Before deciding to withdraw money from their Thrift Savings Plan (TSP) accounts, TSP participants are advised to be aware of the tax rules associated with TSP withdrawals. Since tax rules are complex, TSP participants should consult with a tax professional who is familiar with the income rules with qualified retirement plans. While the TSP can assist TSP participants with their TSP distributions, the TSP cannot provide tax advice.
The TSP reports all TSP distributions to the IRS and to the appropriate state tax agencies (if applicable) and to the TSP participant on IRS Form 1099-R (Distribution from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.). Distributions from beneficiary participant accounts will be reported as death payments on Form 1099-R.
The TSP in most cases is required to withhold part of the taxable portion of TSP participant’s distribution for federal income taxes. With certain types of taxable TSP withdrawals, a TSP participant may request that a different percentage of federal income taxes be withheld or no federal income taxes be withheld.
Note that the TSP does not withhold state or local income taxes. However, that does not mean that a TSP participant who lives in a state that taxes TSP withdrawals does not have to pay state and local income taxes on their TSP withdrawals. The TSP reports all TSP distributions to a TSP participant’s state of residence at the time of payment, if that state has an income tax. The TSP participant is responsible for paying state and local income tax due on taxable TSP distributions and is advised to consult with a tax professional in their state as to how these state and local income taxes can be paid.
Taxation of Traditional TSP Withdrawals
A distribution from a TSP participant’s traditional TSP account is fully taxable. This is because the entire income consists of before-taxed income; namely, employee contributions deducted from the federal employee’s gross salary (CSRS and FERS employees), accrued earnings, agency automatic 1 percent of gross pay contributions (FERS employees only) and agency matching contributions (FERS employees only).
Taxation of Roth TSP Withdrawals
TSP participants who have a Roth TSP account have two separate pools of money. One pool of money is contributions which were deducted from a federal employee’s after-taxed salary. Participants have already paid federal and state income taxes on this pool of money and therefore money withdrawn from this pool of money is not taxed.
The other pool of money from a TSP participant’s Roth TSP account is accrued earnings – interest, dividends and capital gains – which is also not taxable when distributed if the distribution is qualified. For a distribution to be qualified, the Roth TSP participant must be age 59.5 or older, permanently disabled or deceased. Five years must have passed since January 1st of the year that the Roth TSP participant made his or her first Roth TSP contribution. Note that the Roth TSP account has been available to employees at most federal agencies since the year 2012.
Taxation of TSP Distributions That Include Traditional TSP and Roth TSP
When a distribution includes money from both the traditional TSP and the Roth TSP, the tax rules for the traditional TSP balance apply to the traditional portion and the tax rules for the Roth STP balance apply to the Roth TSP balance. The following example illustrates:
Jan, age 57, has a TSP account consisting of a traditional TSP balance of $600,000 and a Roth TSP balance of $400,000. Jan has been contributing to the Roth TSP for nine years, since 2016. The Roth TSP balance includes $150,000 in contributions and $250,000 in earnings. Jan is retired from federal service and takes a $10,000 distribution from her TSP. Assuming Jan does not rollover any portion of the $10,000 to another retirement account, what portion of this distribution is considered taxable income to Jan?
Note that Jan’s TSP account consists of 60 percent traditional TSP, 15 percent Roth TSP contributions and 25 percent earnings on Roth TSP contributions. Applying those percentages to the $10,000 distribution means that the $10,000 Jan received is made up of $6,000 from the traditional TSP balance, $1,500 from the Roth TSP contributions and $2,500 from the earnings on the Roth TSP contributions.
The traditional portion ($6,000) is all taxable. Also taxed are the earnings included in the Roth TSP balance ($2,500). Even though Jan has met the five-year requirement, Jan is 57 and therefore has not met the age 59.5 minimum age requirement and the $2,500 is not a qualified Roth TSP distribution.
Of Jan’s $10,000 TSP distribution, a total of $6,000 plus $2,500, or $8,500 is taxable. In addition, since Jan is under age 59.5, her $2,500 Roth TSP taxable distribution of earnings is also subject to a 10 percent early withdrawal penalty.
Early Withdrawal Penalty Tax: Traditional TSP Account
A TSP participant who receives a traditional TSP distribution or withdrawal before he or she reaches age 59.5 may have to pay an early withdrawal tax equal to 10 percent on any taxable portion of the distribution or withdrawal. This 10 percent early withdrawal penalty is in addition to any federal and state income taxes. The additional 10 percent penalty tax generally does not apply to:
• Payments made when an employee separates from federal service during or after the year the employee reaches age 55.
• Public safety employees (as defined in Internal Revenue Code section 72(f)(10)(B)(ii) who receive payments after they separate from service during or after the yar they reach age 50 with at least 20 years but fewer than 25 years of public safety service. Or at any age with 25 years of public safety service.
• Up to $5,000 of payment received within one year following birth or qualified adoption in accordance with section 72(t)(2)(H) of the Internal Revenue Code.
• TSP annuity payments.
• TSP payments resulting from total and permanent disability.
• TSP payments resulting from death.
• TSP payments made from a beneficiary participant account.
• TSP payments made in a year in which the TSP participant has deductible medical expenses that exceed 7.5 percent of the participant’s adjusted gross income.
• TSP payments made as qualified disaster recover distributions as defined and limited by section 72(t)(2)(M) of the Internal Revenue Code.
• TSP payments offered by a domestic relations court; or
• Substantially equal payments over the TSP participant’s life expectancy.
Early Withdrawal Penalty Tax: Roth TSP Account
The 10 percent early withdrawal penalty tax never applies to Roth TSP contributions and to qualified distributions of Roth TSP earnings. The penalty tax may apply to non-qualified Roth TSP distributions.