With Record-Low Annuity Rates, Now What?
July 16, 2012
Annuity rates are at a rock-bottom 1.875% for TSP investors who choose to purchase an annuity with MetLife, the Thrift Savings Plan’s sole contracted annuity provider. And chances are, the annuity rate will fall yet again in the coming month or two, since rates for U.S. treasury bonds continue to fall. The interest rate on the 10-year treasury bond dropped to below 1.45% today before recovering slightly to 1.464%, which represents a new closing low for the U.S. bond.
This month’s TSP annuity rate is, by the way, lower than inflation from the 2000-2009 period, which ran at about 2.56%, and is about the same as inflation over the past two years, which has been running at around 1.8%. Inflation over the past century has averaged 3.24%, well above the current annuity interest rate.
(See current TSP Annuity Rates here.)
With a 1.875% interest rate, according to the annuity calculator on tsp.gov, if you were to purchase an immediate annuity with $500,000 at age 60, you would make $2,229 per month. This is $80 less per month than one month ago, when the rate was 2.125%. Annuities that included a spousal survival option or inflation protection of up to 3% per year would provide less income initially.
Given the very low rates of the TSP annuities, what other options are there? There are several. For those who simply do not need to use the money right now, leave it where it is. If I were leaving government or military service, and if I were able to delay using the funds for a few years, I would take a very conservative investment strategy as discussed in TSP Investing Strategies. I would consider placing my funds in the L Income Fund, to preserve capital in case of a sudden fall in stock market prices in the coming couple of years. The large majority of the L Income Fund is invested in the G Fund, preserving my original investment, while smaller portions are invested in the stock funds (C, S, and I funds), and in the U.S. bond fund (F Fund), providing a bit of diversification for growth as well.
If I were ready to use some of my TSP investments now, I would consider investing at least a portion in low-fee, dividend-paying stock funds.
As noted in a previous post, the initial monthly payout of investing in a dividend fund paying 4% per year would be lower than a TSP annuity – about $1667 per month from a $500,000 investment (or $20,000 for the year). While the principal – the original $500,000 – might increase or decrease in the medium term depending on market volatility, over the years dividend-paying funds usually increase their payouts. The payout after 10 years for an index fund that increased its dividends by 5% per year would be $31,026 per year, or $2,585 per month.
One important feature in this investment strategy is that you have access to the entire invested amount at any point, whether it goes up or down. In purchasing an annuity, you are buying an insurance product that will provide you income for the rest of your life, whether you live two years or 50 years, and depending on the insurance contract, the annuity will provide your spouse with income as well. However, you have given up control of those funds that you used to purchase the insurance contract. If on the other hand you keep the money and invest it in a mainstream dividend paying stock fund, the entire invested amount is available at any time – you just sell it and invest it as you wish. Of course, the goal is to use only the dividend portion of the investment and leave the rest to grow, but the money is there nonetheless, both during your lifetime and during your spouse’s lifetime. And it can be passed on to the next generation or to a charity of your choice. You have many options when you control your own funds.
Below are some mainstream and large dividend-paying funds that I would consider if I were preparing to invest some of my TSP funds for income. These index funds invest in a range of large dividend-paying companies in the United States and abroad. This is just a short list of basic income-producing funds from which to start your research – there are many others available. The 12-month yield is noted in parentheses.
US Funds:
DLN – WisdomTree LargeCap Dividend Fund, an ETF that invests in the 300 largest companies of the U.S. dividend-paying market (3.11%) DVY – Dow Jones Select Dividend Index Fund, an ETF of the 100 highest-paying U.S. dividend stocks that have kept or increased their payout each year for ten years (3.47%) MGV – Mega-Cap 300 Value ETF, a fund that invests in value companies among the top 300 of the S&P 500 companies based in the United States (3.00%) PFF – S&P U.S. Preferred Stock Index Fund, an ETF that invests in the “preferred” or hybrid stock/bond shares of U.S. companies (5.88%) VIG – Dividend Appreciation ETF, a fund that invests in stocks of U.S. companies that have increased their dividends in each of the past 10 years (2.32%) VYM – High Dividend Yield ETF, a fund that invests in the highest dividend-paying stocks of companies based in the United States (3.32%)
International/World Funds:
DEW – WisdomTree Global Equity Income Index, a fund that invests in the top 30% of dividend-yielding companies in the United States and abroad (5.6%) IDV – Dow Jones Select International Dividend, a fund that invests in the 100 leading dividend-paying companies in developed countries (5.43%) IOO – S&P Global 100 index fund, an ETF that invests in the largest 100 companies of the world (2.77%)
Real Estate Funds:
FTY – FTSE NAREIT Real Estate 50 Index Fund, invests in the largest Real Estate Investment Trusts (REITs) in the United States (3.65%) IYR – Dow Jones U.S. Real Estate Index Fund, invests in most publicly traded U.S.-based REITs (3.47%) WPS – S&P Developed ex-U.S. Property Index Fund, invests in REITs based in developed countries outside of the United States (4.06%)
Multi-Asset Funds:
CVY – Guggenheim Multi-Asset Income ETF, a fund that invests in a combination of dividend-paying common stocks of companies based in the United States and abroad, Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs), close-end funds, Canadian royalty trusts, and preferred stocks (4.85%) HGI – Guggenheim International Mutli-Asset ETF, a fund that invests similarly to the CVY, but has a more international leaning (4%)
Note that the above list does not include some high-paying but very focused dividend-paying funds, such as the “Market Vectors Uranium and Nuclear Energy ETF” (NLR), which has a dividend yield of 13.72%, or the “iShares MSCI Spain” ETF (EWP), which has a dividend of 12.28%. There is no need to risk your hard-earned money in such focused funds as these, despite the high dividend yields.
Again, these are a few funds in which I would consider investing if I were getting ready to use my TSP funds. Your situation might differ, so ask your financial consultant for advice about what options might be right for you. And remember to ask your financial consultant how they are paid – if they get any sort of commission from an investment you make, chances are they are steering you in a direction that will benefit them more than it will benefit you. It is always best to use a fee-only advisor who you and you alone are paying, not the insurance or investment companies trying to sell you products.
Related topics: annuities