What is the one thing federal employees need most when it comes to retirement planning?
A fully inflation-indexed immediate life annuity.
The one missing piece of the retirement puzzle for federal workers is the option to use their Thrift Savings Plan balances to create a stream of income that is guaranteed to last a lifetime and to maintain its purchasing power over the years.
Yes, you do have the option to purchase a TSP annuity, but it has what may, for many, be a fatal flaw: It doesn’t guarantee that the payments will keep pace with inflation.
Planning for retirees covered by the Civil Service Retirement System is fairly easy since much of their expected income will likely come from an annuity that is fully inflation-adjusted.
This means that those payments can be expected to support the same standard of living 20 years into retirement that they support during the first year of retirement.
This characteristic eliminates a major source of uncertainty in retirement planning, making the job much easier for the average beneficiary.
Employees covered by the Federal Employees Retirement System have much more uncertainty, and a more difficult analytic problem to contend with in planning and managing their retirement.
They start with Social Security benefits, which are the equivalent of a fully inflation-adjusted life annuity, although without the contractual guarantee.
This income is typically a fraction of the CSRS annuity for a career employee with similar history, however, and the FERS annuity income that will make up most of the difference is not fully inflation-adjusted.
It is adjusted for inflation by a special formula that will make the real value of the payments decline over time, making planning more difficult. Finally, there are no guarantees on the real income that will be produced by TSP savings.
There are basically two options for TSP savings: Either manage the money yourself and take withdrawals for income, or use the money to purchase a life annuity. The annuity converts your TSP funds, via the purchase price, to a guaranteed stream of income.
This is a useful device in that it removes the investment market and management risk from the equation and allows the income streams from all three sources — Social Security, the FERS annuity and the TSP — to be nailed down in advance.
But the TSP income stream, in the form of the currently available TSP annuity, is only specified in nominal terms, without accounting for the potential effects of inflation on its real value over time.
Even the increasing payment option available on the annuity does not adequately guarantee the purchasing power of the income, since it limits its inflation adjustments to 3 percent in any year.
What if inflation rises, like it did in the 1980s, to double-digit levels? Your TSP annuity payments will lose purchasing power from that point on. And adding the increasing payment option to your annuity will cost you nearly one-third of your initial payment amount.
This option is not only an inadequate protection against inflation, but it doesn’t help make planning any easier, either.
The option of purchasing a fully inflation-adjusted life annuity with your TSP assets should be near the top of the federal workforce’s retirement wish list.