In my previous articles, I shared thoughts and strategies for navigating retirement planning and specifically challenges that I see in taking withdrawals from the Thrift Savings Plan (TSP).
I will begin by pointing out that I feel the TSP has made strides toward reducing impediments to use in retirement. That being said, I feel some issues may remain and I will share them here.
TSP Tax Traps
Perhaps I should expand this to tax traps and trips because some of them are stumbles and some can be hits.
No state tax withheld
Admittedly this is one with an easy fix but I include it here because it is something for which we must prepare. This represents the first time that most federal employees will have the experience of making quarterly tax payments to the state.
If you reside in one of the 12 states that do not tax TSP withdrawals, wonderful. However, if you will spend retirement in one of the remaining 38, a good place to begin is with your state’s income tax website. Here you can find the rules and forms for complying with remitting payments.
Here’s a good page from the IRS site to get you started.
Unable to do qualified charitable distributions (QCD) from TSP
Ok Jen, what’s a QCD?
In brief, it is a donation that you make directly to a qualified charity from your IRA. A growing number of retirees are taking advantage of this tax planning strategy. Sadly, this cannot be done directly from TSP (and to be fair 401ks). To do so you will want to first transfer funds from TSP to your qualified IRA. For more on this check out this article from my colleague Ed Zurndorfer.
Don’t rush to combine your military and civilian TSPs
We are fortunate to have many members with prior military service in our civilian workforce. This means many of you have both military and civilian TSP accounts. This may tempt one to decide to combine the accounts for “simplicity.” Here I urge caution.
If you served in a combat zone while you contributed to your military TSP you are eligible for special tax treatment on those contributions. The Combat Zone Tax Exclusions (CZTE) rules exempt income from taxation and therefore TSP contributions. TSP keeps track of this for you. However, if you combine the accounts the commingling will result in loss of that tracking.
RMDs are coming and may be sent automatically
Once you reach your required beginning date for TSP required minimum distributions, TSP will make sure that you never forget to take one. This means if you have not satisfied your required minimum distribution (RMD) from your TSP account, TSP will calculate and send to you.
OK Jen, feels like you are reaching. That DOESN’T sound like a bad thing. True, in and of itself this may not be an issue for you. But what if you have outside IRA accounts and have already taken sufficient distributions in that tax year to satisfy the combined RMDs across ALL qualified accounts for the year? SURPRISE, you will have more taxable income from the TSP auto RMD. That would not happen if you had transferred your TSP funds to an IRA.
Maybe this is not a trap but a possible unwelcome surprise. What if that bumps you into a higher bracket for Medicare part B premiums? Ouch.
Tax issues for heirs from a spousal beneficiary TSP
This might be the biggest “trap” of all and can be a nasty surprise for your heirs. This applies if your non-fed spouse inherits your TSP and does not exhaust it before their passing. If there are funds that remain in the spousal TSP, their beneficiaries (often your children), will be subject to taxation on any remaining balance with no opportunity to transfer it to a beneficiary IRA. This can be tax nightmare for the beneficiaries who inherit the fund.
From the TSP booklet:
TSP distribution of death benefits. Death benefit payments made from your beneficiary participant account must be paid directly to your beneficiary(ies). These payments are subject to certain tax restrictions and cannot be rolled over to an IRA or eligible employer plan. In addition, your beneficiary(ies) will have to pay the full amount of taxes on the taxable portions of the payment in the year it is received.
On this one forewarned is forearmed. Have a plan for your successor TSP beneficiaries or they will end with “tax tears”.
Jen, this article is a real downer.
I understand it can seem that way, but BELIEVE me my goal is to arm you with knowledge to make a difference. So now let’s press on to:
TSP Withdrawal Woes
Ok that title could be a little overkill. But again, I am sharing things and situations that might otherwise hide in the shadows of life.
Let me sketch out a scenario for you. You and your spouse are planning a dream trip and request a withdrawal from your TSP for the deposit. Submit, receive, remit, no problem. Commence dreaming.
But wait! Your trip organizer contacts you and offers a nice discount for paying in advance in full. Great news!! But the organizer needs the payment in 10 days so back you go to TSP only to find that you must wait 30 days between unscheduled distribution requests. Now you must scramble due to limited access to your money.
Now I will admit that this is a very specific example, but easy and timely access to YOUR money is a basic right in my opinion.
Pro Rata Rule Wrinkles
This one might seem a little obscure, but I do believe it can present a challenge without knowledge and planning. When we request a withdrawal from TSP the liquidations to generate the cash will be made from each of the invested funds in proportion (or pro rata).
Uh, OK Jen, what’s the big deal?
Again, allow me to offer a scenario. You have an allocation across the core funds G.F.C.S and I, and let’s say it is for ease of numbers it comprises 60% equities and 40% bonds.
Now let’s assume you wish to take a withdrawal. 60% of the proceeds will come from the equity funds (C, S and I) and 40% from the bond funds (F and G). Makes sense, right? But is that always the best way to do it?
In a flat market, perhaps, but what if we are experiencing a bear market for equities? Is it advisable to liquidate from that area while the market is down? Short answer, no. I think you get my point.
Being able to select the specific funds for liquidation can be an important advantage across market conditions. Unfortunately, that is not an option within the TSP. This can be overcome, but not without strategy and planning.
In summary, the TSP as an accumulation vehicle is an important part of building your retirement plans. Once it becomes a distribution vehicle, it is important to understand the nuances that make it different from other retirement vehicles.
I hope this piece gives you some material for thought. Use of your TSP can not be a set-it-and-forget-it situation for you in retirement. Have a plan in advance and make the most of what you have labored so hard to accumulate.
Until next time.
The information has been obtained from sources considered reliable but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Jennifer Meyer and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy suggested. Every investor’s situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making any investment or financial decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. The Thrift Savings Plan (TSP) is a retirement savings and investment plan for Federal employees and members of the uniformed services, including the Ready Reserve. The TSP is a defined contribution plan, meaning that the retirement income you receive from your TSP account will depend on how much you (and your agency or service, if you’re eligible to receive agency or service contributions) put into your account during your working years and the earnings accumulated over that time. The Federal Retirement Thrift Investment Board (FRTIB) administers the TSP.