Thrift Savings Plan participants have the option of purchasing an annuity through the plan, but the TSP
annuity has one noteworthy shortcoming: It does not guarantee a fully inflation-indexed income.
The best the TSP annuity can offer is to adjust payments annually with increases in the consumer price
index up to 3 percent per year. This produces risk — the risk that the purchasing power of those payments
will decline in future years.
For years, I have been frustrated by the absence of a voluntarily purchased annuity contract that would
provide a guaranteed stream of income, in any amount desired, with payments that are adjusted each
year, without limit, to keep pace with inflation.
Now, investors have access to such a tool to help them build a better retirement. That venerable stalwart
of low-cost investing, Vanguard, is offering a fully inflation-indexed fixed immediate annuity contract.
Actually, Vanguard markets the annuity as a proprietary product, but it is underwritten and guaranteed by
AIG Life Insurance Co. — one of the world’s largest insurers.
I’m not trying to promote Vanguard here, nor do I have any interest in its product, but it deserves credit for
being what I believe is the first to offer such a product on the open market.
The company has also demonstrated its commitment to pioneering low-cost investment products — an
effort I support.
There are two ways you might use this annuity to your advantage. First, it provides a useful benchmark
for evaluating your retirement income options. In addition, you might actually purchase the annuity to
supply a stream of income over a lifetime or another fixed period that you choose.
While those who choose to purchase the annuity likely are to be in the minority, its usefulness as a
comparison and analysis tool is valuable to most — if not all — people who will rely on an income from their
savings.
Annuity as benchmark
Vanguard provides an annuity payment calculator on its Web site, www.vanguard.com. Click on the
words “Personal Investors,” then “Account Types & Services,” then “Retirement,” then “Annuities,” then
“Vanguard Lifetime Income Program.” Finally click on “Get an Instant Quote,” where you can enter your
information and calculate the amount of investment necessary to produce a specified income payment, or
calculate the income you would receive from a specific investment amount. Remember to make sure
you’ve selected the consumer price index inflation adjustment option before requesting the solution. If you
have trouble, Vanguard will provide support via telephone or e-mail.
Consider the following example: A married couple — 60-year-old Ed and 57-year-old Anita — are
considering retiring. Ed has accumulated $200,000 in his Thrift Savings Plan account and is considering
his options for using this sum to produce a consistent stream of retirement income.
He has two basic options. He can leave his balance invested and take regular withdrawals, or he can use
some or all of the money to buy an annuity.
The invest-and-withdrawal option is the more risky choice, since the strategy includes the possibility that
he might unexpectedly run out of money. He’d like to compare that option with a “safe” alternative.
He visits www.tsp.gov and runs the annuity calculator there. On the day of his visit, April 23, Ed makes
note that, with a 100 percent survivor benefit option, the TSP annuity will pay $772 per month, before
taxes.
He then directs his Web browser to the Vanguard site and enters his information. Again, with the 100
percent survivor benefit, and no other options except the full CPI inflation adjustment elected, he sees
that his $200,000 will buy a monthly income of about $682 per month, before taxes.
To sum up the options, Ed and Anita note the TSP annuity guarantees an initial annual payout equal to
about 4.6 percent of the $200,000 starting balance, while the Vanguard annuity guarantees an initial
payout of about 4.1 percent. But of the two, the Vanguard annuity is the only option in which payout is guaranteed to be worth as much in 30 years as it is today, and so it serves as the “safest option”
benchmark against which all other options should be compared. Ed and Anita then go on to consider the
invest-and-withdrawal option in light of this information.
Keep in mind the actual numbers will depend on your specific circumstances and annuity rates and terms
in effect when you do your research.
Choosing to purchase
Before deciding to actually purchase a fixed immediate annuity, like the TSP or Vanguard versions, you
should keep in mind a few important facts:
- The purchase of an immediate annuity is generally an irreversible decision in which you exchange a
lump sum of money for the promise of a future income stream. Once the stream of income has been
provided, there is no remainder left to be passed on to beneficiaries. - A cap on the inflation adjustments applied to annuity income payments can produce significant risk to
the value of future income streams. One or more years of inflation that exceeds the cap will do
irreversible damage to all payments that follow, reducing spending power and effectively reducing your income. - A prudently managed, diversified investment portfolio can be expected to produce initial withdrawal
rates of 4 to 6 percent, or even more, adjusted for inflation, for a couple like Ed and Anita. In addition to the income produced, such an investment portfolio would provide continuing access to its principal and would be likely to produce a residual value for beneficiaries. This is the most risky option, however — heavily dependent on the behavior of the investor and others involved in the management of the portfolio.
Written by Mike Miles
For the Federal Times
Publication April 30, 2007