Annuities for TSP
As a Chartered Federal Employee Benefits Consultantsm, I interact with federal employees on a regular basis. In focusing on the federal market, I’m aware that federal employees are either part of the Civil Service Retirement System (CSRS) or the Federal Employees Retirement System (FERS). Upon retirement, a federal employee will receive a regular, monthly payment based partly on their “High-3” salary and years of service.
An annuity is a financial product that’s designed to provide regular, monthly payments to someone, typically in retirement. Most often, these payments are made by an insurance company, but in the case of federal employees, payments come from the federal government and depending upon which retirement system, it’s either called a CSRS Annuity or FERS annuity. The regular, monthly payments coming from the federal government is backed by the full faith and credit of the United States Government, but in the case of an insurance company, those payments are based upon the claims-paying ability of that insurance company.
Upon retirement or upon reaching age 59 ½ (Age-based In-Service withdrawal), a federal employee has the option of leaving their funds in the TSP or transferring/rolling over all or some of their balance to an Individual Retirement Account (IRA). That IRA can be held at an insurance company and typically those funds will purchase an annuity. Although those regular, monthly payments may not begin immediately, a federal employee will have the option of having another source of regular monthly payments at some point in the future.
Before you decide to purchase an annuity with funds in your TSP, here are some considerations:
Know what the surrender schedule and surrender charges are. Most annuities do not have upfront or initial sales charges. However, they often require you to keep in funds in the annuity for a specified period of time (years). The surrender schedule will outline how many years the penalty is in effect. An annuity will often allow withdrawals without penalty if the withdrawal doesn’t exceed 10% of the initial purchase amount. Any withdrawal above 10% would be subject to penalty. The surrender charge will specify the amount (often expressed as a percentage (%)) of the penalty assessed for withdrawals greater than 10%. The amount of the penalty varies by product and by insurance company. A short surrender period could be three (3) years, but some annuities have surrender periods of fifteen (15) years or more. Some surrender charges can be as high as 20%. Look for a table similar to the one below.
What is the guaranteed minimum investment return?
Is it a fixed annuity or a fixed-indexed annuity? A fixed annuity will have a stated interest rate for a specified period of time (1 year, 3 years, for example), after which a renewal rate will be determined based upon prevailing interest rates in the future. A fixed-indexed annuity will not have a stated interest rate, but the rate is determined based upon the performance of indexes tied to the financial (stock, bonds, or a combination thereof, and other investments) markets.
What is the crediting method? The crediting method will determine how much in earning you will receive in your annuity. A participation rate is applied to the return overall return of the indexes tied to the financial markets. Participation rates vary widely, with some participation rates being 40% to others being 100% or more. For example, if the participation rate is 40% and the financial market index has an 6% return (increase), you will receive 40% of the 6% return or 2.4% (6% x 40% = 2.4%). An alternative crediting method is known as a spread crediting method. If the stated spread amount is 3%, for example, and the financial market index has an 6% increase, you would earn the total amount above the stated spread amount. In this example, you would earn 3%, (the 6% return/increase minus the 3% spread).
This certainly is not an exhaustive list of the considerations that a federal employee should have when it comes to annuities. Annuities are particularly attractive to those individuals that will not have a source of guaranteed income that you cannot outlive. Traditional pensions offered this benefit to those in the private sector, but the use of traditional pensions has fallen dramatically, leaving the 401(k) as the most widely available retirement plan.
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