You’ve contributed to the TSP for your whole career and are ready for retirement! Hooray!
But wait, nobody ever gave you advice on the best way to withdraw from the TSP? Is it a smart move to purchase a TSP Annuity? Hmm, maybe you should have paid closer attention in that retirement training…
Don’t worry! This post will explain everything you need to know about the TSP annuity option and whether you might benefit from purchasing one.Get Gov Worker’s top 4 tips for federal employees!
Table of contents
- What is the Thrift Savings Plan (TSP)?
- Understanding the TSP Annuity as a withdrawal option
- Is the TSP annuity taxed?
- Is a TSP Annuity right for me?
- Where to get more information on the TSP
Please do not confuse my personal blog for financial advice, tax advice or an official position of the U.S. Government. This post may contain affiliate links. If you make a purchase after clicking on a link, I get a small percentage of the sale at no additional cost to you.
What is the Thrift Savings Plan (TSP)?
The Thrift Savings Plan (TSP) is a retirement savings plan available to federal employees and members of the uniformed services. The TSP is similar to 401(k) retirement benefits available to private sector employees. It’s a powerful tool for saving for retirement.
You can contribute to a Traditional or a Roth TSP. These accounts have different tax benefits. You defer paying taxes until retirement on contributions to the Traditional TSP. You pay taxes in the current year on contributions to the Roth TSP. Both are great choices to start saving towards your future retirement income!
The maximum contribution limit for both types of TSP account is $20,500. You can make an additional “catch-up contribution” of $6,500 if you are over age 50. Check out this article to learn about whether you should max contributions to your TSP.
What are the benefits of the TSP?
The TSP is a valuable benefit of federal employment that helps you save for retirement.
A federal government entity called the Federal Thrift and Retirement Board oversees the TSP. As a TSP participant, you benefit from their modest administrative expenses and minimal overhead costs by paying low total expense ratios. This helps you keep your hard-earned savings instead of spending them on fees!
In addition, TSP investment options are low-cost funds that generally track passive index fund equivalents. For example, the C fund is one of the most popular TSP fund options.
For civilian employees, the government will match 5% of your salary no matter which type of contribution you make. However, agency contributions always go into your traditional TSP balance. Different requirements for TSP contribution matching apply to US military members under the Blended Retirement System.
How do I withdraw from the TSP?
The TSP has flexible withdrawal options when it comes time to spend down your nest egg.
Some situations allow you to withdraw money from your TSP while you are still working as a federal employee. In-service TSP withdrawals include general purpose and residential loans that you must repay while you are still working. However, you are restricted from further in-service withdrawals if you have an outstanding TSP loan.
There are several options for withdrawing your money from the TSP once you separate or retire from federal service. These include a partial or total lump sum withdrawal that distributes money directly into your bank account.
You can also rollover TSP funds to a traditional IRA account. Click to learn about the difference between the TSP and an IRA.
You can select an installment plan that sends you regular monthly payments. The amount of these “substantially equivalent periodic payments” are determined by a lifetime expectancy table specified by the IRS.
Lastly, you can withdraw some or all of your TSP account by converting it into a TSP life annuity.
Understanding the TSP Annuity as a withdrawal option
Types of TSP annuities
Metropolitan Life Insurance Company (also known as MetLife) has been the sole annuity provider of TSP annuities since 1986. You need to make two key decisions to help you choose between the different types of annuities available:
- Do you want to provide survivor benefits to a spouse or other beneficiary?
- Do you want level payments that remain the same over time, or payments that increase by 2% each year?
The single life annuity is the simplest option and provides the highest monthly payments because there are no survivor benefits. The joint life annuity option provides either 100% or 50% benefits for the rest of the joint annuitant’s life.
What Happens to the Annuity When You Die?
If you select a joint-life annuity, payments will continue to the named joint annuitant for the rest of their life. Otherwise, there is no cash value remaining in the annuity after your death.
Additional Annuity Features
If you die before receiving a specified amount of annuity payments, there are additional options designed to provide value to your beneficiaries. These options are more expensive and will reduce your monthly payment amounts.
If you receive less value in payments than the amount of money used to purchase the TSP annuity, the cash refund option pays the remaining value to a named beneficiary. The ten-year certain option guarantees payments to your beneficiary for ten years, even if you die during the option period.
You should consult the table on page 3 of the TSP’s Annuities pamphlet for important information about combining each of the TSP annuity options.
Similar to other types of post-employment withdrawal, purchasing a TSP annuity is subject to a spousal notification requirement. Your spouse must sign a form in front of a witness agreeing to your TSP annuity purchase.
How big will my TSP Annuity Payment be?
Because the interest rate fluctuates over time, you won’t know the exact payment amount until the time of purchase. You can use the TSP’s annuity calculator to estimate monthly annuity payments and compare them to installment payment options.
The TSP annuity interest rate index fluctuates from month to month. In 2021, the TSP annuity interest rates ranged from 1.491% to 2.075%. The monthly payment amount also depends on the type of annuity and options chosen.
Understanding the difference between a TSP annuity and installment payments
Purchasing a TSP annuity is a one-time transaction where you use a lump sum amount from your TSP to purchase future payments from a third-party annuity provider. This is different from installment payment options that allow you make partial withdrawals while leaving money invested to grow in the TSP.
There are two options for withdrawing your TSP in a series of installment payments: fixed payments or “substantially equivalent periodic payments” based on life expectancy tables.
Both the installment payment options and the TSP annuity option can provide a predictable, regular stream of payments into your bank account. However, the TSP annuity is less flexible because you can’t reverse the one-time transaction of converting your TSP to annuity payments. You can’t make adjustments to the purchased annuity, but you can make changes to the installment payment options if you change your mind later.
The TSP pamphlet called “Withdrawing From Your TSP Account for Separated and Beneficiary Participants” describes changes to the payment amount or frequency that you can make after you have started annual installment payments.
Comparing the TSP annuity and installment payments for a hypothetical federal employee
If you are considering taking a TSP annuity, I strongly recommend you check out the TSP’s annuity calculator.
The calculator helps you compare your expected monthly payments from the annuity and installment payments.
Here is an example from someone with a $250,000 TSP balance at retirement age. They can expect to withdraw a fixed amount of nearly 150% more than the annuity during retirement if they can maintain a 7% rate of return in retirement.
Is the TSP annuity taxed?
The IRS will tax TSP annuity payments as ordinary income after you have elected to begin regular annuitized payments.
If you purchase the annuity using money from your traditional TSP account, you must pay federal income tax for the annuity payments that are deposited into your bank account each month.
TSP annuity payments are not excluded from the IRS calculation of provisional income, so they may have an impact on how much of your social security benefits are taxed. Click here to read about minimizing federal income tax in retirement.
If you live in a state that taxes ordinary income, you may also owe state income tax on these payments. For more information, consult this post about the best states for federal retirees.
Should I buy a TSP annuity with my Roth TSP?
Purchasing a TSP annuity with Roth TSP contributions is not tax-efficient
If you purchase the annuity using Roth TSP dollars, the annuity payments are partially taxable. Qualified dividends representing contributions from your Roth TSP are not taxable. You already paid income tax on these earnings in the year you made the contributions.
However, the portion of the payments that represent interest earnings (determined by the interest rate at the time of purchase) is a taxable distribution from the TSP annuity. Therefore, purchasing a TSP annuity with Roth TSP contributions is not a tax-efficient withdrawal method. Withdrawing interest earnings from your Roth TSP is tax-free, but you will have to pay income tax on the same earnings if they are distributed from the TSP annuity.
If you buy a TSP annuity with your Roth TSP, the qualified dividend portion of annuity payments does not count as provisional income for social security purposes. The IRS will count only the interest earnings portion of the payments towards your provisional income.
Is a TSP Annuity right for me?
Pros of TSP Life Annuities
The main benefit of a TSP life annuity is providing guaranteed income for life. This mitigates the risk that you will run out of money in old age.
If you want a “set it and forget it” approach to converting your TSP into a monthly cash flow, a TSP annuity could meet your needs. It’s literally impossible to change, so you can’t get much simpler than that!
The low interest rate might be appropriate for very conservative, risk-averse investors. However, most federal employees can afford more risk with their TSP accounts. You will have additional income sources in retirement from FERS annuity and social security payments.
Cons of TSP Life Annuities
For most people, the value of an annuity comes from providing guaranteed income for life. However, federal employees already have guaranteed pension streams from FERS annuity and social security payments. Therefore, TSP annuities provide little additional benefit to most federal employees.
Investments in equities such as the S Fund have a much higher rate of return than the TSP annuity. The effects of this underperformance will compound over long periods of time. You will most likely receive lower monthly payments from the TSP annuity than if you left your money invested in TSP funds.
The final amount of the monthly income streams is not determined until the TSP annuity purchase closes.
You can’t make adjustments to the TSP annuity after it has been purchased. Other TSP withdrawal options give you much more flexibility for spending your TSP dollars.
MetLife does not guarantee annuity payments if they go bankrupt, although state guaranty funds may provide protection in this scenario.Get Gov Worker’s top 4 tips for federal employees!
Where to get more information on the TSP
Have a comment on the article? Post it in my Federal Employee Facebook Group where you can connect with fellow feds.
Want more information on the TSP? Check out my TSP School!
SamSam i.e. "Gov Worker" started working for the government at age 18 and loved it so much that he never left. He started GovernmentWorkerFI in 2019 to help fellow federal employees understand their benefits, take control of their finances, and live their best lives.
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