In a previous article: Proud to Be an American, I covered the options for taking income from TSP at retirement. Those options are:
To understand the difference between accumulation and distribution from TSP, I like to use the analogy of climbing Mount Everest and descending from it. There are strategies that you’ll need to employ when you’re making the ascent to the summit - and very different strategies to use coming down the mountain. Looking at the period from September 2000 through September 2002, if you were invested in the C Fund, your account would have dropped by 44.73%. If you were able to stomach that fall and stayed in the C Fund, you would have recovered by October 2006. So if you had a $100,000 investment, it would have gone down to $55,270, but as long as you had the guts to stick it out, you would have recovered this loss.
Now, let’s look at the same market if you’d been retired and taking income.
Again, in this example you have $100,000 in your Thrift Savings Plan. It’s all in the C Fund and you’re paying yourself a check in the amount of $500 per month. Then comes the downturn. If you were in the C Fund taking monthly distributions from September 2000 through September 2002, you would have dropped by 44.73%, and because you are taking distributions, your account value would have dropped to $42,770. In reality, if that happened the average person is not going to stick that out. They’re going to shut it down and get out of the C Fund, and lock in the losses. That was what many federal employees did during this period, because what was required to get back up to $100,000 would be a positive return of 133 percent!
So, how can you design a plan for taking income to assure that you are not going to outlive your money?
One strategy that has become increasingly popular among the retirees I work with is SIPS, which is an acronym for Sequential Income Planning System. By utilizing SIPS, you are simply creating income over different time periods. You can use a variety of different vehicles including TSP, CD’s, annuities, mutual funds, stocks and bonds.
In the example below, a combination of the TSP G Fund, and two fixed indexed annuities were used. CD’s, savings bonds and treasury bonds could be used as well. If you are looking to have a solid, reliable income strategy, you may not want to rely on the stock market. I’m not saying you cannot use mutual funds and stocks in this strategy, however if you do, you must have a backup plan for income in the event of a declining market.
A hypothetical situation to illustrate how this can work:
Mary retired with $300,000 in her TSP. Her husband Tom had retired the previous year from the private sector, and had rolled over his $200,000 401(k) to an IRA. Mary and Tom decided that Mary’s pension, their Social Security, and taking income from TSP would be sufficient to meet their fixed expenses, and they would use Tom’s IRA to provide supplementary income if needed. Mary utilized the SIPS strategy to create income from Mary’s TSP. What Mary does with the $300,000 TSP is to leave $71,993 in the G Fund at TSP. She is going to take income immediately, so she wants that asset to be guaranteed. At the same time she is going to roll over the balance of her TSP to two other investment options.
For the first five years of Mary’s retirement, she is going to take income in the amount of $1,292 a month and after five years, her TSP account will be spent down. Meanwhile, at retirement, she had taken the balance and put it into two other investment accounts. One was set up with $65,854, and that went to a fixed indexed annuity. The index annuity allows Mary to participate in higher excess interest rates over the long term. (Index annuity returns can be as low as 0, if there is no gain, to 15% or 16%. On average, returns have been 4% to 6%).[SUB] 1[/SUB] So, in this example, if she averages just a 3% interest rate the initial $65,854 would grow to $82,450, and in the sixth year, when her TSP account is spent down, she will start drawing from this annuity. Mary can choose a 5 year payout, which will give her a monthly check for $1,427 during the next five years. [SUB]2[/SUB]
At the end of the second five year period, both the TSP and the annuity will be drawn down. It is time for her to take income from the third account that originally started with $162,153. A fixed index annuity was also the option that Mary chose, and in addition, she added a guaranteed lifetime withdrawal benefit rider. This rider provides an 8% rollup for the first 10 years. If Mary waited ten years to withdrawal from this account, the withdrawal balance would be $378,082.
As long as Mary and Tom stay within the withdrawal limits of the annuity, which in this case is 5% for a joint withdrawal, they are guaranteed $1,575 a month. Once Mary and Tom pass away, if there is any remaining account value left, the balance will then transfer to Mary’s named beneficiaries. [SUB]3[/SUB]
What happens if Mary and Tom need additional money?
First of all, the plan was to utilize Tom’s IRA for supplemental income; however, if Mary wanted to draw additional income she would have choices. Let’s assume that Mary is in the 8th year of her retirement. She has spent down her TSP account in the first five years. She is currently taking income from the first annuity, which will last through her 10th year of retirement. As for the remaining account, she had hoped to wait until the 11th year, to turn on income. Meanwhile, Mary needs $15,000 to buy a new car. Because Mary has not annuitized her entire TSP, she has access to these funds. Mary can also take the $15,000 from the third bucket, the account that had a starting value of $162,153. The downside would be that the withdrawal would reduce her guaranteed monthly payments proportionately.
SIPS is not right for everyone, but can work very well in many cases.
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1. Wharton Study on Fixed Annuities, October 5, 2009
2. This example and rates of return are for illustrative purposes only and are not indicative of future investment returns. Please consult with a qualified professional before making investment decisions.
3. A fixed indexed annuity is not an investment in the "'market" or in the applicable index: the participation rate and./or cap rate, and any other non-guaranteed components of the indexing formula may change and may be different in the future; Indexed interest could be less than with a traditional product, and could be zero (if applicable); Some indexed annuities guarantee a minimum interest rate.
Indexed annuities may not be suitable for all investors. Features such as participation rates, rate caps, and spread/asset/margin fees may change over time and adversely affect your return if an insurance company subsequently lowers the participation rate or cap or increases the spread/asset/margin fees.
Some fixed annuities come with high guaranteed interest rates that can decrease after a set number of years to a much lower minimal interest rate.
Investors can lose principal if an indexed annuity is terminated prior to the end of the surrender period.
The principal guarantee and income for life guarantee features of fixed and indexed annuities are subject to the claims-paying ability of the issuing insurance company.
If you take an early distribution from an annuity you may be subject to a surrender charge which could result in a loss of principal. You may also be subject to a tax penalty if you make a withdrawal before age 59/'z.
(1) Take monthly withdrawals from TSP,
(2) Create an annuity with TSP through MetLife, or
(3) Rollover TSP to an IRA and take distributions.
(4) You can also do a combination of these options.
Imagine that you have worked for the federal government for 30 years. You’ve been faithful to making contributions and managing your TSP account. Now that you are ready to retire, how do you turn that investment into a monthly check?(2) Create an annuity with TSP through MetLife, or
(3) Rollover TSP to an IRA and take distributions.
(4) You can also do a combination of these options.
To understand the difference between accumulation and distribution from TSP, I like to use the analogy of climbing Mount Everest and descending from it. There are strategies that you’ll need to employ when you’re making the ascent to the summit - and very different strategies to use coming down the mountain. Looking at the period from September 2000 through September 2002, if you were invested in the C Fund, your account would have dropped by 44.73%. If you were able to stomach that fall and stayed in the C Fund, you would have recovered by October 2006. So if you had a $100,000 investment, it would have gone down to $55,270, but as long as you had the guts to stick it out, you would have recovered this loss.
Now, let’s look at the same market if you’d been retired and taking income.
Again, in this example you have $100,000 in your Thrift Savings Plan. It’s all in the C Fund and you’re paying yourself a check in the amount of $500 per month. Then comes the downturn. If you were in the C Fund taking monthly distributions from September 2000 through September 2002, you would have dropped by 44.73%, and because you are taking distributions, your account value would have dropped to $42,770. In reality, if that happened the average person is not going to stick that out. They’re going to shut it down and get out of the C Fund, and lock in the losses. That was what many federal employees did during this period, because what was required to get back up to $100,000 would be a positive return of 133 percent!
So, how can you design a plan for taking income to assure that you are not going to outlive your money?
One strategy that has become increasingly popular among the retirees I work with is SIPS, which is an acronym for Sequential Income Planning System. By utilizing SIPS, you are simply creating income over different time periods. You can use a variety of different vehicles including TSP, CD’s, annuities, mutual funds, stocks and bonds.
In the example below, a combination of the TSP G Fund, and two fixed indexed annuities were used. CD’s, savings bonds and treasury bonds could be used as well. If you are looking to have a solid, reliable income strategy, you may not want to rely on the stock market. I’m not saying you cannot use mutual funds and stocks in this strategy, however if you do, you must have a backup plan for income in the event of a declining market.
A hypothetical situation to illustrate how this can work:
Mary retired with $300,000 in her TSP. Her husband Tom had retired the previous year from the private sector, and had rolled over his $200,000 401(k) to an IRA. Mary and Tom decided that Mary’s pension, their Social Security, and taking income from TSP would be sufficient to meet their fixed expenses, and they would use Tom’s IRA to provide supplementary income if needed. Mary utilized the SIPS strategy to create income from Mary’s TSP. What Mary does with the $300,000 TSP is to leave $71,993 in the G Fund at TSP. She is going to take income immediately, so she wants that asset to be guaranteed. At the same time she is going to roll over the balance of her TSP to two other investment options.
For the first five years of Mary’s retirement, she is going to take income in the amount of $1,292 a month and after five years, her TSP account will be spent down. Meanwhile, at retirement, she had taken the balance and put it into two other investment accounts. One was set up with $65,854, and that went to a fixed indexed annuity. The index annuity allows Mary to participate in higher excess interest rates over the long term. (Index annuity returns can be as low as 0, if there is no gain, to 15% or 16%. On average, returns have been 4% to 6%).[SUB] 1[/SUB] So, in this example, if she averages just a 3% interest rate the initial $65,854 would grow to $82,450, and in the sixth year, when her TSP account is spent down, she will start drawing from this annuity. Mary can choose a 5 year payout, which will give her a monthly check for $1,427 during the next five years. [SUB]2[/SUB]
At the end of the second five year period, both the TSP and the annuity will be drawn down. It is time for her to take income from the third account that originally started with $162,153. A fixed index annuity was also the option that Mary chose, and in addition, she added a guaranteed lifetime withdrawal benefit rider. This rider provides an 8% rollup for the first 10 years. If Mary waited ten years to withdrawal from this account, the withdrawal balance would be $378,082.
As long as Mary and Tom stay within the withdrawal limits of the annuity, which in this case is 5% for a joint withdrawal, they are guaranteed $1,575 a month. Once Mary and Tom pass away, if there is any remaining account value left, the balance will then transfer to Mary’s named beneficiaries. [SUB]3[/SUB]
What happens if Mary and Tom need additional money?
First of all, the plan was to utilize Tom’s IRA for supplemental income; however, if Mary wanted to draw additional income she would have choices. Let’s assume that Mary is in the 8th year of her retirement. She has spent down her TSP account in the first five years. She is currently taking income from the first annuity, which will last through her 10th year of retirement. As for the remaining account, she had hoped to wait until the 11th year, to turn on income. Meanwhile, Mary needs $15,000 to buy a new car. Because Mary has not annuitized her entire TSP, she has access to these funds. Mary can also take the $15,000 from the third bucket, the account that had a starting value of $162,153. The downside would be that the withdrawal would reduce her guaranteed monthly payments proportionately.
SIPS is not right for everyone, but can work very well in many cases.
----------
1. Wharton Study on Fixed Annuities, October 5, 2009
2. This example and rates of return are for illustrative purposes only and are not indicative of future investment returns. Please consult with a qualified professional before making investment decisions.
3. A fixed indexed annuity is not an investment in the "'market" or in the applicable index: the participation rate and./or cap rate, and any other non-guaranteed components of the indexing formula may change and may be different in the future; Indexed interest could be less than with a traditional product, and could be zero (if applicable); Some indexed annuities guarantee a minimum interest rate.
Indexed annuities may not be suitable for all investors. Features such as participation rates, rate caps, and spread/asset/margin fees may change over time and adversely affect your return if an insurance company subsequently lowers the participation rate or cap or increases the spread/asset/margin fees.
Some fixed annuities come with high guaranteed interest rates that can decrease after a set number of years to a much lower minimal interest rate.
Investors can lose principal if an indexed annuity is terminated prior to the end of the surrender period.
The principal guarantee and income for life guarantee features of fixed and indexed annuities are subject to the claims-paying ability of the issuing insurance company.
If you take an early distribution from an annuity you may be subject to a surrender charge which could result in a loss of principal. You may also be subject to a tax penalty if you make a withdrawal before age 59/'z.
