MML #072: Your TSP wants you to annuitize. I usually wouldn't.

A reader wrote in this week:

"My TSP benefits statement constantly refers to an annuity, but I have not seen any persuasive reason to get one. Why shouldn't I just use the TSP value until it's gone, if that ever happens."

‍

For anyone outside the federal world, the TSP is essentially a government 401(k). And like a lot of statements, it's quietly nudging the reader toward something called an income annuity. So the real question is whether that nudge deserves any attention. (By the way, you don’t need a TSP to purchase an income annuity. I’m just flowing with the example provided)

Let me walk you through how I think about it.

What an income annuity actually is

An income annuity is a deal you cut with an insurance company. You hand them a lump sum. They send you a check every month for the rest of your life, or for some defined period, or until both you and a beneficiary pass away. You pick the flavor.

Sounds great on paper. Assuming the insurance company stays in business, you stop worrying about outliving your money. That's the entire pitch.

The catch

Most investors, if their accounts are structured properly, would have earned more by staying invested.

Past returns don't guarantee anything. But the historical pattern is fairly consistent, and the annuity wrapper costs you growth. Annuity payments also rarely keep pace with inflation unless you've paid for a Cost-of-Living-Adjustment rider, which lowers your starting payment to begin with.

And then there's the sales side. Income annuities are often oversold, and the commissions paid to the people selling them are not small.

When they actually make sense

Working with lawyers, I see this all the time. You spot downside risk for a living. You spend your career identifying what could go wrong, what the other side might argue, what could come back to bite. That instinct doesn't switch off at retirement. So when a TSP statement starts dangling a guaranteed paycheck, of course it lands.

And there's a real use case worth flagging.

If market ups and downs scare you out of staying invested, an annuity might be the only thing keeping you from making a bigger mistake. Locking in a smaller-but-guaranteed check beats selling stocks during a 25% drawdown.

Same goes for anyone who can't structure a proper cash reserve to ride through short-term volatility. Most clients can't live entirely off money market funds and CDs, so some risk has to stay on the table. If you genuinely can't sit with that risk, even after working through a plan with a professional, trading some of it to an insurance company isn't crazy.

Three questions I'd ask before going further

Before you make the call either way, sit with these:

1. How do you actually behave when markets drop 20-30%? Be honest with yourself. If you've moved to cash before, chances are you'll do it again.
2. What do your retirement expenses look like, and how will inflation chew at them over 25 years?
3. Do you already have a cash reserve and a portfolio structure that lets you avoid selling stocks at the worst possible time?

My honest take

I don't use annuities much. I never lead with them. Most clients who work through our process land in the same place, which is that they'd rather manage market risk themselves with someone they trust than hand it off to an insurance company for life.

But the answer isn't always no. There are situations where transferring some of the risk really is the right move. So I'll always reserve "maybe, let's explore it" before closing the window on what's best for someone.

If you're staring at that TSP statement wondering whether to pull the trigger, I'd love to walk through your specific numbers. Reply to this email or grab a time on my calendar.

Cheers, David

‍