TSP Options Post-Separation from Federal Service
Leaving Your TSP Alone
Full Withdrawal Options
Avoiding the 10% Early Withdrawal Penalty
Don’t feel bad if the topic of what to do with your TSP when leaving federal service makes your blood pressure increase and your eyes glaze over. It’s a complicated maze of options and rules…a dizzying array of things to consider and steps to take. Tangerine to the rescue for federal employees! We’ve broken down the information into “bite size” pieces to help you “digest” the information slowly.
To get started, let’s establish a few key TSP terms and their definitions.
Distribution, payment, and withdrawal all mean the same thing – money you receive from your TSP account.
Earnings equals the money that your TSP account has made (earned) on both your contributions and your agency (if applicable) contributions. Your earnings are determined by how you chose to invest your TSP account funds.
Roth refers to TSP contributions with pay that’s already been taxed. Roth earnings are distributed tax-free if they are qualified.
Traditional balance means everything in your TSP account that is not in your Roth balance, all non-Roth contributions. This is the portion of your account on which you’ve deferred paying taxes.
Eligible employer plan includes various employer-sponsored retirement plans, including 401(k) plans, profit sharing plans, defined benefit plans, etc. A complete definition may be found here.
Eligible rollover distribution is a type of distribution from the TSP that the IRS allows to be rolled over into another retirement plan or Individual Retirement Account (IRA).
Required Minimum Distribution, or RMD, is an IRS rule that requires you to receive a certain portion of your account each year based on your life expectancy once you’ve reached age 70 ½ providing that you’re a separated employee. We cover RMDs fully in a separate Tangerine article.
As long as your vested TSP balance is $200 or more after you leave federal service, you have three options: leave your money in the TSP until Required Minimum Distributions must begin at age 70 ½, withdraw a portion of your TSP, or withdraw all of your money.
If your vested balance is less than $200, the TSP automatically sends you a check for the amount in your account, i.e. you cannot leave this money in the TSP. However, you can combine TSP accounts if, for example, you have both Civilian and Uniformed Services TSP accounts. Additional information on that topic is available on the TSP site under Combining Your TSP Accounts. Some people also choose to consolidate retirement funds in their TSP for simplicity purposes. Rollovers and transfers from an IRA or eligible employer plan into your TSP also allow you to take advantage of the low costs associated with the TSP – administrative costs you’re charged to maintain your retirement funds is not something you should ignore. They add up over time!
Whether you choose to leave your money in the TSP or withdraw funds, your decision should be guided by your personal and financial circumstances...and you may make new choices as your life changes. The TSP has assembled Withdrawal Strategies information that is a good starting point for you to consider various TSP withdrawal options in retirement.
Leaving Things Alone
As we said earlier, one option when you leave federal service is to do nothing with your TSP, i.e. leave it alone. This strategy is viable until you’re required to begin required minimum distributions per the IRS. Required minimum distributions (RMDs) must begin by April 1st of the year after you turn age 70 ½. This might be confusing so let’s look at two examples:
· You’re retired and your 70th birthday was June 30, 2018. You reach age 70 ½ on December 30, 2018 and you must take your first RMD (for 2018) by April 1, 2019.
· You’re retired and your 70th birthday was July 1, 2018. You reach age 70 ½ on January 1, 2019. You do not have an RMD for 2018. You have until April 1, 2020 to take your first RMD for 2018. (Sorry all you late June babies…)
Required minimum distributions are covered in more detail in a separate Tangerine article.
With the implementation of the TSP Modernization Act in September, 2019, there is no limit on the number of partial withdrawals you can take after separating from federal service. The only “catch” is that you can’t take a withdrawal more than once every 30 days.
So let’s say that you’re receiving post-separation installment payments and you want to supplement with a partial withdrawal too – that’s totally fine! And the source of your withdrawal is also under your control. If you have both traditional and Roth balances in your TSP, you can choose whether your withdrawal comes from your traditional balance, Roth balance, or a proportional mix of both. Gone are the days of mandated proportional withdrawals! This is not only important from a personal choice standpoint but also for tax purposes; where your withdrawal comes from also impacts whether the contributions and their earning are taxable. Remember our Key Terms and Definitions above?
What you do with your partial withdrawal is, of course, a personal decision but it should be an informed one. Withdrawing Your TSP Account After Leaving Federal Service offers you all the details and considerations in one handy guide.
Another option available to you when leaving federal service is a full withdrawal of funds in your TSP with the choice of how your entire account will be distributed using one, or any combination of, three withdrawal options:
A single payment
A series of TSP installment payments
A life annuity purchased for you by the TSP
This is often referred to as a “lump sum” withdrawal because a single payment allows you to withdraw your entire TSP account at one time, in one payment. That may sound enticing from a “let’s tour Europe” perspective but be aware of the possible tax implications associated with a single payment. You cannot avoid the mandatory 20% federal income tax withholding on any taxable amounts that you elect to receive directly and that includes deposits to your checking or savings account. And be aware that the TSP does not withhold amounts for state or local taxes. If, after you receive your single payment, you decide to place all or part of the funds in an IRA or eligible employer plan within 60 days (what’s called a rollover), the TSP is still required to withhold 20% of your distribution.
Installment payments were one area that gained considerable flexibility with the TSP Modernization Act. Prior to the Act’s implementation, your only option for frequency of installment payments was monthly. Not any longer!
Your choices for post-separation installment payments now include monthly, quarterly or annually. Plus, you can now start, stop or make changes to your payments at any time. You no longer have to wait for an open season to change the amount or frequency of your installment payments. You can also change from life-expectancy payments to a fixed dollar amount at any time throughout the year. As before, though, this is a one-time only change. Once you choose to receive “dollar amount” payments, you cannot switch to life-expectancy.
The dollar amount of the installment payment that you receive can be computed in one of two ways. You can let the TSP calculate your payment based on IRS life expectancy tables OR you can select a specific dollar amount as long as it’s $25.00 or more. Choose carefully! Note that if you select monthly payments, you cannot switch to life-expectancy. You are permitted to make a one-time change from life-expectancy payments to a specific dollar amount and the new rules allow that change at any time during the year as mentioned above.
The other type of full withdrawal that’s available to you once you’ve left federal service is the TSP life annuity. A life annuity, in a nutshell, is an insurance product that provides guaranteed monthly payments for as long as you are alive – that’s a single life annuity. You also have the choice of an annuity with survivor benefits. We suggest that you thoroughly explore annuity options and features in the TSP booklet Withdrawing Your TSP Account After Leaving Federal Service.
Taxes on Withdrawals
You must pay income taxes on the taxable portion of TSP withdrawals when they are paid directly to you. What’s the taxable portion? Basically, that’s your traditional balance and their earnings. Roth earnings that are not qualified are also taxable. See “Key Terms and Definitions” earlier in this article for a link to what determines qualified Roth earnings.
To retain the tax-deferred status of the traditional portion of your TSP withdrawal, you have the option to transfer the funds to a traditional IRA or eligible employer plan. You can also transfer it to a Roth IRA; however, you would have to pay taxes on the transfer in the year it is made.
You will not pay income taxes on the portion of your withdrawal that comes from your Roth contributions AND you will not pay taxes on the earnings if they’re qualified.
For more information, we recommend: (in addition to consulting your tax advisor!)
Familiarize yourself with spousal rights concerning TSP withdrawals after leaving federal service. Special Withdrawal Considerations is a recommended read.
If you have an outstanding TSP loan at the time you separate, you should repay it. Otherwise, the IRS will declare it a taxable distribution.
Thinking about moving your TSP to another plan? Check out Keeping Score.
Publish Date: September 6, 2019 © Tangerine, Inc. All rights reserved. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular individual or circumstance. This article is not intended to be a client-specific analysis or recommendation. Do not use this article as the sole basis for any financial decisions. Consider all relevant information. Information should not be considered as tax or legal advice. You should consult with your tax advisor and/or attorney regarding your individual circumstances.