Ask The Experts: Money Matters

By Mike Miles

Taxes on TSP withdrawals

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Q: My wife wants to withdraw money from her TSP to pay off financial obligations. How much can we expect to pay in taxes if she withdraws $65,000?

A: Her withdrawal may be subject to withholding. You can review the information in the document at How much you wind up owing in tax will depend upon the specifics of your tax return for the year of the withdrawal.

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Withdrawing from TSP

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Q: I am 62 years old and will retire this year under the Civil Service system after 41 years. I want to take all of my TSP out to pay off my second trust on my home this year. I was told when I withdraw my TSP I will pay a 26 percent withdrawal tax. Will I also have to pay an income tax on that money when 2011 income taxes become due?

A: Your withdrawal will be subject to 20 percent tax withholding, which will be applied as a credit against your tax liability when you file your tax return for the year.

TSP transition from L2040 to L2050

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Q: I am 27 and I’ve been in the federal service for five years. All my contributions to the TSP are in the L2040. Since I do not expect to retire before 2040, I think the smartest move should be investing in the new L2050 fund. But my question is, should I move all the money that I already have to that fund, or should I just start investing in the L2050 and leave whatever I have in the L2040?

A: The TSP recommends that you invest all of your account assets in the L Fund that corresponds most closely to your retirement year. Of course, they make no promises regarding the results.

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TSP withdrawal to pay off mortgage

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Q: I am a 54-year-old FERS employee who will be forced to retire soon. My 6.2 percent mortgage will eat up over half my pension. Would it make sense, upon retirement, to withdraw enough from my TSP to payoff the mortgage and leave the remaining funds? I will need 65,000 and have about 170,000 in my TSP.

A: Whether it’s a good idea or not will depend upon how the move fits into your overall retirement strategy. Without a clearly defined strategy for managing your resources through retirement, it is impossible to say whether the move will help or hurt. In my experience — where I’m the one responsible for formulating and managing the retirement plan — it’s usually not the recommended tactic, since it tends to impair liquidity and ability to fund cash flows in retirement.

TSP payment

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Q: With it taking up to 12 months to start receiving a full retirement check once you retire, how long will it take to receive my TSP lump-sum payment after I retire?

A: I can’t tell you, exactly, but based on my experience, it shouldn’t take more than a couple of weeks.

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Revocable living trust

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Q: Two of the biggest selling points of placing assets in a revocable living trust is that when you die your assets can be distributed privately and without the need for probate. But if everything is done privately and no probate court is involved, how would the IRS know whether or not the decedent’s estate was subject to estate taxes?

A: The decedent’s estate is required to file tax returns, trusts or no trusts.


Rolling an IRA into a TSP

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Q: My wife, a federal employee, has a traditional IRA. Some of the contribution made to the IRA was with money that was considered a deduction when it was contributed, thus no taxes were paid on those contributions. Some of the contributions over the years were made with after tax money. She could not deduct those contributions because of our combined income. My wife would like to know if she can transfer the money from her IRA to her TSP? Can all the increase in the value of the IRA be transferred to the TSP, even if the increase occurred because of gains on the IRA? Is there a special form for this transfer if it is allowed?

A: She can only transfer the IRA into the TSP if she’s willing to say that it’s all taxable when it comes out. She can’t segregate the pre- from the post-tax money. Each dollar in the IRA is considered to consist of part of each.


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25 percent savings rate bold, safe for young feds

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I recently interviewed Kimberly Palmer, author of “Generation Earn: The Young Professional’s Guide to Spending, Investing, and Giving Back.”
Palmer recommends young professionals save at least 25 percent of their pretax income as they earn it. She adds that up-and-coming feds should take advantage of their retirement benefits, particularly the Thrift Savings Plan.

I advocate the TSP as the best retirement investment vehicle available anywhere. Its low expenses, efficient design and simplicity make it better than any other defined contribution retirement plan I know of. I agree with Palmer’s advice to maximize your TSP contributions. Generally, I prefer to see my clients save to the TSP first, then to a tax-deductible traditional IRA, then to a Roth IRA and then to a taxable account, to the extent that each of these options is available.

But I am intrigued by Palmer’s rather aggressive recommendation that young professionals save at least 25 percent of their pretax income. This is a significantly higher savings rate than is typically realized, or even targeted, by most people. Palmer points out that, in addition to retirement, her recommended savings rate includes allowances for other goals, such as emergencies and travel.

I’d like to focus on the savings rate required to fund income replacement in retirement. I’ve run some analyses aimed at determining the savings rates required to fund full — 100 percent — replacement of your pre-retirement income from your TSP account. In my analysis, I assumed that the TSP money was invested and annually rebalanced using an allocation of 55 percent in the C Fund, 25 percent in the S Fund, 10 percent in the I Fund, 5 percent in the G Fund and 5 percent in the F Fund before retirement and a more conservative 40 percent in the C Fund, 15 percent in the S Fund, 5 percent in the I Fund, 15 percent in the G Fund and 25 percent in the F Fund during retirement.

My findings:

  • The earlier you start saving, the less you’ll have to save. For example, I estimate that if you start saving at age 25 and want to retire at age 67, you’ll need to save about 10 percent of your gross income in the TSP to fund a plan that includes lifetime withdrawals equal to your pre-retirement gross income. Wait until you’re 35 to start saving and the required savings rate rises to 20 percent.
  • The earlier you retire, the more you’ll have to save. For example, if the 25-year-old saver above retires at age 57, she’ll need to save about 25 percent of her gross income to fund full income replacement from her TSP account in retirement.

The preceding estimates do not take into account any Social Security, annuity or other retirement income. If you assume that those sources of income will be there when you retire, as promised today, my analysis shows they may support, on their own, full income replacement for career employees up to General Schedule Grade 9 who wait until their full Social Security retirement age to retire. In other words, as they are configured today, Social Security and the Federal Employees Retirement System, after your 40 years of service, will replace close to 100 percent of your pre-retirement income as long as your pre-retirement pay doesn’t exceed about $50,000 per year, in today’s dollars.

As your pay rises beyond that level, the FERS component of your retirement income will rise accordingly, but the Social Security component will lag behind, and you’ll have to make up the difference out of your savings. This means that, if you’re expecting Social Security to replace a portion of your pre-retirement income, the more you earn, the more — as a percentage of your gross pay — you’ll have to save.

The amount you’ll need to save for retirement varies considerably according to the assumptions used in analysis. It is possible to determine your unique required savings rate, but if you’re not up to the task, Palmer’s 25 percent recommendation seems like a safe bet for most young feds.


Re-balancing advice

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Q: I will be rebalancing my portfolio biannually to the initial allocation until I reach an age that justifies a change to a more conservative approach. To complete this action, do I process both an interfund transfer and a contribution allocation? Is biannually OK?

A: You’re asking for specific, individual investment advice, which I can’t provide through this forum. In general, I recommend that Thrift Savings Plan investors using this do-it-yourself strategy set the contribution allocation to 100 percent G Fund and then periodically rebalance the existing assets to their selected allocation. I recommend that you rebalance no more frequently than once every three months and less than once per year. My firm’s standard rebalancing cycle is every six months.

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TSP and tax time

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Q: I withdrew money from my Thrift Savings Plan and now it’s tax time, so we have to pay quite a bit. Will I be able to change the Code 1 into an “L” on Form 1099 so we do not have to pay so much in taxes?

A: No, you can’t just change the code on a 1099 to avoid paying taxes or penalties. If you took an early distribution and don’t meet one of the IRS exceptions, you’ll owe the penalty. Maybe you should consult a CPA before filing your return.

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