The Difference Between a TSP and a Monthly Retirement Annuity

The TSP is a defined contribution plan, which means the amount of money you get at retirement is based on how much you put in and how well your investments perform. Workers kick in cash through elective deferrals, and some federal agencies also make matching contributions. When you retire, you have the option of getting your money in one lump sum, breaking it up into a set number of monthly payments or stretching your payments out over the course of your lifetime. As of 2013, you could sock away up to $17,500 per year in your TSP. If you're over 50, you can stash away an extra $5,500 per year. The limit on total contributions, including the employer match, was $51,000 annually.

When you purchase an annuity from an insurance company, you pay them a set amount of money for the contract, and there's no limit on how much you can invest. In exchange, the insurance company agrees to make payments to you at a future date. A fixed annuity pays you the same amount, while variable and indexed annuity payments are tied to investment performance. Depending on your needs, you can arrange for the payments to last for a set period of time, or you can purchase a lifetime annuity. A lifetime annuity can be set up to continue paying benefits to your spouse after you die.

Generally, your TSP benefits are subject to federal taxes. Depending on where you live, you may also have to pay state taxes on your retirement income. When you put money into a TSP, you have the option of using pre-tax or after-tax dollars. If you make pre-tax contributions, you won't pay any taxes on the money until you start making withdrawals. If you kicked in after-tax dollars, then qualified withdrawals are tax-free. If you used after-tax dollars to buy an annuity, your benefits are only partially taxable. The part of your monthly payment that represents a return of your initial investment is tax-free.

If you take money out of your TSP before you turn 59 1/2, you may have to pay a 10-percent early withdrawal penalty unless you're eligible for an exemption. For example, the IRS typically waives the penalty if you've become totally and permanently disabled. If you decide to leave federal service before retirement age, you can leave your TSP money in your account, take a partial withdrawal or roll it over to another qualified retirement plan to defer taxes. If you're thinking of buying an annuity, you should carefully evaluate all of the costs involved. Typically, annuities tend to carry higher fees than other types of investments. For example, you may have to pay a penalty if you take the money out before you're scheduled to start receiving benefits.