A Life Annuity vs Monthly Payments

The idea expressed here was inspired by changes being made to the TSP platform. TSP stands for Thrift Savings Plan, one of the primary platforms used by Federal employees, members of the military, and certain others engaged in federal service, to set aside money from earned income to be used later in retirement.

Since I’m heavily invested in teaching people the ins and outs associated with money in retirement, this seems like a natural for me. It’s intended as a generic but narrow overview for anyone with money saved somewhere and looking to make an informed decision about how to use it to generate an income.

So what’s the difference between them and why should you care?

Annuities come in two flavors, immediate and deferred. They exist in the almost exclusive purview of insurance companies and their customers. Some charitable organizations offer what are known as charitable gift annuities that attempt to do almost the same thing. Instead, the charity makes the profit, not the insurance company, unless the charity does what TSP is expected to do and farm them out.

But back to the question at hand. In my 43 years as a financial planner, etc., I never once sold anyone an immediate annuity. And before you get further confused, the option I’m talking about as available for TSP members is an immediate annuity, as opposed to a deferred annuity.

Buying or arranging for an immediate annuity means handing your wallet over to an insurance company in exchange for a promise to send you X dollars, usually every month, for the rest of your life. If you’re lucky, and know to ask for it, they may have an option that causes the monthly check to increase incrementally over time.

If they do, it means your checks early on are going to be smaller than the ones that appear later in life. If you die before you get back what was in your wallet, then someone, a named beneficiary, will get what’s left. If you live beyond life expectancy, you keep getting checks. There are other payout options but without more information about what TSP plans to offer, I’m in the dark right now.

If you have money at TSP, and want a life annuity, my understanding is you are actually turning the chosen amount over to an insurance company like MetLife. Now, there’s nothing wrong with MetLife. The guarantees they offer are as good as they come.

But by handing them your wallet, you have deprived yourself of any flexibility if your life circumstances change. The “cost” of that lost flexibility is their guarantee that you cannot outlive whatever it is they agree to send you every month. If you live in fear of running out of money, this may be just the thing for you.

Whether it has a cost of living adjustment is something for which I don’t now have an answer. It may be that MetLife, if they are the company chosen by TSP to provide the life annuities, will make available to you any one of several life options. I won’t speculate what those might be.

As someone who thinks of themselves as knowledgeable about these things, I think you should forget about a guaranteed annuity. But them I’m biased. Well, maybe take a small amount, maybe 20% of your total, and direct it toward a life annuity. You’ve hedged your bets, without depriving yourself of all flexibility.

But if you choose to leave the rest with TSP, or for that matter even someone like Vanguard, then a valid option may be to choose monthly payments. I suspect there’ll be a process where you effectively take what are called systematic withdrawals. You decide the monthly amount, perhaps based on some loose assumption about how long you will live, then assume an annual growth rate of your remaining account, and TSP or whomever turns some of your account every month into cash, and starts sending you monthly checks.

You retain all kinds of flexibility. Suppose you sell a piece of real estate you inherited and really don’t want your monthly payments for the next few years. No problem. That’s not an option with an immediate life annuity. You can start again at a later date. You do have to be mindful once you reach age 7½ that you don’t run afoul of the required minimum distribution rules, but that’s not a big deal if you know where to look.

As you can imagine, I’ve left a lot unsaid, but if I’ve given you a little insight into the two options shown in the headline above, that’s a good thing.

Tony Kendzior \ 07 AUG 2019