According to TSP governing board (www.frtib.gov), “In the first eight months of 2024, Thrift Savings Plan (TSP) participants put $175 Million toward annuities...” That will be 44% more than in 2023 if purchases continue at that rate through the end of the year.
The “annuity” being discussed is not the FERS Annuity, which is a pension. The annuity mentioned is the TSP Life Annuity (click TSP Life Annuity Fact Sheet), an withdrawal option in the TSP that is only available to retirees. The TSP Life Annuity is an Immediate Fixed Annuity sold by MetLife. It is available inside the TSP.
Because the Life Annuity is becoming a more popular choice for retired Feds, this blog explores how the TSP Life Annuity works, its advantages and disadvantages and what retirees should consider when deciding whether to purchase the Life Annuity. The key question: Does the Life Annuity make sense for FERS annuitants?
Two Definitions of an “Annuity”
There are two definitions of “annuity” in finance:
- A regular, specified payment at stated intervals for a fixed period, often for the recipient's life. Examples: Social Security and pension payments. That is why the Federal pension is called an “Annuity.” That is technically correct but causes confusion when considering the second type of annuity.
A financial product sold by an insurance company. Typically, the insurance company is paid (initial investment or premium) for some combination of regular income, living benefits and guarantees. There are currently three types of annuities: Fixed, Variable and Equity Indexed annuities. The TSP Life Annuity is an Immediate Fixed Annuity.
What Are Immediate Fixed Annuities?
When you buy an Immediate Fixed Annuity, you are paying an insurance company in advance for monthly payments that continue until you die. Typically, the payments do not change once they start and the money paid to the insurance company is not returned to heirs.
There are options that allow for increasing payments and refunds to heirs. But those options reduce the monthly payments.
The purchase cost and the monthly payments are determined by the insurance company and depend upon the type chosen, purchase price, age at purchase, options, prevailing interest rates and other factors.
Immediate Fixed Annuities are sold by many insurance companies. They may be purchased within the TSP, an IRA or with after-tax funds.
Purchasing an Immediate Fixed Annuity, including the Life Annuity, is a permanent decision. Nothing can be changed once payments start. The money used to purchase the annuity leaves the TSP account (without taxes on withdrawal) and becomes the property of the insurance company. In exchange, the purchaser receives monthly payments.
The Life Annuity; the TSP Immediate Fixed Annuity Option
The TSP authorizes one insurance company, MetLife, to sell an Immediate Fixed Annuity, called the Life Annuity, with funds in a retiree’s TSP account. Only retired Feds can purchase it. The minimum purchase amount is $3500. It can be purchased with some or all funds in an account.
There are two types of Life Annuities:
- Single life (payments end when the retiree dies)
- Joint Life with a spouse or someone with an “insurable interest." Payment to the Joint Annuitant can be 50% or 100%. Payments last until the retiree and the Joint Annuitant are both deceased.
The TSP website offers a calculator to estimate payments. Go to TSP Annuity Calculator. The monthly payment is determined by the insurance company and is based upon:
- Age at time of purchase -- The older the retiree when purchased, the higher the monthly payment, since life expectancy is shorter.
- The purchase amount: The more funds invested in the annuity, the larger the monthly payment.
- The type of annuity (Single or Joint Life) and monthly payment options.
- The annuity interest rate when purchased.
- Other factors determined by the insurance company.
Here are examples of how lifetime payments are affected by age when purchased and whether Single or Joint Life is chosen.
Monthly payment options:
- Fixed for life
- Increasing payments: Payments increase 2% annually.
- Cash refund: If the annuitant dies before payments equal the amount used to purchase, the balance is returned to heirs.
- 10-year certain payout: Payments guaranteed for 10 years even if annuitant dies before the end of 10 years
This makes the Life Annuity a complicated choice. In addition to deciding whether to purchase, when and how much to invest, there are 18 combinations of options available for the monthly payment. And all decisions are permanent once payments begin. See table below for monthly payment options.
The monthly annuity payments are automatically transferred to the retiree’s bank account (a withdrawal) by MetLife. The payment is taxed the same way as any other withdrawal. The mandatory 20 percent Federal income tax withholding does not apply to annuity payments and annuity payments are not subject to the IRS early withdrawal penalty tax.
Is the Life Annuity a Good Choice for FERS Retirees?
Whether or not a fixed annuity is a good choice depends upon a retiree’s financial situation, goals and needs. The advantages and disadvantages are discussed below.
Advantages:
- Lifetime Income: No matter how long a retiree lives, monthly payments continue.
- Simplicity, predictability and protection from market volatility: The Life Annuity offers a simple and predictable income stream. Retirees do not need to worry about fluctuations in the TSP stock and bond funds.
- Options for Survivor Benefits: The TSP Life Annuity allows retirees to select options that provide income to a spouse or other beneficiary after their death. The survivor benefit options reduce the monthly payment but may offer the peace of mind that a loved one will have additional lifetime income.
Disadvantages.
- Loss of purchasing power: Because the payments are fixed for life, inflation reduces purchasing power. The longer the payments are made, the greater the reduction in purchasing power.
- The Federal Government does not guarantee the payments. The insurance company, MetLife, guarantees the payments but that guarantee is based upon the financial strength and claims paying ability of MetLife.
- Loss of Premium: The money used to purchase the Life Annuity becomes the property of the insurance company. It is no longer available to retirees or their heirs.
- Fixed annuities are a permanent decision. Nothing can be changed once payments start.
Loss of purchasing power due to inflation is the most important disadvantage.
The biggest retirement risk for Federal retirees is not running out of money; Social Security and Federal pension payments will continue until they die. The biggest retirement risk is being forced to reduce spending many years later because FERS Annuity (pension) loses purchasing power anytime inflation exceeds 2% and bank accounts and bond investments (including the TSP G and F Funds) are likely to lose purchasing power.
Using part of your TSP balance to invest in the Lifetime Annuity just makes that problem worse.
To sustain a lifestyle through a long retirement, investments and income must maintain purchasing power over many decades, even after taking into account taxes and inflation. Historically, only well-diversified and well managed stock (and stock fund) portfolios were able to do that.
One situation where the Life Annuity might make sense: Because Life Annuity payments are based upon age, someone who purchases a fixed annuity at an older age receives more than a younger purchaser. So fixed annuities may make sense for older retirees who cannot generate enough income from investments to maintain their lifestyles.
With that one exception, most Federal retirees should probably avoid the Life Annuity. Retirees already have two lifetime payments: their Federal pension and Social Security. Both have excellent Cost of Living Adjustments. Why take funds from the TSP to purchase another lifetime payment, one that isn’t expected to keep up with inflation, resulting in a loss of purchasing power? Funds in the TSP can be invested for growth, which most retirees will need.
Disclaimers:
This is for educational purposes only. To learn more about the topics mentioned and if they are suitable for you, consult an appropriate professional. Tax laws can change at any time.
Any information provided in this presentation has been prepared from sources believed to be reliable, but is not guaranteed and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for information purposes only and does not constitute a recommendation.
Arthur Stein and Arthur Stein Financial, LLC are not authorized to give legal or tax advice. For information on your specific situation, please consult your tax advisor regarding any tax implications and your attorney for legal implications. As required by the US Treasury Regulations, you should be aware that this presentation is not intended to be used and it cannot be used for the purposes of avoiding penalties under federal tax laws.
Keep in mind that:
- Past performance is no guarantee of future performance;
- Investments involve the risk of loss of principal and earnings;
- ETFs, mutual funds, money market funds, etc. are not guaranteed by the US Government, the FDIC, a bank or anyone else.
- “Average annual return” evens out variations in the actual year-to-year returns.
- ETFs, mutual funds and individual stocks and bonds fluctuate in value and there will always be times when they lose value.
- None of the information provided is necessarily relevant to anyone’s personal situation. Circumstances differ among individuals and you should not assume that these generalizations or information apply to you.
- Investments mentioned may not be suitable for all investors.