One of the most misunderstood components of federal retirement policy is the “lump-sum option,” often known as the “alternative form of an annuity.” Even though it is no longer widely available, many employees nearing retirement age still ask for it.
The lump-sum option was developed to replace the previous “three-year recovery rule.” A program under which retirees are exempt from paying taxes on annuity payments for up to three years in exchange for receiving a refund equal to their contributions to the federal retirement fund. For most retirees, the tax-free period was around half that long in practice.
The initial lump-sum option permitted retirees to take out an amount equal to their contributions upon retirement while accepting an actuarial reduction of their annuity amount based on their average life expectancy. After its inception in 1986, the choice was widely available and enormously popular. However, it garnered a lot of attention from those in charge of the federal purse strings, and it was repealed on October 1, 1994, for everyone save those with a medical condition that is predicted to kill them within two years.
Although everyone currently eligible for this option has a substantially shorter life expectancy, those with life-threatening diseases may elect to get the lump sum and, as such, have their annuity actuarially decreased using the same life expectancy method.
The Office of Personnel Management (OPM) maintains a list of medical problems that automatically qualify for the alternative kind of annuity. It often requires providing medical papers for it. Other circumstances are evaluated on a case-by-case basis.
Even though that transition occurred many years ago, most employees approaching retirement appear to be making plans based on the availability of a lump-sum payment. This may be because they entered government employment around the period of the original lump-sum design and still believed in it.
Those who require a lump-sum withdrawal in retirement for a specific purpose, like paying off mortgages or other debts, or making a large purchase, should consider a Thrift Savings Plan (TSP) lump-sum withdrawal.
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