life annuity options and features:
To help better understand the various features and options available with TSP life annuities; an example is presented.
An employee, John, retired from federal service on July 31, 2020 and in late August 2020 elected to use $250,000 from his traditional TSP account to purchase a TSP life annuity.
Going to the TSP website (https://secure.tsp.gov/components/CORS/monthly Annuity Factors.html), John found the annuity factors: for two types of annuities: (1) Single life (level payment with no cash refund), (level payment with cash refund), (level payment with 10-year certain). (increasing payment using a CPI of 1.5 percent and no cash refund), (increasing payment using a CPI of 1.5 with cash refund) and (increasing payment with a CPI of 1.5 percent and 10-year certain); and (2) Joint life annuity with his wife Carol, age 57; (level payment, 100% survivor benefit, no cash refund). (level payment 50% survivor benefit, no cash refund); (level payment, 100% survivor benefit with cash refund), (level payment 50% survivor benefit with cash refund), (increasing payment using CPI of 1.5 percent with 100% survivor benefit and no cash refund), (increasing payment using CPI of 1.5 percent with 50% survivor benefit with no cash refund), (increasing payment using CPI of 1.5 percent with 100% survivor benefit with cash refund), and (increasing payment using CPI of 1.5 percent with 50% survivor benefit with cash refund).
The monthly payment amounts for years 1 through 10 following the annuity purchase date resulting from accessing the appropriate annuity factors are presented in Chart I, Chart II, and Chart III:
Chart I: John, age 60 at time of TSP life annuity purchase
$250,000 Single Life Annuity
Assuming 1.5% CPI every year
Chart II: John, age 60
$250,000 Joint Life Annuity with spouse Carol, age 57
100% survivor benefit, 50% survivor benefits, level payment
Chart III: John, age 60 at time of TSP life annuity purchase
$250,000 Joint Life Annuity with spouse Carol, age 57
100% survivor benefit, 50% survivor benefits, increasing payments
Assuming 1.5% CPI
Some observations and conclusions based on the information in these charts for John’s choices of a TSP life annuity using $250,000 from his traditional TSP account to purchase the annuity:
1. The “annuity factors” as provided on the TSP website depend on an “interest rate index.” Although no information is provided in the TSP Fact Sheet “Annuities” as to what this interest rate index is based on, in general if interest rates are low, then the annuity factors are lower compared to what they would be if interest rates are higher. In the past, the “interest rate index” was based on the G fund interest rate at the time an annuity was purchased. Since interest rates (and the G fund interest rate) are currently low, John’s monthly payments are lower than they would be compared to if interest rates were higher.
2. John’s highest monthly payment is with a single life annuity, level payment and with no cash refund. However, John’s monthly payments remain the same for the rest of John’ life. If John were to die at any time, anything remaining in the annuity stays with the annuity provider.
3. If John wants to make sure that whatever remaining in the annuity goes to a designated beneficiary, he can choose the single life annuity with a cash refund. But in choosing the cash refund option, John’s monthly payments are permanently reduced $96 a month.
4. John wants to make sure that if he were to die within the first 10 years of his annuity purchase, then a designated beneficiary would get the same monthly payment until the end of the 10th year. In choosing the 10-year certain options, John will receive $22 a month less compared to a level payment with no cash refund.
5. In choosing increasing payment, John will receive an increasing monthly payment each year. However, to “pay for this” John starts in year one with a monthly payment that is about $326 to $337 less compared to level payments. Also, the assumption is made that CPI will be 1.5 percent each year for the 10-year period. There is no guarantee that CPI will be that high or low. Some years it may be more, but not more than three percent CPI is used, and could be less than one percent.
6. With respect to John’s joint annuity with his wife Carol, in general the monthly payments are lower compared to John’s monthly payments under a single life annuity.
7. Just as what is happening with John’s single life annuity, the more “bells and whistles” added to the annuity (cash refund, ten-year certain, increasing payments), the less the monthly payments.
8. It is important to note that with the different types of joint life annuities – level payments, no cash refund or level payments, cash refund or increasing payments, no cash refunds or increasing payments with cash payment – the 50 percent survivor benefit has higher monthly payments compared to the 100 percent survivor benefit.
But there is a risk to John in choosing the 50 percent survivor benefit. Recall from above what the 50 percent survivor benefit means. The 50 percent survivor benefit means that no matter which individual dies first – the annuitant or the joint annuitant – the survivor will receive 50 percent of what the annuitant was receiving at the time of the death of the individual.
For John and Carol, this means no matter who dies first, the surviving spouse will receive a 50 percent reduction in his or her annuity for the rest of his or her life. Consider what were to happen to John if he chooses joint annuity with Carol, 50 percent survivor benefit with no cash refund. Chart II shows a monthly payment of $1,560. If Carol were to die in year 4, then John’s monthly payment decreases 50 percent to $780 per month for the rest of his life. And if John were to predecease Carol, the same would be true for Carol. In other words, the 50 percent reduction applies to the surviving spouse no matter who dies first.
It is hoped that this example gives TSP participants a better understanding of TSP annuities including how they work, their advantages and disadvantages, their risks, and most important how a TSP annuity can fit into a federal annuitant’s financial goals for retirement.