5 Things You Should Know About Withdrawing From Your TSP

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Whether you are nearing retirement or still building up your nest egg, it’s important that you take the time to understand some of the complexities that are involved with taking TSP withdrawals. Understanding these complexities will help ensure you are not missing critical elements in the multistep retirement planning process. Read on to learn the five things you should know about taking TSP withdrawals during retirement.

1. Not An IRA

Although the TSP and the Individual Retirement Arrangement (IRA) share many similarities, some federal employees mistakenly assume that both accounts have the same withdrawal options. However, this is not the case, as the TSP’s withdrawal options are quite different.

For example, while distributions from IRAs prior to age 59½ are subject to a 10% penalty (with certain exceptions), if you’re a federal employee who separates from service at age 55 or older, you can take penalty-free withdrawals from your TSP.

Furthermore, if you’re a Special Category Employee (Law Enforcement, Air Traffic Control, Firefighters, etc.), you can separate from service at age 50 or older and take penalty-free withdrawals.

Note: There are a few other exceptions that will allow you to take penalty-free withdrawals (death, disability, etc.).

You must be age 55 or older (age 50 for Special Category Employees) and separate from service to take penalty-free withdraws.

2. Tax Status of Withdrawals

How your distributions will be taxed depends on whether you have a traditional or a Roth TSP. Here is the difference:

Traditional TSP (Tax Me Later): The traditional TSP allows you to make your contributions before taxes are taken out of your pay. These pre-tax contributions provide an upfront tax benefit by deferring taxation until you make withdrawals. While your contributions and earnings will grow tax-deferred, your distributions from the TSP are fully taxable at ordinary tax rates.

The Traditional TSP allows you to postpone your tax payment until you withdraw your funds.

Roth TSP (Tax Me Now): Roths allow after-tax contributions and tax-free withdrawals. You pay taxes upfront contributing to your Roth with money that has already been taxed. Once in your Roth, your contributions grow tax-sheltered, and as long as you meet specific IRS requirements, your withdrawals are tax-free at retirement.

The Roth TSP acts as the opposite of the traditional TSP.

3. Methods of Withdrawing

Once you separate from federal service, you’ll have three options for taking TSP withdrawals. They are:

I. Lump-Sum: Whether you just need a portion of your TSP savings or want to withdraw the entire balance, you can have your funds transferred directly to you or an eligible retirement plan (IRA, 401(k), etc.). You can take as many withdrawals as you like but are limited to one withdrawal every 30 days.

II. Installment Payments: This option has some features of both the lump sum and the annuity options. For example, like the lump sum, this option allows payments to be transferred into an IRA or other eligible retirement plan. And like the annuity option, the installment provides a stream of automatic payments. When it comes to payment frequency, you have a few choices; You can choose between annual, quarterly, or monthly payments, and you can change your election at any time.

III. Annuity: The annuity option provides a guaranteed stream of monthly income for the rest of your life. Here is how it works; the TSP will take the funds you designate and purchase an annuity from MetLife. MetLife will then issue the monthly payments and handle all the administrative tasks for your annuity.

Note: You can use one of these methods or any combination of them.

4. Pro Rata Distributions

All distributions from your TSP will be disbursed proportionally between funds. This means that once you start withdrawing from your TSP, if you’re invested in more than one fund, you will not be able to pick which funds to sell. For example, if your TSP allocation is divided into 50% G-Fund and 50% C-Fund, every dollar you withdraw must come out in the exact proportion of 50% G and 50% C.

This limitation can force you to take withdrawals from a fund that has declined in value and severely limits your ability to control your retirement income strategy.

5. Required Minimum Distributions from the TSP

At age 72, the IRS will require that you take required minimum distributions (RMDs) from your TSP. Your TSP RMDs will be calculated for you, and if you have both a Traditional and a Roth account, the distributions will be drawn proportionately from both. Once distributed, the portion of the RMD from your traditional account will be taxed at your ordinary-income tax rate, while the amount from your Roth will be tax-free (assuming all requirements are met).

Note: RMDs are not required from your TSP if you are still an active federal employee.

Final Thoughts

Understanding the complexities involved with taking TSP withdrawals is critical to the longevity of your financial plan. So, make sure you take the time to plan how your withdrawals will work throughout your retirement. As always, if you are not comfortable with creating your financial plan or would like a professional opinion, consult with a qualified financial planner.

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2023 Legislative Change Notice

The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.

Published by Jose Armenta, MsBA, CFP®, ChFC®, EA

Jose Armenta is a CERTIFIED FINANCIAL PLANNER™ professional who specializes in helping federal employees get the most out of their federal benefits. Jose’s experience serving federal employees has provided him with valuable insight into federal employees' unique financial planning needs.

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