When you’re ready to retire, you face a variety of options, each designed to meet certain needs, for withdrawals from your Thrift Savings Plan account.
The most straightforward option is to take a lump-sum distribution. The advantage is you receive all of your savings at once. The problem is you’ll have to pay income taxes on all of your savings at once and, depending on your age, you may have to pay an early withdrawal penalty. You’ll also have the responsibility of finding some place to invest any of the money you don’t spend. Unless you urgently need the money, this is probably not an attractive option.
You may also elect to withdraw your balance in monthly payments, based on your life expectancy or a fixed dollar amount. Your life expectancy and the resulting withdrawal amount will be recalculated yearly to produce the lowest monthly payment possible while stretching the payments over your expected lifetime. This allows the balance to be distributed over a longer time — delaying and potentially reducing the tax effects. If you want income from your account for life, aren’t too concerned about the exact amount, and want to maintain control of your investment, this might be the choice for you
If you choose to take payments in fixed dollar amounts, the payments will last until your account is depleted. You may adjust the payment amount each year, but once you reach age 70½ the payments must be at least as high as the life expectancy payments would be in order to meet the IRS’ minimum distribution requirements. This might be attractive if you want a small amount of income now and want to defer the tax bite as long as possible.
Another withdrawal option is the purchase of a guaranteed life annuity contract, currently from MetLife and designed especially for TSP participants. Details are explained in the booklet, “TSP Annuities,” at www.tsp.gov.
The advantage of an annuity, through TSP or a private insurer, is that the insurance company is guaranteeing payments for life, and possibly the life of your survivor. The disadvantage: When you
purchase an annuity, you relinquish any right to your investment during your lifetime. In other words, if
you use your $100,000 TSP balance to buy an annuity, you may no longer access the remainder of that
balance if an unforeseen need arises — the money has been spent on what is essentially an insurance
premium. There are also inconspicuous costs associated with an annuity. The insurance company takes
your money and pays it back with interest over your lifetime. Depending upon how long you live, your
return will vary considerably.
The final option is to transfer your TSP balance, all or in part, into an individual retirement account (IRA)
or employer sponsored plan and continue its tax-deferred status. You may also transfer equal monthly
payments in this way if the payments are large enough to deplete your account in less than 10 years. You
may then withdraw money as you need it, subject to the IRA distribution requirements beginning at age
70½. This has the advantage of giving you control over your investment and flexibility in taking
withdrawals.
Of these options, only the annuity offers guarantees both time and amount, so it is the benchmark against
which other options should be measured. Annuity payouts fluctuate over time with interest rates, and the
only way to know exactly what monthly income your money will buy is to get a quote from the annuity
provider.
The IRA transfer option is at the opposite end of the spectrum from the annuity, offering the most freedom
and no guarantees.
The accompanying table, developed as analysis for a client, shows estimated annual after-tax income
from a tax-deferred investment such as an IRA. These are not guaranteed values, but are highly likely
(more than 90 percent confidence) to be sustained under a cost-efficient, diversified investment strategy
allocated as specified.
You may use this data as a reference point when comparing the IRA transfer or monthly payment options
with the annuity payments you’re offered by an insurance company.
Written by Mike Miles
For the Federal Times
Publication July 19, 2004