Pros & Cons of TSP Annuity
Pros & Cons of the (Antiquated) TSP Annuity
An annuity, in the broadest terms, usually refers to an investment or program where the participants exchange a sum of money (contributions) for a guaranteed stream of income. In general, programs like this look to mitigate longevity risk – or the risk that you will outlive your personal life savings. Since no one knows exactly how long they are going to live, an annuity refers to a family of investments generally designed for individuals to pool their money together in order to collectively mitigate the risk of any individual participant outliving their own personal savings. There are many different types of annuities with different strengths and weaknesses (work with a professional to understand them clearly), but the annuity family of investments represent the only tools in the retirement toolkit that can guarantee payments for life – even after your account balance (the grand total of your contributions and any earnings) reaches zero.
Now everyone knows that during our career we save up a big nest egg to live on in retirement – so it is natural that we are conditioned to view our nest egg as a lump sum. But in retirement, we rarely ever need to use our nest egg as a lump sum – unless [expletive deleted] really hits the fan, right? Most of us slowly draw from our nest egg to replace a portion of our income each month, like the FERS 3-Legged Stool and the now-obsolete 4% Rule teach us.
Since your investing goals change when your paycheck goes away in retirement, it is key to understand that in the Fixed-Income chapter of your life:
INCOME is the OUTCOME that matters most!
Generating retirement income within your TSP is easy if you are lucky enough to retire into a bull market – when the C and S funds are returning double digits year after year you can simply live off of your account’s earnings. But what if we retire into a bear market with a negative sequence of returns? In todays suppressed interest rate environment, it is an incredibly daunting task to personally generate a safe, sustainable income when our lifestyle costs more than our account can earn without significant market risk. It is no wonder today that retirees fear outliving their savings more than they fear death!
As such, the TSP offers participants the option to purchase a Single Premium Immediate Annuity (or SPIA) from MetLife with all, or part, of their TSP balance in order to create income for life, a supplemental personal pension. The TSP annuity converts a lump sum contribution (single premium) into a series of payments that start immediately (annuitization).
The SPIA model has not changed in generations, payments can never be outlived by the owner (the annuitant) – regardless of market conditions, interest rate environments, or how long you live – but you are forced to irrevocably forfeit 100% of your contributions to the SPIA. This rigidly inflexible approach is what most people think of when we hear the word ‘annuity’. Now while people love stress-free guaranteed income, people don’t like completely surrendering access to their hard-earned money.
So, how do you ‘win’ with a SPIA?
You simply ‘keep on keepin on’ long enough to get more money out than you initially put in.
While you lose most control in a SPIA, you do initially get to elect from a menu of payout methods though. Married TSP participants have 17 different combinations of payout options within the TSP Annuity (such as Level, Increasing, single-life, joint-life, period certain – learn more here).
Here are the conceptual highlights:
1. The TSP annuity’s biggest monthly payment option comes from electing a “Single Life Only” payout – meaning MetLife only needs to pay you as long as you are alive and then gets to keep anything left over when you pass. Period.
a. For those without spouses or dependents, this may be a great way to maximize income for yourself because the payouts are the largest
b. For the vast majority of retirees, it is too big a gamble to risk completely disinheriting loved ones
2. All of the other options that obligate MetLife to make more payments to your loved ones if you were to pass early will permanently reduce the monthly benefit you receive while you are alive
3. Most importantly you must be sure to choose wisely, for in the TSP Annuity – your initial election is finaaaaaaal and irrevocaaaaaaaaaable (Ghoulish Halloween laugh echoes)
Thankfully not all annuities available to investors today are as restrictive and inflexible as the antiquated Single Premium Immediate Annuity offerings from the TSP. In today’s competitive market, the latest generation of annuities offer more control and flexibility in crafting your personal pension than ever before.
While you can also purchase a SPIA outside of the TSP, insurance companies have created a number of more innovative types of annuities to offer flexible approaches to addressing the income needs and investment goals of today’s retirees. The main innovation, common to most of today’s annuities, is that insurance companies no longer require you to irrevocably forfeit control of your contributions (aka annuitize) in order to receive a Lifetime Income Benefit!
Let me repeat that into the megaphone:
Nowadays you DO NOT need to irrevocably forfeit control of your money in order to receive a guaranteed income for life!
It’s the best of both worlds knowing that you cannot outlive your annuity income but can still access any remaining balance if you suddenly need your money back. People also sleep easier knowing that any remaining funds transfer directly to their listed beneficiaries, without going through probate, if they were to pass before spending the account all the way down. Many even have features to assist with Long-Term Care.
While it is incredibly important to understand the fees, liquidity, risk tolerance and other considerations – remember, a properly designed and implemented annuity is the only investment out there that contractually guarantees you can never outlive your income. So, if a portion of your TSP is intended to generate supplemental income in retirement, then it is critical that you work with a Federally Focused Retirement Planner to help you compare the TSP Immediate Annuity to some of the more innovative alternatives available today.