One Big Mistake Most Federal Employees Make

Using the TSP to save for retirement is a good thing, but the author says that many federal employees make a mistake in their planning.

“I just need ‘x’ amount of years for my pension and then I have the TSP as well,” I heard my wife say to a co-worker the other day. 

It is true federal employees have a head start when it comes to retirement planning; pensions are not very common these days.

But, there is a mistake that most Feds are making.

This is how the financial situation looks for a lot of folks in the federal system we talk to. 

  • Some cash savings in the bank to cover emergencies and enough to feel good about having a reserve.
  • Home equity – homes have appreciated across the country and Feds are good at staying in one place and paying down the mortgage. This is a good thing and contributes to an asset on the balance sheet. 
  • Thrift Savings Plan – a significant balance in the traditional TSP plan based on employee contributions and agency contributions.  

So where is the mistake? 

Most assets are tied up in the Thrift Savings Plan. Ok, but why is this a mistake? 


Like any retirement plan the TSP is an incentive to save for retirement years – retirement plans allow for potential tax benefits and in return you may not access funds without penalty until “retirement age”.

The earliest you can tap your TSP is age 55 if separated from service and age 59.5 as an in-service withdrawal. 

I’m not suggesting you should be spending down your investments prior to these ages, but it’s important to have the option to access your money for other goals and to create flexibility. Life happens in between, other investments and opportunities may arise, and family goals and priorities may change. 

Of course, the FERS system is set up to encourage making a career out of federal service. If you didn’t have a pension, what would you do differently?


Tax planning is the most overlooked opportunity by federal employees. While there isn’t a way to get around paying taxes, we can try to be efficient.

If your situation is as described above, the majority of your retirement income will be fully taxable as ordinary income. 

FERS three legged stool - the "big 3" of a federal employee's retirement under the Federal Employees Retirement System (FERS)

FERS Pension

Except for a very small portion, your FERS pension will be taxable at ordinary income rates. The non-taxable portion represents the return of your contributions, generally amounting to somewhere around 2-5% of pension income. 

Social Security

Social security is also taxable for most folks. 85% of your benefits are taxable if you make over $34,000 as an individual or $44,000 filing jointly. 


Distributions from the traditional portion of your TSP account will be 100% taxable as ordinary income. This money has never been taxed, you received a deduction on contributions and the account grows tax deferred. With the numbers showing a small adoption rate for the Roth TSP lots of feds will be in this position.

With a great pension and social security, you might not need to take much from your TSP to supplement retirement income. However, starting at age 72, you’ll be required to start taking money from the account, and when you do, the IRS will be waiting for its share of tax due on the distribution. 

Required minimum distributions are based on a life expectancy table. The current RMD divisor at age 72 is 27.4 which equals 3.65% of account value that must be distributed. This percentage increases each year based on decreasing life expectancies within the table.

For example – TSP account balance $1,000,000 x 3.65% (or divided by 27.4) = $36,500 first year RMD

Or for the sake of further illustration, let’s say you wanted to take $300,000 from the account to invest in a real estate property or buy that 2nd home at the beach – this amount is fully taxable, and as part of your household income it helps determine your adjusted gross income and likely moving you to a significantly higher tax bracket.

With money coming from these 3 sources, it’s easy to see how you can get to the 22% tax bracket quickly.

2022 Tax BracketsSingle2022 Tax BracketsMarried Filing Jointly
10%$0 – $10,27510%$0 – $20,550
12%$10,275 – $41,77512%$20,550 – $83,550
22%$41,775 – $89,07522%$83,550 – $178,150
24%$89,075 – $170,05024%$178,150 – $340,100
32%$170,050 – $215,95032%$340,100 – $431,900
35%$215,950 – $539,90035%$431,900 – $647,850
37%$539,900 +37%$647,850 +

The Opportunity

As I reminded my wife, together we’ve established different types of accounts to complement what’s going on in the FERS system. I want us to have as much flexibility and freedom as possible by creating a smart financial plan. An important part of that is tax diversification. 

What is tax diversification? 

Just like your investment portfolio may benefit from diversification, your income can do the same. 

The tax structure of your accounts determines when and how your assets will be taxed. Different rules apply to different types of accounts, because of course they do (it’s taxes). Let’s look at the three major types of accounts and their characteristics:

Tax-deferred (traditional)Tax-free (Roth)Taxable
Usually funded with pre-tax money and receives a deduction
Accounts grow tax-deferred
Distributions are taxable as ordinary income

Funded with after-tax money
Accounts grow tax-free
Qualified distributions are tax-free
Funded with after-tax money
Account earnings are subject to taxation
Capital gains and dividends receive favorable rates
Cost basis determines taxability

The idea is to be proactive by using tax planning and a combination of account structures to create efficiency and optimize your financial plan, not only for tax rates, but also to create flexibility and choice. You want to be able to take advantage of any opportunities that come your way and access your money. 

Retirement accounts are great and every situation varies, but I feel everyone should own and consistently fund a taxable investment account.

Financial planning is more than just the FERS system. It’s a wonderful foundation, but to create a great plan we need to think beyond that.

The content is developed from sources believed to be providing accurate information. This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.

About the Author

Justin is the owner of District Financial Advisors, a firm focused on serving the needs of federal employees and their families. He is a Certified Financial Planner and has been helping people make the most of their money for over 21 years.