How Many Annuities Do You Need?

When it comes to annuities, the author says that federal employees can have too much of a good thing.

Leo Tolstoy in 1886 wrote a short story, How Much Land Does a Man Need? A poor peasant named Pahom believes he needs more farmland and enters into an arrangement to acquire more real estate. Unfortunately, it does not end well for him. 

The same may be said for annuities. How much of your retirement should be an annuity? Too much may not be a good thing.

Consider that as members of the Federal Employees Retirement System (FERS) or member of the armed services you will eventually have a retirement. 

FERS and military retirement plans provide benefits from three different sources

  • a Defined Benefit Plan, 
  • Social Security, and 
  • the Thrift Savings Plan (TSP). 

Two of these components, the Defined Benefit Plan and Social Security are pensions. These federal pensions can also be described as annuities.

An annuity provides you with a predictable stream of income in retirement. The FERS and Social Security pensions are attractive for several reasons. This is because they:

  • provide monthly amounts for the rest of your life
  • are guaranteed by the federal government
  • have an annual cost of living (COLA) feature
  • are sometimes not taxed by certain states

So, with two pensions/annuities available to federal employees and military retirees should they consider using their TSP to purchase a commercial annuity?

Shakespeare’s Rosalind in As You Like It asked, “Why then, can one desire too much of a good thing?” Stan Lee, the writer and author of Spider-Man had his Green Goblin advise five hundred years later, “Too much of a good thing can be a bad thing.”

A study released this January by the Center for Retirement Research, How Much Do People Value Annuities and Their Added Features?, concluded, “People may be deterred not by a lack of interest in annuities but by a lack of knowledge of the product and how to buy it.”

For most federal and military retirees, adding an annuity or annuities to your retirement portfolio may be too much of a good thing. And remember commercial annuities are different than your FERS and Social Security pension/annuity. 

The federal pensions/annuities do not have any of the expenses and fees of commercial annuities. Administrative fees associated with annuities are usually around 0.3% of the annuity’s value, while mortality expenses can range from 0.5% to 1.5% annually. Surrender fees, which you only incur if you try to withdraw money early, can be as much as 10%. Inflation protection like the federal COLAs is an additional cost. And unlike federal pensions/annuities, the parent company that issues the commercial annuity may go bankrupt.

Still, some financial planners will promote commercial annuities for federal and military retirees. For many years, the belief among financial planners was that retirees would try to maintain a consistent standard of living, which meant they would need a “real” inflation-adjusted stream of cash flows to support their retirement lifestyles.

Then, Michael Stein, in 1998, presented his concept of a three-phase retirement: the Go-Go years, the Slow-Go years, and the No-Go years in his book, The Prosperous Retirement: Guide to the New Reality.

Stein shattered the conventional approach by arguing early retirement is represented by the Go-Go years having a continuation of a lifestyle similar to pre-retirement; the Slow-Go years are when health and energy begin to decline along with a change in spending activities like travel or even just eating out begin to decline; and finally, the No-Go years defined as a total shutdown of activity-related spending.

David Rodeck in a Kiplinger article, Retirees, Here’s What to Consider When Buying an Annuity interviewed Wade Pfau, a professor of retirement income at The American College of Financial Services who provided this advice for those thinking of annuities: “If you plan on spending more to maximize your lifestyle at the start of retirement and aren’t as worried about outliving your savings, an annuity might not make sense.” 

Another important consideration for federal and military retirees considering purchasing commercial annuities is to have enough assets for emergencies and other expenses that usually do not get enough visibility in budgets. Home repairs, automobile purchases, and health expenses are bills with inflation potential that sometimes do not get factored into a budget.

And what about an emergency fund? If it has to be used – and it will, how are you going to restore it for the next emergency on a retirement income flow that is restricted by the purchase of commercial annuities?

Finally, if you are a federal or military retiree and still thinking of exploring a commercial annuity, you may want to read How Much Land Does a Man Need? before making a decision.

About the Author

Francis Xavier (FX) Bergmeister retired from the USMC and the F.B.I. Consider following him on LinkedIn as he shares articles from others about retirement and other financial topics. He also provides retirement seminars thru Federal Career Experts.