Episode 21 – DCP earnings and annuities
Episode transcript:
[musical intro]
Jenny
Welcome back to Fund Your Future with DRS. And we got a question from one of our listeners asking about using your funds from DCP in your retirement. “How does DCP help your retirement income?” And we at Retirement Systems, spend so much time telling people to save, save, save for retirement and then that retirement day finally comes.
And now guess what? You get to actually spend your retirement income. But a lot of people kind of…. maybe they’ve spent so much time waiting and saving, they don’t really know how to go out and spend that money and maybe have some fun with it.
Seth
It’s so true. I think people get used to looking at their balance every day and they want to see it go up. And then you’re like, “oh, now I can actually spend this and what should I spend it on?” And then I often joke with people like, “you can do whatever you want with it. You can buy a boat, you can buy a Winnebago, you can pay off all your debt, you can pay your mortgage off, or you can just let it sit there until the IRS is going to make you start taking some of it out.”
Jenny
And then you can take it out and put it into a savings account. It’s still not spend it.
Seth
Exactly. Yeah. Just because you have to pay taxes. But that’s the difference. But yeah, you still… you’re right. You still don’t have to spend it. At DRS we have a number of options if people are thinking about wanting to convert that money into some sort of like monthly income stream through annuity options. And sometimes annuities feel like bad words to people or they have like, bad impressions of them.
And so, part of I think why we wanted to do this episode, I think Clara was the person that asked the question is just a let people know that there are different options for saving that money and might also give you a goal when you’re saving for like, “Hey, I’m going to turn this money into a monthly income stream.”
So that I can, you know, go out to eat more often. And when I’m retired [I can] plan on having a vacation once a month or travel with that money. So yeah, there are lots of different options to spend once you save.
Jenny
Yeah. And so, we want to clarify that. You know, when you retire, obviously you’ll be getting a certain pension amount as a public employee. Then at some point you’ll be getting income as well from Social Security. But then if you have a DCP account, you can also draw funds from this DCP account. And so as we talk about DCP gives you options and like you said, all these things, you could either take out all the money at once and make a splurgy purchase like a boat, or you can set it up to say, “okay, I want x amount per month.” Gives you a lot of good choices to consider.
Seth
Yeah. So when a person retires from one of their state retirement systems, whether it’s the Law Enforcement Plan or the Teachers’ Plan or the Public Employees’ Plan, School Plan… one of their options when they retire is that they can do what we call “purchase an additional annuity,” and they can use funds from outside savings like DCP to increase what their pension benefit is going to be every month for the rest of their life.
Yeah, and for some people that’s really important because you know what your set expenses are and your pension and your Social Security might not meet that need.
Jenny
Yeah, or like you said, it could give you that little bit extra to do fun splurgy things like eating at fancy restaurants or traveling more often. Yeah.
Seth
And some people really appreciate having a monthly amount that they know they can spend. Yeah. You know, it’s like I think it’s really common for people who are working. It’s like, well, I know my check my paycheck every month is this amount of money. So that’s how much money I can spend. I know I’m going to get another check next in two weeks or at the end of the month or whatever.
And so I think it’s very similar for folks who have this big pot of money to not know exactly how much to do, how much to spend out of it. But if you’re getting this monthly amount through an annuity, it can give you a little more certainty in what your options are.
Jenny
Yeah, that’s a really great point. Instead of just looking at your DCP account balance and going, “Wow, that’s a lot of money, but is it a lot of money?” Like, “maybe I want someone to help me kind of restrain my spending a little bit.” So, like you said, an annuity can help basically put some parameters around that. Yeah.
Seth
I think one of the other nice things about the annuity options is that they are guaranteed for the rest of your life. Yes. So it’s not going to run out. I think that’s one of the things that people get scared about with… They see their DCP and oftentimes, to your point, people won’t start taking distributions out of their account because they don’t want that money to run out.
There’s that fear of, “Oh, what if I live to 110 and I still need some income?” And now, yeah, you’re going to have your pension, you’re going to have your Social Security. Those are going to pay you every month for the rest of your life. And if you add an annuity option on, that’s also going to continue to pay from the state for the rest of your life.
Jenny
What are some examples? Like what is the base price of an annuity? Obviously, you can’t buy an annuity for $1,000, but…
Seth
Yeah. So, the state offers different annuities and different plans have different limits…not limits. Some do have limits, some have minimums. Most of the plans [start] around $25,000. Yeah, so you have to save at least that amount of money over the course of….
Jenny
$25,000.
Seth
Yeah. So in this case, I ran, just for the minimum $25,000 in the Public Employee Plan. And so, $25,000, you could turn into $142 every month for the rest of your life. And sometimes people look at that and go, “oh, man, that seems like not very much money.”
Jenny
And that’s retiring at age 65.
Seth
Yeah.
Jenny
And purchasing an annuity for $25,000. Yeah. Gives you $100…
Seth
Uh, $142 roughly speaking in the Public Employee System. And that’s…One of the things to be aware of, like all of these factors are personal. So, it depends on what plan you’re in, what your age is, and if you’re going to have a survivor option. So, the numbers we’re sharing today are just examples. And you can run your own scenarios for “if I retired at 70 or if I retired at 55 and purchased one of these annuities, what would the scenarios be?”
I think one of the things that oftentimes turns people off of private sector annuities is that they don’t have what’s oftentimes referred to as like a refund option. So, in this case, let’s say I purchase an annuity for $25,000, I get my first check of $142 and then I die the next month. And people are like, “Oh, I just wasted $25,000 that could have gone to my heirs.” With the state annuities, these are refundable up to the amount of your purchase and how much you’ve received back.
Jenny
So, in that example, if you died a year after retirement, the remaining amount would still go to your…
Seth
Yes, to whoever I’ve listed as my beneficiary. Yeah. So, the $25,000 minus whatever payments I’d already received.
Jenny
In the last year.
Seth
So, if I’ve already received payments over the $25,000, then there’s no remaining amount to be paid out. But if there is a remaining amount to be paid out, it will go to whoever is listed as a beneficiary. And I think for a lot of people that kind of relieves some of the pressure, like though I want to say buyer’s remorse, that isn’t the right the right word.
But that concern of like, “oh, I made a bad choice.” And on some level it’s like, well, you’re no longer alive. You’re not going to know if you made a bad choice or not.
Jenny
But you want to leave your family in good standing and you don’t want to leave your family angry at you or something. Yeah.
Seth
Or feeling like I wasted it.
Jenny
Yeah.
Seth
Yeah, exactly. So, I think that’s an option for people to really consider if they have this big lump sum of money or any lump sum of money and they’re thinking about what they want to do with it. Now, there are some, I guess, downsides to that type of annuity, to the annuity with the state, because you can only purchase it when you start your pension benefit.
And so, for a lot of folks, that makes sense. That’s when they’re completely transitioning their life. They’re all their regular payment sources are stopping from their job. And so, they want to start their pension, they’re going to start their Social Security. But some people aren’t planning on starting their Social Security right away, and they need money out of their deferred comp to get them to when they’re going to start their Social Security.
And so, they need more out of their deferred comp or something like that. So maybe this type of annuity might not make as much sense because there are different types of annuities in the private sector where people can like it’ll pay you just an annuity for of a certain amount for ten years or 15 years or 20 years or things like that.
Jenny
So, if I’m just drawing kind of random amounts, I decided to draw random amounts from my Deferred Compensation account in retirement. How often can I do that? Could I do that once a month and choose my own amount?
Seth
Yeah. Yeah, that’s a good question. You can take out distributions whenever you want, basically. And I think I think right now we only make payments twice a month on the first or the 15th, but you can set up installment payments so you can set up regular installments and say, you know, I want $1,000 every month until the money runs out or until I tell you to stop. But you can also say, “I’m going to take out $5,000 this month. And I’m going to wait until I need money again.”
Jenny
Right. And then decide later.
Seth
Yeah. How much you need and when you need it. Yeah. So, yeah, there’s a lot of flexibility with, Deferred Comp. or other types of like retirement savings to do that sort of… use it more like a savings account sort of.
Jenny
Right.
Seth
This is how I think about it. Or maybe to replenish your savings account.
Jenny
Right. Because and the other thing to mention is obviously then as you’re leaving the money in your Deferred Compensation account, it’s going to continue to grow with interest.
Seth
Yeah. Depending on how it’s invested and how the market does during that time period, it certainly can grow. We were talking before we started recording, but I read a study a little bit ago that and I don’t remember the numbers off the top of my head, but a certain percentage of retirees end up passing away with more money in their retirement accounts than when they actually retired because the market did well while they were retired and they weren’t spending as much out of their account.
And so, it continued to grow when they actually couldn’t spend it fast enough. And so, yeah, it’s something to be aware of that for a lot of folks when they retire, they still have 20 or 30 years that that money is going to last. And that’s a long time to have money invested. And yeah, there can be significant growth.
But that’s also why it can be scary. Like, I might need the money in 20 or 30 years, so I’m not going to want to spend it.
Jenny
True, because like we’ve had episodes about this before, but about health care expenses, you don’t know what’s going to happen to you in 10 years, especially in retirement.
Seth
Yeah, all sorts of long-term care expenses that people I think, kind of save for worst case scenario. And it’s great to have the money if that comes up, but the worst-case scenario doesn’t happen for everybody and you might end up at the end of your life with more in that account than you expected. And that’s a good problem to have and figure out what to do with it. Yeah.
Jenny
Like we said, you could leave it to your family as well. And then in terms of withdrawing money like we said, you can leave it in the account. But at a certain point there of course are these things called required minimum distributions.
Seth
Yeah. So, you have to start taking the money out at a certain age and that age has changed over time. The federal government has changed it a couple of times. I think for younger folks, it’s pretty safe to say right now that it’s at age 75, you’ll start having to take that money out for people who are retiring.
Now, it’s probably going to be more like 73 when you have to start taking that money out and there are formulas that basically say that you have to take a certain percentage out based on how old you are. And it’s something to be aware of for folks to plan for those taxes. That’s why you’re having to take the money out, is that the IRS will want you to start paying taxes on this money.
So, you’re going to have to take out a certain percentage every year. That percentage will change over time. And if you haven’t taken out the required amount, it’ll be forced out to you. So that way you don’t receive a tax penalty for not taking the money out. And as you said, I really actually appreciate this… People sometimes think like, “well, what am I going to do with that money?” Well, if you if you don’t need it, you can put it in a savings account.
Jenny
You can put it in a savings account. You don’t have to spend it on items.
Seth
Yeah. You can even put it in an investment account and let it continue to grow.
Jenny
In a private account. Yeah.
Seth
After tax comes out. So that’s something just for people to be aware of.
Jenny
So, another example is if you’re in Plan 3 and you purchase a TAP annuity and Plans 1 and 2 use a annuity, but Plan 3 uses the TAP annuity and TAP stands for…
Seth
The Total Allocation Portfolio. And so yeah, Plan 1 and 2 and even Plan 3 members can purchase that additional annuity as part of their pension. When they retire, they can start an additional annuity that they’re using supplementary savings from like their DCP account or other 457 accounts or something like that. Part of being a Plan 3 member, is that your contributions are going into an investment account.
And when you stop working similar to the DCP, you have this investment account, but you’re a Plan 3 member, you can do what you want with that money. You can buy a boat, or buy a Winnebago. But another option is that you can purchase what’s called the TAP annuity, the Total Allocation Portfolio annuity. And this is an annuity once again through the state of Washington.
One of the things I like about the TAP annuity is that you can actually start at any time. So if you quit work at 55 and want to retire early, but you don’t want to start collecting your pension yet, you can actually start your TAP annuity.
Jenny
Oh right.
Seth
Yeah. Or, you can leave that money there until you’re 72 and then purchase the TAP annuity and get the income stream started later on.
Jenny
Yeah.
Seth
So, and you don’t have to use your entire account balance. You can use whatever amount from that investment account that you want to purchase an annuity. So similarly you can say, I want to use $100,000 or I want to use $50,000, but you can only purchase one. I ran a couple of more scenarios. I ran one for school employee, Plan 3 member who currently is 65, and they’re going to start collecting their TAP annuity.
And I said that they had $100,000 in their account and if they chose to purchase at a TAP annuity, they would start receiving about $540 every month for the rest of their life. So, they could turn $100,000 into about $542 of monthly income for the rest of their life. Yes. And similarly, that’s got the same sort of refunds they pass away immediately after purchasing the annuity.
That $100,000 goes to whoever they had listed as their beneficiary or if they live for a few years, whatever the remainder of that amount is. The other thing I like about the TAP annuities are really annuities in general, but I ran a similar scenario for a school employee, but I kind of had this thought in my head like they need an additional $1,000.
They know what their pensions are going to be. They know what Social Security is going to be, but they would feel better if they had another $1,000 every month. And so I ran that scenario and said that meant that they would have to purchase an annuity for $184,000. So if they had $184,000 in their Plan 3 account, you know, after working for 20 or 30 years might be totally possible.
They could then add a fixed monthly amount of $1,000 to their income streams that they’re going to have. That’s cool. It can kind of be overwhelming for people like what dollar amount to choose or how much to annuitize. The real message is that you have flexibility with those investment accounts in different things to think about. For some folks, that’s going to make it so that they could retire earlier and have like a secure monthly amount.
Jenny
And of course, for those who are listening, you can go on to your online account, have some options in there for running numbers on these particular annuities.
Seth
You can run all sorts of scenarios. I think that you’re right, it’s super helpful. We talked to folks who have like $500,000 in their Plan 3 account. They just have no idea what they’re going to do. It sort of feels like life changing money. Yeah, you can say, “well, you could convert that to, you know, $2,500 every month.”
Okay, that helps kind of put it in a more realistic, understandable sense. Yeah. A person could say I’m just going to take $200 a month because that’s what I need or, that’s going be my fun money. And I’m going to use that and not feel guilty about whatever I’m going to do with it.
Yeah. I really just wanted to make sure that we de-stigmatize annuities a little bit and let people think about what options they might have. And the annuities we’ve talked about is [what] that the state offers. We’re not in the business of making a profit off of them. There are private sector annuities that might give different options that make more sense for a person, and it’s certainly a good idea to shop around and think about what might make sense.
And that’s where running those different scenarios and examples can be really helpful for an individual to look at their own personal situation using their DRS online account.
Jenny
I didn’t really realize that there were negative stigmas around annuities and that maybe some of these private companies that they don’t have the insurance backing. So, if you do end up dying before, you know, then the next couple of years. So that’s why it is important to do your research.
Seth
That refund of contributions is a feature that you can pay for. Annuities in general tend to be an insurance type products. They are insured in that, you are guaranteed to receive a monthly amount for the rest of your life.
Jenny
But, you never know how long you’re going to live.
Seth
And that’s exactly right. And I think that’s where it can make people feel a little bit uncertain. For a lot of folks having a set monthly amount that they know they’re not going to drop below. When you have a pension and Social Security, an annuity, it can help relieve a lot of stress in a person’s life.
Jenny
Yeah, for sure. So, it’s great to know that the state of Washington does offer these annuities and TAP annuities and that they are insured. Whether you end up living for a very long age or passing on early, that balance will either be paid out to you or to your beneficiaries.
Seth
Yeah, you know, that’s something that we didn’t talk about that I think one of the reasons people do end up purchasing annuity sometimes at time of retirement is that they want to take their money out of the market. They don’t want to be responsible for that investment risk. I mean, you’re giving up the possibility of the market going up and crazy and your money doubling or whatever.
And so sometimes that’s the reason people don’t purchase annuity. They don’t want their money to be locked in. They think, oh, I can maybe do better with my own investments and get more money in the long run. But it is kind of thing to take into consideration is that like, well then my money’s not going to go down if I’m purchasing an annuity.
And for some people I think that’s really important for them to say like, I’m going to take that risk off the table and feel like I don’t have that risk of running out of money.
Jenny
Yeah. So, I think the bottom line is just obviously do your research, you know, there’s calculators on the DRS website through your online account that you can run numbers.
Seth
Yeah, we have lots of webinars and videos about annuities to try to help people understand if people wanted to take a deep dive. There’s lots more information on our website and tools that people can kind of run their own scenarios.
Jenny
Well, thank you.
Seth
Yeah, thanks, Jenny.
[music outro]
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