When planning for retirement, Washington State employees have lots of options. The employer-based retirement for the Washington Public Employees Retirement System (PERS 3) is one part defined benefit (pension) and one part defined contribution. The state’s contribution and obligation is on the pension side and is based on a formula that creates a guaranteed lifelong income stream for the participant. The employee’s contributions are put into an investment account (the defined contribution portion of the plan) like a 401(k) where you can choose between a few investment options. Returns and payments from investments in the defined contribution plan aren’t guaranteed and are subject to risk; however, they have the potential to grow at a faster rate than your pension benefit.
Once retired, you can either withdraw from the defined contribution portion like a regular retirement account or turn part or all of this account into a guaranteed income stream through the plan’s Total Allocation Portfolio (TAP) annuity.
What is the TAP annuity?
The TAP annuity provides a guaranteed income stream with a 3% automatic inflation increase each year. Furthermore, your beneficiaries receive a refund of any undistributed portion of your investment in the TAP annuity upon your death. For example, if a retiree contributes $200,000 into the TAP Annuity and passes away five years after retirement, having only received $60,000 in monthly income, their heirs would be entitled to a refund of $140,000.
Upon separation from service or at any time after, participants invested through the Washington State Investment Board (WSIB) can purchase the TAP annuity with a minimum investment of $25,000 made from the defined contribution portion of their PERS 3 plan. You can only put money into the TAP annuity once. Since PERS 3 is a pre-tax account, meaning you received a tax deduction on any contributions, any distributions/payments are considered ordinary income.
Who is eligible?
Participants in the Public Employees Retirement System (PERS) plan 3, Teachers Retirement System (TRS) plan 3, and School Employees Retirement System (SERS) plan are eligible for the TAP annuity.
How does it work?
At any time, participants can go to the Washington State Department of Retirement Systems website and estimate their potential income stream through the TAP annuity calculator. You can enter different payment start dates and purchase amounts to see how your benefit will vary based on the single life annuity and survivorship options (100%, 50%, and 66 2/3%).
The below tables show an example of a PERS 3 employee nearing retirement who’s evaluating their options using the TAP annuity calculator. As you can see, the 50% survivorship annuity payment is higher than the 100% and 66 2/3% survivorship payment because the benefit that would be paid to a survivor is less.
Possible Drawbacks of the TAP Annuity
Other important considerations when deciding between the TAP annuity or keeping the funds invested in the Plan 3 participant investment account include:
- Less income growth potential – Historically, a balanced stock and bond portfolio has provided a meaningfully higher return than the TAP annuity’s payment, even after taking into consideration the automatic annual 3% inflation increase. The TAP annuity may lead to less income now and in the future compared to investing the funds in a balanced portfolio.
- Less flexibility – With a TAP annuity, you can’t vary your withdrawal amounts based on your needs. With the retirement account option, you can withdraw funds as necessary to meet your needs, including extra withdrawals for one-time expenses. This lack of flexibility may create a problem for you if you have an obligation that arises and don’t have other financial resources to draw from.
- Less money for heirs – Unless you pass away early, it’s unlikely your beneficiaries will receive any benefit from this annuity. A surviving spouse may continue to receive payments at 100%, 66 2/3% and 50% of your benefit amount depending on the election you made upfront. The non-TAP annuity option has the potential to leave much more for heirs.
- Irrevocable – You can purchase the TAP annuity only once, and if you do purchase it, you can’t change your mind.
Should you purchase the TAP annuity?
Things to consider when making this decision include:
- Do you need the extra guaranteed monthly income in retirement to meet spending needs after taking into consideration the pension portion of Plan 3 and Social Security? Do you still need it after adding in any retirement income sources from your spouse?
- Do you have any other deferred compensation accounts through your employer, or any other investment accounts? Are they large enough to provide flexibility in your spending and/or do they meet your desired level of inheritance for beneficiaries?
- Are the ups and downs of the stock market too much for you? The stability an annuity provides may help with peace of mind.
We suggest speaking with an advisor to evaluate your state-provided retirement options and whether the TAP annuity makes sense given your specific circumstances.
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Geoff has always enjoyed talking with people about finance, learning about their investments, financial strategy, and business sense. His interest only deepened with time, and what began as a hobby has now become a life-long passion, with an unparalleled passion for continuing education that makes him an expert in many subjects from traditional taxes and investments to business succession planning and executive compensation negotiations.
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