Ask The Experts: Money Matters

By Mike Miles

TSP withdrawal strategy

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Q. I have heard that some people are taking a monthly Thrift Savings Plan withdrawal that will have all funds sent to them over a period of 119 months (less than 10 years). Looking through TSP manuals, I haven’t figured out why yet. What are the advantages/disadvantages for this strategy?

A. Check Page 3 of the notice at https://www.tsp.gov/PDF/formspubs/tsp-536.pdf. Payments expected to last less than 10 years are eligible for rollover but subject to 20 percent mandatory withholding. I’m not sure that the advantage is.

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Calculating tax withholding

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Q. I recently retired from federal service. I began receiving my FERS annuity Jan. 1. My annuity is $3,190 gross, plus $1,195 special retirement supplement, minus $190.28 health insurance and $36.34 for dental/vision. I am single with no dependents. I am withholding $641 for federal tax purposes. My state has no income tax.

I want to begin monthly distributions from the Thrift Savings Plan at $4,200 per month. How much should I elect to withhold to ensure that I am not hit with a substantial tax bill for tax year 2014? Assume no itemized deductions.

A. I’m not in a position to calculate your estimated tax liability for the coming year. You can consult a qualified tax preparer for help with this, or review Internal Revenue Service Publication 505 to figure it out for yourself.

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Partial TSP withdrawal

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Q. I will be retiring in May with 25 years of federal law enforcement service. I will be 50 years old and subject to penalties and taxes on a one-time, age-based partial withdrawal from my Thrift Savings Plan. If I withdraw $20,000 to take care of bills and home repair, how much should I request from my TSP account to cover the taxes and penalties?

A. Your withdrawal will be subject to 20 percent minimum mandatory federal tax withholding, so to receive $20,000 from the TSP, you’ll need to request $25,000. The actual federal income tax, early withdrawal penalty and state tax you’ll owe for the withdrawal won’t be computed until you file your tax return for the year of the withdrawal.

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Retirement date, taxable distribution and IRS penalties

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Q. I am an FERS employee and, for various reasons, have selected Nov. 28, 2015, as my retirement date, age 60+ with 21 years civil service and four years military, for which a deposit has been made. One of the many reasons that I selected this date was so that I could have a Thrift Savings Plan residential loan balance declared as a taxable distribution during the 2015 tax year, because I will have substantial withholdings by that time, and given my tax return history, would have a significant tax overpayment that would be useful in paying a portion of the tax bill rather than receiving it as a refund. It was my intention to pay the remaining tax liability (however much it is) with a smaller withdrawal of TSP funds, and take that as a taxable distribution during the following tax year (2016), which could be manageable through withholdings from my pension and life annuity payments.

Subsequently, however, my research has uncovered that the Internal Revenue Service levies a substantial (but unspecified) penalty against any retiree if “90 percent of a payers’ tax liability is not withheld from salary, pension and annuity or made via quarterly payments” during the tax year.

Does this IRS rule apply to my situation? If so, regardless which date I choose in FY2015, I will surely fall short and be subject to that penalty, as I will no doubt be owing greater than 10 percent of my total tax bill, and officially be a “retiree” by the end of tax year 2015, even though I will not have even received any retirement pay from either pension or annuity by years end, due to high processing times.

How much is the penalty that the IRS assesses against retirees who have had insufficient withholdings during a tax year?

If this rule applies to me, I will have to postpone my retirement date until year’s end so that the distribution is declared in 2016, and then make quarterly tax payments to cover the total outstanding amount due, which would greatly complicate my cash flow situation during my first year of retirement, and possibly make it unfeasible.

A. Sorry, but these are questions for the CPA who will prepare your tax returns for the year(s) in question. There are some exceptions to the 90 percent rule and, in my experience, the penalty for under-withholding is not severe.

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Tax withholding rate

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Q. I am a federal employee considering retiring at age 64. I want to withdraw my Thrift Savings Plan funds in one lump sum, which by then will be approximately $400,000. At what tax rate can I expect to be hit upon withdrawal?

A. Your withdrawal will be subject to 20 percent federal tax withholding. Read the document at https://www.tsp.gov/PDF/formspubs/tsp-536.pdf for more information.

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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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Payment to state required for TSP withdrawal?

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Q. I’m planning on a FERS retirement at the end of December 2014. At that time, I’ll have already met the minimum retirement age and will have credit for 32 years of service. I’ve read that I can withdraw funds from the Thrift Savings Plan without an early withdrawal penalty upon my retirement, and that approximately 20 percent will be withheld for federal taxes, but what I don’t know and can’t seem to find is the amount of money that will need to be paid to my state of residence, West Virginia. My plan is to use the money in my account to pay off a mortgage and other debts, and leave the remainder in a savings account. Are there any other issues I should be concerned about?

A. I can’t comment on your plan of action, since I don’t know nearly enough about your circumstances and objectives. There is no withholding from your TSP withdrawals required for state income taxes. The amount that you will ultimately owe West Virginia for taxes can only be determined by preparing your tax return for the year. A tax preparer should be able to give you an estimate if you want to make estimated tax payments or request state tax withholding.

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Double taxation?

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Q. After entering retirement from CSRS, are Thrift Savings Plan funds withdrawn classified as income in addition to the 20 percent accessed at the time of withdrawal from the TSP account. Are there ways to avoid double taxation if they are taxed twice other than rolling over into an IRA or Roth IRA?

A. The traditional TSP funds you withdraw are classified as ordinary income on your tax return. They are not subject to double taxation. The 20 percent withheld from your payment(s) is a deposit against your tax liability. If the distribution is not a required minimum distribution and you meet the timing limits, you may roll your distribution over to an IRA to avoid current taxation.

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TSP loan prior to retirement

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Q. I have to retire in 18 months. I plan on taking a lump sum and monthly allotment from my Thrift Savings Plan at retirement. I understand both of these will be taxed at 20 percent. I am thinking of taking a TSP loan for the amount I had planned on requesting as my lump sum prior to my retirement date, with the understanding that I won’t have the time to pay it back in full and that the amount I don’t pay back will be considered disbursed income. My reasoning is that having the funds now will allow me to begin the process to purchase my retirement home, and allow me to at least pay a portion of the loan back. Is there a downside to this plan?

A. You should consult your tax preparer for testing and advice about the potential impact on your tax returns. The only general implications of this strategy that come to mind are:

1. If the distribution is declared before the calendar year in which you reach age 55, it will be subject to the early withdrawal penalty and

2. There will be no tax withholding in the case of a declared distribution.

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TSP, IRA and retirement

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Q. I am retired military, drawing Social Security. I am planning on retiring from the federal government soon. If I take all of my Thrift Savings Plan, how much will be taken out? I owe $10,000 on a TSP loan and know I should pay it off. If I pay the loan before taking money and I roll into an IRA, will my money then be tied in the IRA and I can’t use it? Also, I heard you can combine military pay with federal retirement. How does that work?

A. Mike: If you withdraw your entire TSP balance after you retire, 20 percent will be withheld as a deposit against your federal income tax liability. If you request a direct rollover into an IRA, there will be no withholding. If you are retiring from TSP covered service between the ages of 54 and 59, inclusive, rolling your TSP money into an IRA may affect your ability to withdraw the money without penalty before you reach age 59½, so be careful if this is the case.

Reg: You can make a deposit to get credit for your active-duty service. That tie will be used to determining your total years of civilian service and in the computation of your annuity when you retire. However, because you are retired military, you’ll have to waive your military retired pay when you retire from your civilian job. If you don’t, your deposit will be returned to you and you won’t get any credit for that time.

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