Ask The Experts: Money Matters

By Mike Miles

Partial withdrawal, Part II

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Q. I retired from an air traffic control job at age 53. I am receiving monthly payments based on my life expectancy. I will be age 55 in April. Can I take a partial withdrawal? If not, are there any options? I need to access more funds. Will there be a tax penalty on the amount I have received? Will my partial withdrawal be penalty-free now that I am 55? Are there other options, such as increased monthly payments?

A. You may not take a partial withdrawal once monthly payments have begun. You may increase your monthly payment amount using Form TSP-73 or you may request a final withdrawal, but making any change to the series of substantially equal periodic payments before you reach age 59½ will subject all of your early distributions to the early withdrawal penalty.

The rules for all of this are complicated. You should consult a CPA before proceeding.

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MetLife

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Q. My mother’s plan was purchased by MetLife. She wants to make a withdrawal but is told she can’t, or she needs a higher monthly payment. It’s only $300 due to a paperwork mistake, but she was told she could only submit this one time this year. Is there anything to do?

A. If she bought an annuity, her monthly payments from that annuity are fixed for life. If she has a balance left in her Thrift Savings Plan account, she has the option of terminating her monthly payments with a final, lump-sum distribution of the remaining balance in her account, which she can roll over to an IRA, which will allow her to withdraw money as she likes.

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72(t) distributions

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Q. I’m about to retire at age 47 after 25 years as a federal law enforcement officer. I plan to roll my 401(k) (TSP) over to a traditional IRA and begin taking substantially equal periodic payments per 72(t) from the IRA, which, as I understand, once I start, I have to continue until age 59 ½. I plan to use the annuitization method to make equal monthly withdrawals, but I would like to take the first year’s withdrawal in a lump sum to help pay off some debt. Will the IRS allow that without the 10 percent penalty, or do I have to consistently stick to either monthly or annual payments?

A. The IRS only cares about the annual requirement being met. They don’t care about how the money is distributed. Monthly payments are not required, and as long as you meet the annual 72(t) requirements, there should be no penalty.

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Matching and Roth TSP

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Q. How is the federal matching amount handled for the Roth TSP option? Under the traditional TSP, that amount is added to the deferred compensation and taxed when distributed. Is the matching put into the Roth? When is it taxed?

A. Matching is based on amounts you contribute to either the traditional or Roth TSP accounts, but agency contributions are directed entirely to your traditional TSP account.

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TSP earnings tax rate

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Q. Are the distributions from my tax-deferred TSP account (not Roth TSP) taxed as ordinary income or capital gains when I start drawing the money out?

A. Ordinary income.

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Rolling a TSP distribution over into a Roth IRA

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Q. Can I roll over a Thrift Savings Plan distribution that I received last week to a Roth IRA?

A. Yes, as long as it’s not a required minimum distribution. Your tax preparer is responsible for making sure that you obey the applicable rules, however. Self-preparation of all but the simplest tax return can be hazardous to your financial health.

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IRA distribution

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Q. As a current furloughed government employee, can I withdraw money from my IRA and not be taxed the additional 10 percent under the exception: being unemployed and paying for health insurance premiums?

A. From IRS Publication 590:

Even if you are under age 59½, you may not have to pay the 10 percent additional tax on distributions during the year that are not more than the amount you paid during the year for medical insurance for yourself, your spouse and your dependents. You will not have to pay the tax on these amounts if all of the following conditions apply:

* You lost your job.

* You received unemployment compensation paid under any federal or state law for 12 consecutive weeks because you lost your job.

* You receive the distributions during either the year you received the unemployment compensation or the following year.

* You receive the distributions no later than 60 days after you have been re-employed.

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Early withdrawal penalty

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Q. I recently lost my job and withdrew my entire Thrift Savings Plan savings. I know that there is a 20 percent penalty for early withdrawal that they took out. Also, another 10 percent penalty that they hit you with at the end of the tax year. Is there any way I can lessen the blow? Are there any exemptions that I could put that money to, such as paying of my son’s college loans, home improvement or repairs?

A. The 20 percent taken from the distribution was withholding against your federal tax liability for the year of the withdrawal. The 10 percent early withdrawal penalty, if applicable, will be calculated and due when you file your tax return for the year. The exceptions to the early withdrawal penalty are listed in the left-hand column on Page 7 of this notice: https://www.tsp.gov/PDF/formspubs/tsp-536.pdf.

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TSP distribution

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Q. My husband is retiring from the Postal Service on Nov. 1. We have $850,000 in tax-free municipal funds (all AAA rated and paying over 5 percent), and another $200,000 in natural gas and oil limited partnerships and some preferred stocks in energy companies that I recently inherited. I would like to live on the interest from these investments, leaving the principal alone.

My husband is 62 and we want to wait until he is 66 to receive his Social Security payments. (Waiting until 70 is out of the question as both parents were stricken with Alzheimer’s disease at an early age. Mother at 70 and father at 75.)

My husband has a Thrift Savings Plan account with a balance of $91,000. I am concerned that the interest and dividends coming in from the inheritance have not had time to accrue enough interest for us to live on and would like your advice on how to distribute his TSP for the first few years.

I am disabled and am receiving a monthly check for $1,477. If my husband takes Social Security now, his monthly payments would be $1,588. Also, my husband will receive a monthly retirement check from the Postal Service for $850 — just enough to cover our health and life insurance and his long-term care insurance.

Can you give me some advice on the best way to get my TSP to pay out a larger sum in the first three years so I can protect the principal of my inheritance? Should we start now collecting his Social Security now?

A. It is not possible to determine the answers to your questions, which are complex and interdependent, without the proper understanding, analysis and consideration. There are no simple answers. Your questions are beyond the scope of a forum like this and will require comprehensive financial analysis to answer.

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Roth TSP and law enforcement

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Q. I am a federal law enforcement officer. I recently read an article that discussed the downside of the Roth TSP for federal law enforcement officers and firefighters. Is this true?

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Many of you are probably unaware of the serious pitfalls you will encounter if you opt to contribute to the Roth TSP.  For a federal law enforcement officer or firefighter, the Roth TSP is a poor choice. It wasn’t until this week that a reader posed a question to me that caused me to realize what a bad idea the Roth TSP is for many of us.

The idea behind the Roth TSP is that you contribute after-tax monies and when you withdraw funds from the account in retirement, the earnings are tax-free. The trick here is that the withdrawal must be a “qualified withdrawal for the earnings to be tax-free. In order for the withdrawal to be considered a “qualified withdrawal” by the IRS, “five years must have passed since January 1 of the calendar year when you made your first Roth TSP contribution AND you are at least 59½, permanently disabled (or deceased).

Here’s the problem: As a law enforcement officer or firefighter, you can retire as early as 50 years of age and are mandatorily retired at age 57.  If you decide to take post-retirement withdrawals from the TSP (under the life expectancy option or the age 55 exemption), you will not meet the age test for the Roth TSP withdrawal to be considered “qualified.”  (You may also not meet the five-year rule as the Roth TSP has only been an option since May 2012.)  Since your withdrawal is not “qualified,” you will be taxed on the portion of your withdrawal that represents the attributable earnings. This eliminates the tax-advantaged nature of the Roth TSP. You’d be just as well off having a regular post-tax investment account outside of the TSP. You’re contributing after-tax dollars and paying taxes on the earnings generated by the post-tax investment.

The TSP will not allow you to specify that your post-retirement withdrawals come only from your traditional TSP balance, nor will the TSP allow you to roll over/transfer out only the Roth TSP portion of your account.  When you make any withdrawal from the TSP, the withdrawn amount will be taken ratably from both your traditional and Roth balances under TSP rules.

If you roll over/transfer both your traditional TSP and Roth TSP to another custodian, then you lose your eligibility under the age 55 exemption, as that requires the funds to be left in your employer-sponsored account.  If you retire between age 50 and 59½, at retirement, you could roll over/transfer your traditional TSP and Roth TSP to another custodian and withdraw only the funds that came from the Traditional TSP account using an IRS Section 72(t) withdrawal plan and wait until age 59½ to start to withdraw the portion that came from the Roth TSP funds.

Please consider these facts when deciding if the Roth TSP is right for you. If you already jumped into the Roth TSP, you can always stop and change your contributions to be 100 percent traditional TSP and limit the tax damage.

Even folks who aren’t covered under the special provisions get affected by these rules if they retire at their MRA.

A. The issue you raise is valid. You can get around it by transferring the Roth portion of a distribution to a Roth IRA. I realize this isn’t ideal, but it is an option to avoid the penalty.

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