The TSP (Thrift Savings Plan) is an incredibly convenient and effective tool in building wealth. It allows employees to take money straight from their paychecks and invest it while also getting great tax advantages.
If you invest in the traditional TSP (this is where most federal employees have their money) then you get a tax deduction in the year that the money goes into the TSP. If you invest in the Roth TSP, then you don’t get a tax deduction for saving but that money can then grow tax-free for as long as it is in the account.
Long story short, the TSP is awesome and every Fed should be using it.
20% Off The Top
Most feds understand the process of getting money into their TSP, but getting money out is much more in the dark.
One thing that catches most retirees off guard is the fact that when they request $1,000 from the traditional TSP, they generally only receive $800. In most cases, the TSP is going to send you only 80% of what you requested and will send the other 20% straight to the IRS for taxes.
But we have to remember that just because they withheld 20% that doesn’t mean that you are going to owe exactly 20% in taxes. That will depend on what other income you have and what your effective tax rate ends up being for that year.
For example, your effective tax rate may actually be 10% or even 30%, but the TSP will still only withhold 20% unless you tell them otherwise. As a general rule, you can tell the TSP to withhold more than 20%, but in most cases you can’t have them withhold less.
So if you think you will owe more than 20% in taxes then you can either request that the TSP withhold more or you can save more by yourself for tax time.
Note: This 20% withholding only applies to the traditional TSP. When you take money out of the Roth TSP there is no withholding because there are no taxes due (assuming you followed all the rules).
Not Always 20%
But I have to admit something. This 20% rule is not as simple as I tried to make it seem in the previous section. There are actually 17 different types of TSP withdrawals that are subject to different rules and withholding rates.
That being said, the most common withdrawal types that are used by retirees all have a minimum withholding amount of 20%.
The most common exception is when you take an installment payment for more than 10 years or a payment based on the IRS life expectancy tables.