The last post discussed the TSP’s withdrawal options, including penalty-free ways to tap into your account before age 59.5. It also includes the TSP’s draft of their rules for the 2012 Roth TSP.
In this post, we’ll get into greater detail about TSPs and fill in some missing information or questions you might have.
Let’s start with the basics.
Table of Contents
What Is a TSP Annuity?
The Thrift Savings Plan (TSP) is a defined contribution retirement plan offered by the U.S. government to federal employees, including civil service, including military service members. The plan is administered by the Federal Retirement Thrift Investment Board.
A TSP annuity is a life contract purchased using funds from your TSP account. An annuity is an investment product that provides you with a fixed income stream that retirees often used to fund provide guaranteed income for life.
When you purchase a life annuity from the TSP, you are purchasing what is known as a “single premium immediate annuity”
There are several funds to meet the various investment objectives and risk tolerance levels for participants. TSP funds are diversified and offer high and low risk annuity options. They are professionally managed and have low-cost fees.
The TSP offers the following types of funds, listed from most conservative to most aggressive:
- Government Securities Fund (G Fund) – short-term stable U.S. debt securities with a low yield.
- Fixed Income Fund (F Fund) – tracks performance of the Bloomberg Barclays U.S. Aggregate Bond Index that has exposure to government, municipal, and corporate bonds, and mortgage-backed securities.
- Common Stock Fund (C Fund) – tracks performance of the Standard & Poor’s 500 Composite Stock Price Index (S&P 500).
- Small Cap Stock Fund (S Fund) – tracks performance of the Dow Jones U.S. Completion Total Stock Market Index.
- International Stock Fund (I Fund) – tracks performance of the MSCI EAFE (Europe, Australasia, Far East) Index. It is the most volatile of TSP benchmarks.
Why Should You Consider A TSP Annuity?
If you’re retired from the military then you already have an annuity: your military pension. It includes a COLA, a survivor benefit plan, and the world’s most reliable payment agency. You just can’t buy a better annuity than your pension, and another one might not be worth the money.
As annuities go, the TSP annuity is a bargain. However, if your military pension meets your bare-bones spending needs, then you may want to keep control of your TSP assets. Even the most conservative financial advisers recommend annuitizing only a portion of your retirement income, not all of it. A TSP annuity is safe but you surrender control over the money.
When you withdraw your TSP funds you can choose nearly any combination of a single payment, monthly payments, and an annuity. If you buy a TSP annuity then you give up a lump sum that you could have spent on other essentials (like long-term care) or passed on to your heirs. Instead of being able to dip into your TSP funds for large expenses like a new roof, caring for a loved one, or a fantasy vacation, you’d have to save the money out of monthly annuity payments. Better still, if you use the TSP’s other withdrawal methods then your account funds will continue to grow and will probably outperform an annuity.
How Does A TSP Annuity Work?
You can start your TSP annuity anytime after age 59.5. (TSP withdrawals before then are subject to early withdrawal penalties, although there is a complex 72(t) loophole to avoid the penalties.) The IRS requires you to start your TSP annuity before 1 April of the year after you turn 70.5 in order to comply with the required minimum distribution rules.
You can buy your annuity for just yourself (with or without a survivor option) or jointly with another annuitant. Typically that’s your spouse, but it could be an immediate family member or business partner with an “insurable interest”. Survivor options include “100% payment” and “50% payment”. Of course the size of the survivor benefit that you’d like to pass on will reduce the amount of your own annuity payment. There are additional rules for survivor annuity options you familiarize yourself with. Once again, if you have a military pension then its Survivor Benefit Plan is probably a better deal than a survivor option on your TSP annuity.
The annuity can be paid with or without a COLA. The COLA option will raise your annuity payment each year by the amount of inflation measured in the Consumer Price Index (CPI) up to a maximum of 3%. This option will also reduce the amount of your initial annuity payment, but that reduced amount will preserve its purchasing power for much longer.
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Is A TSP Annuity A Good Idea?
If you have a military pension then there may be still be a few reasons to opt for a TSP annuity— you could have spendthrift concerns or you may prefer to shield assets from litigation. But before you decide to take this option, it’s worth spending an hour or two with a financial adviser (or on Early-Retirement.org!) to explore other options.
If you won’t have any other pension income then a TSP annuity is one of the world’s best safety nets. (The other, believe it or not, is Social Security.) However, you still don’t want to go overboard on annuitizing your income. For most retirees, your annuity (plus Social Security) should cover an absolute minimum standard of living–one cut above cat food.
Even if you’re highly risk-averse, you can invest most of your remaining funds in assets like TIPS or I bonds that will afford inflation-fighting income while minimizing the risk of losing principal. If you later decide that you’re not comfortable with this approach then you can always buy more annuities. Once you purchase a TSP annuity, however, it’s an irrevocable decision.
Several factors impact the ammount of your TSP annuity payment. These factors should be considered as you weigh the possibility of buying an annuity. Some of those considerations include:
- Your age when you purchase the annuity
- A single life annuity vs a joint life arrangement
- The age of the joint annuitant (or co-owner of the annuity), if you choose a joint annuity
- The amount of money used to purchase the annuity
- The interest rate when you purchase the annuity
- Choosing level payments vs. increasing payments
How Is TSP Annuity Calculated?
The annuity options are quite complex, and their interactive effects on the monthly payment are hard to assess. The TSP annuity calculator can help sort through the choices to see how each one would affect the amount of the payment during your life expectancy and (if a survivor option is selected) your survivor’s remaining life expectancy.
The annuity can be paid with or without a COLA. The COLA option increasing payments each year by the amount of inflation measured in the Consumer Price Index (CPI) up to a maximum of 3%. This option will also reduce the amount of your initial annuity payment, but that reduced amount will preserve its purchasing power for much longer.
If your TSP account includes tax-exempt contributions (from a combat zone), the annuity vendor will track the taxable and tax-free proportions and report those amounts in your annual tax statement.
After you apply for your annuity, the TSP purchases it from a major vendor like Metropolitan Life. The federal government buys a large volume of annuities for its retirees and the vendors don’t have to spend money marketing them, so the vendors are expected to offer their annuities at lower prices and commissions. However, this bargain-basement price comes at a cost: the decision is irrevocable.
Once the TSP has bought your annuity for you, you can’t cancel or change its option or change its joint annuitant. It’s hypothetically possible to exchange an annuity for an annuity from another company, or to sell the continuing stream of payments to a third-party buyer, but a TSP-funded annuity includes a number of restrictions that may render it ineligible for the secondary annuity market.
Remember: if you’re receiving a military pension, its survivor and COLA benefits are probably a better deal than the TSP annuity. If you decide to buy a TSP annuity then purchase the absolute minimum amount you need, and consider the impact of interest rates. It’s always difficult to time an investment decision, but you get a higher annuity payment when interest rates are higher. It may be wise to delay your TSP annuity as long as possible or to purchase smaller annuities (from other companies) over several years.
What Is The Current TSP Annuity Rate?
The timing of your annuity purchase has a big impact on its amount. Annuity providers use an “assumed interest rate” to determine the discounted value of an annuity. It works just like a mortgage. When interest rates are high, your payment is high. When interest rates are low, your payment is low.
Payments are based on the interest rate index in effect at the time you purchase the annuity. The rate is based on a moving average of 10-year U. S. Treasury bonds, which can change as frequently as monthly.
To explore annuity estimates based on a different type of annuity purchase—or an annuity purchase combined with other withdrawal options—you can use the TSP payment and annuity calculator.
Over the last several years, the interest rate has been as high as 3.125% (November 2018) and as low as 1.375% (September 2016).
The Advantages and Disadvantages of a TSP Annuity
Here are a few of the TSP annuity pros and cons for you to consider. These just scratch the surface and you’ll need to do some additional research and determine how individual advantages and disadvantages apply to you.
Pros
- Tax-deductible contributions and tax-deferred growth. You don’t pay taxes on your earnings or contributions until you withdraw funds or start receiving payments. Deferred tax payments let accounts grow faster.
- A choice of several investment options ranging from stable and conservative to aggressive and volatile.
- TSP annuities are a defined contribution plan, funded by employee payroll contributions and partial, matching contributions from the U.S. government.
- Flexibility to buy an annuity for yourself with or without a survivor option, or jointly with another annuitant. Joint purchases can be an immediate family member or business partner with an “insurable interest.”
- Overall, TSP annuities remain one of the safest long-term investments.
- Flexibility of choosing annuity payments with or without a COLA. The COLA option raises your annuity payment each year by up to 3% each years measuredby inflation in the Consumer Price Index.
Cons
- Other than a few select circumstances, you can begin withdrawals until 59.5. Or you will be subject to early withdrawal penalties.
- More volatile fund options can create an unacceptable level of risk for some participants.
- Other types of investment vehicles may offer a greater rate of return.
- TSP annuities have several restrictions that may render it ineligible for the secondary annuity market.
- If you buy a TSP annuity, you give up a lump sum that you could have spent on other essentials.
- After you buy a TSP annuity, it’s an irrevocable decision.
How Much You Should Have In Your TSP When You Retire?
Your TSP balance should be part of an overall retirement investment strategy. It’s best for you to sit down with a financial planner and discuss your overall goals and current portfolio before deciding how much you should have in your TSP when you retire.
However, by way of example, if you want your TSP balance to generate an inflation-indexed annual income of $ 10,000, most financial planners will suggest that you have a $ 250,000 balance by the time you retire.
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