Examining the TSP as an Income Stream

How your TSP produces income during retirement largely depends on the tax status of your TSP account.

Living as a federal retiree requires a shift in types of income. A federal salary is replaced with a federal pension, Social Security (for some), and any savings, which for many federal employees will be their Thrift Savings Plan (TSP).

When it comes to federal income tax, a FERS pension is generally taxable and Social Security may be taxable.

So how does the TSP compare to the first two income streams? Is there any control over the tax paid on TSP money?

To answer these questions, we must first examine the TSP to consider its tax status.

Is my TSP taxable?

When it comes to the TSP, the question is not really if individuals will pay tax but when they will pay tax.

Contributions to a traditional TSP are made pre-tax; therefore, money goes into the account before taxes are paid. The benefit of this strategy is that it lowers an individual’s taxable income in the present and consequently lowers one’s overall current tax bill.

So, when are taxes paid on a traditional TSP? With a traditional TSP, taxes will be paid when money is withdrawn from the account. This means that taxes deferred while working will be paid in retirement when the retiree begins to take distributions from the account. 

Unlike a traditional TSP, a Roth TSP is not tax-deferred. Taxes on Roth TSP are paid when funds are contributed. While this results in a higher tax-bill in the present than if taxes were deferred, it also allows funds inside a Roth TSP to generally grow tax free. Not only is Roth money growing tax free, but distributions from the account could be tax free, assuming the rules regarding age and accessing the account are followed. 

Consequently, a retiree may be asking the question, “Is my TSP taxable in retirement?” The answer to this question lies in whether the TSP is traditional or Roth. 

What is the purpose of the TSP?

When examining the TSP as an income stream, one must also consider the purpose of the TSP.

For example, Bob needs to use his TSP as an income stream to pay monthly bills and to support a particular standard of living. Due to this, he will likely have a different approach to accessing his TSP than Lucy. She can live comfortably on other forms of income and wants to preserve her TSP for occasional travel and be able to leave an inheritance for her children and grandchildren.

While Bob and Lucy have differing purposes for the TSP, both need to remember that money cannot remain in the TSP untouched forever. At 72, both Bob and Lucy will be required to take required minimum distributions (RMDs). The tax status of these RMDs will once again depend on whether the funds in the TSP are traditional or Roth.

About the Author

Brandon Christy, CPA, PFS, is the founder and president of Retirement Benefits Institute, Inc. He is an established leader in contracted federal retirement benefits education, and his company has trained over 10,000 federal employees to help them gain clarity and confidence in retirement.