The Thrift Savings Plan is a great benefit that all federal employees should be using to accumulate funds for retirement, but it doesn’t work quite as smoothly once you are in retirement.
Here are four things you can’t do with TSP that could otherwise benefit you in retirement.
#1 You cannot specify which funds to take distributions from
This has long been a hindrance for retirees with TSP. Any distribution from the Plan will be prorated according to your balance. For example, if your TSP allocation is 62% C fund and 38% G fund, any distribution would be apportioned as 62% from the C fund and 38% from the G fund.
There are many reasons you may want to take a distribution from a specific fund in retirement. For example:
- If one fund performed very well in a given year, you may want to take a distribution from that fund in order to rebalance your asset allocation.
- If you were employing the so-called TSP “barbell strategy,” you would hold a specific number of years of expenses in the G fund and take distributions from that fund – which won’t fluctuate in value – when the stock market is down. The theory is that this strategy allows your stock investments time to recover. But because TSP won’t allow distributions from a specific fund, you would be forced to rebalance your asset allocation every month if you were taking monthly distributions.
#2 You cannot specify tax withholding on some distributions
TSP doesn’t allow participants to stipulate how much they can have withheld from distributions labeled “installments expected to last less than 10 years.” It is my understanding that such an installment payment would be one that is more than a 10% withdrawal. This doesn’t apply to transfers, however, but to distributions.
Here is what TSP says on the matter: “We are required to withhold at least 20% of any taxable part of your installments that you do not directly transfer.”
This means that if you take one of these payments, TSP will withhold a minimum of 20% for federal taxes, but you may elect to have a higher percentage withheld.
This can be cumbersome for people who take a distribution for a specific need and are only in the 12% tax bracket. Yes, the 8% will be returned when you do your tax return, but it may cause account holders to take a larger withdrawal to make up for the extra 8% withheld because they need the funds at the time of the withdrawal.
#3 You cannot do an in-plan conversion
Roth conversions are a common tax planning tactic used by retirees. As such, people are always asking how they can convert some of their TSP funds to their Roth TSP and the simple answer is they can’t. Because TSP doesn’t allow in-plan conversions, a retiree must move funds to an IRA and then do a conversion to a Roth IRA.
#4 You cannot do a Qualified Charitable Distribution (QCD)
A qualified charitable distribution (QCD) is a great way for a retiree to save tax dollars on charitable contributions. QCDs allow a person who has reached age 70 ½ to donate funds to a charity directly from their IRA. When a QCD is executed, no taxes need to be paid on the distribution.
A QCD can also help retirees satisfy their Required Minimum Distribution (RMD) requirements. Here is an example:
Joe Federal gives $6,000 a year to charities. His house is paid off so he doesn’t have mortgage interest to deduct, and he pays $7,000 a year in state and local taxes. For Joe to get a tax benefit for his charitable donations, he would have to give over $20,000 a year because the itemized deduction for married filing jointly is $27,700, and then he would only get a benefit for the amount that put him over the standard deduction (amount of deductions minus the standard deduction). But his total deductions add up to $26,000, therefore he will not itemize, but rather take the standard deduction of $27,700.
Instead of doing charitable contributions with cash, Joe could do a qualified charitable distribution directly from his IRA once he reaches age 70 ½ and not pay any taxes on the distribution while also having the QCD apply toward his annual RMD.
Retirees often face the decision of whether or not to move funds from their TSP to an IRA. These four reasons tilt in favor of a TSP transfer.
