The Thrift Savings Program (TSP) is the primary retirement savings method for federal employees, and the benefits are well known. The diversified options and low investment expenses make it a great vehicle for adding to a nest egg. While saving and investing are relatively straightforward within TSP, making withdrawals when you actually make it to retirement can be much more complicated. Here are the options available and some important factors to consider when making your decisions.
TSP Withdrawal Options
There are many working and retired federal employees that utilize the TSP throughout their careers, and will at some point begin taking withdrawals. The TSP itself, though, has limited resources available for servicing those accounts. In order to make it manageable for the agency, the withdrawal options are limited to just a few. They include a one-time partial withdrawal, full withdrawal, a series of monthly payments, or an annuity. Funds can also be moved to an IRA account, to be withdrawn from there.
One Time Partial Withdrawal
You are eligible for a partial withdrawal from TSP only once in your lifetime. Accordingly, there are a few considerations to keep in mind when considering this option:
- The minimum withdrawal amount is $1,000.
- Since you cannot repeat the partial withdrawal again, all potential needs should be addressed and planned for before deciding on a withdrawal amount.
- This option is not available if an age-based withdrawal was taken while employed. Age-based withdrawals can only be taken by working employees over age 59 ½.
- The pre-tax portion of a withdrawal is not taxed if transferred to an IRA. If it is a direct distribution to a participant, income tax is withheld. If an entire distribution is not needed immediately, the income tax can be spread out by transferring to an IRA first, and then taking the withdrawals from there.
A withdrawal of the entire TSP balance is allowed at any time in retirement. No income tax is withheld if the pre-tax balance is transferred to an IRA. A direct distribution to the participant is not typically recommended for a full withdrawal, since the entire income tax burden would be absorbed in one year and could possibly push the income level into a higher tax bracket. It is possible to transfer the pre-tax amount directly to a Roth IRA as well, though income tax would be due and that strategy should be discussed with a financial planner before implementing.
Series of Monthly Payments
One method of receiving regular funds from the TSP is through a series of regular monthly withdrawals. The amounts for the withdrawals can either be determined by the IRS life expectancy tables or a specific dollar amount determined by the participant. Here are a few additional considerations:
- Once withdrawal amounts are determined, by either method, they are fixed for an entire year and cannot be changed.
- Life expectancy withdrawals are designed to last for an entire lifetime, but that is not guaranteed. The tables are applied to the balance at the end of each year and the amount will vary based on investment performance.
- If the life expectancy method is used, there is a one-time option to change to the specific dollar amount method. There is no option to change from the specific dollar amount method to a life expectancy method.
- Withdrawals based on life expectancy tables cannot be transferred to an IRA, and income tax must be withheld.
- Specific dollar amount withdrawals can only be transferred to an IRA if they are expected to last less than ten years. If the amounts are projected to last longer than ten years, an IRA transfer is not allowed and income tax must be withheld.
Annuities are a contract with an insurance company that can provide income for life in exchange for an initial premium. There are many different options and types of annuities, which are constantly changing. Before considering any annuity purchase, you should review your specific situation with someone familiar with the options available, to see what type of contract is appropriate or if an annuity is appropriate at all. Once an annuity is purchased, the premium paid is committed and the funds may no longer be available.
Annuities that are purchased from within the TSP are all done through an exclusive contract with the Metropolitan Life Insurance Company, or MetLife. MetLife offers standard options for fixed annuities, but does not offer any variable annuity options through the TSP. It is also possible to transfer funds to an IRA, and purchase any type of annuity within the IRA account. It is strongly recommended to consider all of your options, including those available outside of MetLife, before purchasing any annuity contract. It is often possible to find either rates or options that are better or more appropriate for you.
Another option for accessing TSP funds is to first transfer them to an outside IRA account. From there, funds can be transferred without any restriction as to amount or timing. There are some tax considerations as discussed below, but no program-related limitations.
Special Considerations for Employees Retiring Before Age 59 ½
Federal employees are generally eligible for standard immediate retirement at age 55 (depending on birth date, retirement system, and service length), and even earlier for law enforcement, air traffic controllers, and employees retiring under Voluntary Early Retirement Authority (VERA). Those retiring prior to age 59 ½ will face some special tax rules for accessing their funds.
The IRS imposes an early-withdrawal penalty of 10% on retirement funds drawn from most designated retirement accounts prior to age 59 ½. That would include standard IRA’s, etc. There are a few exceptions to the penalty, though. Some of the most common include:
- The 10% penalty is not imposed on withdrawals from the TSP if the employee retired “during the calendar year that they turn 55” or later. That means that many retired federal employees can make their withdrawals from TSP penalty-free if they meet the requirement. A consideration should also be made of this exception if an outside IRA is to be used, either for investments or to purchase an annuity. In that instance, it will typically make sense to leave enough money in the TSP to cover all needed expenses until age 59 ½. Those calculations should be based on a complete retirement income plan, so that they are accurate and any unnecessary penalty can be avoided.
- For those retiring before age 55, the primary way to access the TSP funds without incurring the 10% penalty is through a process commonly called 72(t), named for the IRS rule describing it. The technical term is “substantially equal periodic payments” (SEPP). It is a very complicated rule, but the essential concept is that withdrawals can be taken early if they are of an amount that is expected to make the account last for a person’s lifetime. Here are a few particular highlights:
- A 72(t) withdrawal must be an annual amount that is projected to have the account last a lifetime. The calculations can be done using IRS life expectancy tables, annuity tables, or interest rate calculations. The specific calculations may be complicated, but the end result is a withdrawal rate of approximately 3% to 5% for someone in their early 50’s, depending on the method chosen.
- Withdrawals must last at least five years, or until age 59 ½, whichever is longer. Any deviation from the set payout schedule during that time will trigger the penalty on all withdrawn amounts.
- Within the TSP, the simplest way to make 72(t) withdrawals is to select the life expectancy monthly payment option. Those TSP-determined amounts will automatically qualify. If the amount is self-determined, it is up to the participant to verify that the amount is correct. It is not recommended to use the self-determined method, as the margin for error is great. Also, if there is an error at any point, all withdrawals made over the entire 72(t) period are subject to the 10% penalty retroactively.
- If a small amount is needed from the TSP that isn’t as high as what would be prescribed by the 72(t) tables, there are a couple of options available. The first is to take the full withdrawal based on the tables and entire account value, and put the excess money into a standard investment account to be used later when needed. The second is to move the money into separate outside IRA accounts. Since a 72(t) program only applies to a given account, it is possible to have two different IRA’s with only one of them being used as the basis for withdrawal calculations.
- If a larger amount is needed that what is available through a 72(t) withdrawal, it is strongly recommended that the retirement date and overall financial plan be revisited. By definition, withdrawals higher than allowed through 72(t) would likely use up all of the funds in an account before the normal life expectancy.
- Other scenarios can also provide an exception to the 10% penalty, though they are less common. That would include deductible medical expenses over 7.5% of adjusted gross income, disability, domestic court orders, and others. A professional tax advisor should be consulted before any of these exceptions are used, to ensure eligibility.
Technical Issues with TSP Withdrawals
There are a few details particular to the TSP program that should be considered when making withdrawals:
- TSP withdrawals come from all investment accounts equally. If a tiered strategy is being used and the money is intended to come only from the G fund, a rebalance may be needed after a withdrawal.
- TSP withdrawals also come proportionally from the pre-tax and Roth accounts based on existing balances, and there is no way to modify the proportion.
- An unpaid loan existing at retirement has 60 days to be paid back, and then it is declared a taxable distribution. The declaration can be made faster than 60 days if it is indicated that the participant does not wish to pay it back. This taxable distribution will be subject to the 10% early withdrawal penalty based on the same rules as any other withdrawal.
- Minimum distributions are required once age 70 ½ is reached, similar to other types of retirement accounts. This requirement can be satisfied by taking the monthly payment distribution option and selecting the IRS life expectancy table method. Minimum distributions are not required if the participant is still employed in federal service.
An overall TSP withdrawal strategy should be based on a solid and well thought-out retirement income plan, and is particular to a particular person and their situation. As people are retiring earlier, living longer, and having more expensive lifestyles, it is more important than ever to have a solid foundation for the decisions that are made early in retirement. There are a few particular strategy components that will be a part of many people’s plan, and they are reviewed here:
- All withdrawals (except transfers to an IRA) from the pre-tax account have income tax deducted. It is wise to pay attention to current tax brackets when making withdrawals, particularly large ones, to make sure unnecessary income tax isn’t paid.
- If an unpaid loan is present at retirement, it is often worth trying to get the distribution declaration made in a year without a full salary to avoid excessive income taxes.
- Since all withdrawals come from both standard and Roth accounts simultaneously when making distributions from the TSP, it is often advisable to transfer one or both portions out to an IRA or Roth IRA. Once transferred, the participant can control the tax treatment of withdrawals by picking the account to make the withdrawal from.
- If an annuity is to be used, it may be advantageous to invest in the contract early after retirement to take advantage of offered contract benefits. If this is done in an outside IRA account, the one-time partial withdrawal option may be needed.