The funds in a participant’s traditional Thrift Savings Plan (TSP) account are taxed as ordinary income in any year that the TSP funds are withdrawn. This is because the participant’s contributions to the traditional TSP account, automatic agency 1 percent of gross pay contribution, agency matching contributions (FERS employees) and accrued earnings in the participant’s traditional TSP account have not been previously included in the traditional TSP participant’s income. As discussed below, the way a traditional TSP participant withdraws his or her traditional TSP account balance determines when Federal and (and in states with income taxes) state income taxes are levied.
Roth TSP Balance
Starting in 2012, the TSP offered to Federal employees and to Uniformed Service members a Roth TSP option, in which after-taxed salary contributions are made to the Roth TSP account. This means that Roth TSP contributions are included in the employee’s income in the year the contributions are made and will not be included in income when withdrawn. Agency contributions (automatic 1 percent and matching contributions) (FERS employees only) are always deposited into a FERS employee’s traditional TSP account. This is the case even if the TSP participant contributes the maximum possible in annual elective deferrals ($18,500 during 2018) to the Roth TSP.
Qualified distributions from a Roth TSP account are not included in income. This applies to the accrued investment income (interest, dividends, capital gains) in the Roth TSP participant’s account. A qualified distribution from a Roth TSP account is defined as a distribution that is:
- Made after 5 years have passed since Jan. 1 of the calendar year in which the TSP participant made his or her first Roth TSP contribution (this is referred to as the “5-year rule”); AND
- Made or after the date the Roth TSP account owner reaches age 59.5, made to a beneficiary or the account owner’s estate after the account owner’s death, or attributable to the account owner’s being disabled.
Example. Joan started contributing to her Roth TSP account on July 1, 2013 when she was age 56. As of Jan. 1, 2018 when Joan was age 60, she was able to request a qualified distribution from her Roth TSP account.
Uniformed Services TSP Account
Those TSP account owners who have a Uniformed Services traditional TSP account that includes contributions made from combat zone pay should be aware that the distributions attributable to those contributions are tax-exempt. This is because the combat zone pay was nontaxable. Any earnings on those contributions are subject to Federal income tax, however, when they are distributed. When such an account is distributed, the statement that is sent to the combat zone participant will separately state the total amount of the distribution and the taxable portion for the year it was distributed. Since the nontaxable portion and the taxable portion of the account are separated, combat zone participants with a Uniformed Service traditional TSP account and who also have a civilian traditional TSP account are advised not to merge their civilian and Uniformed Services traditional TSP accounts. If they do, then all cash withdrawals from the merged traditional TSP account will be fully taxable.
Direct Rollover or Transfer of the Traditional TSP Account
If a traditional TSP account owner asks the TSP to directly rollover or transfer any part of his or her account to a traditional IRA or to another qualified retirement plan such as a 401(k) retirement plan, then any tax due that part of the traditional TSP account is deferred until the account owner makes withdrawals from the traditional IRA or qualified retirement plan.
Some rules on direct rollovers and transfers:
- In general, a direct rollover or transfer is a tax-deferred withdrawal of cash or from one qualified retirement plan or traditional IRA to another qualified retirement plan or to a traditional IRA. The amount directly rolled over is not included in the retirement plan owner’s income. The amount rolled over is taxed later when funds are withdrawn from the new qualified retirement plan or traditional IRA.
- Qualified retirement plans include a 401(k) plan, a tax-sheltered annuity or 403(b) plan, or an eligible state or local government section 457 deferred compensation plans. The TSP is also considered a qualified retirement plan for the purpose of a rollover.
- Any portion of a traditional TSP account can be directly rolled over or transferred except: (1) A distribution of one’s account balance that the account owner chooses to receive in monthly payments over the account owner’s life expectancy or the joint life expectancies of the account owner and the beneficiary. A period of 10 years or more is also necessary for this distribution; (2) A required minimum required distribution (MRD) generally beginning when the account owner becomes age 70.5 and every year thereafter; (3) A declared distribution because of an unpaid loan if the account owner has not separated from federal service; and (4) A hardship distribution.
- If a traditional TSP account owner chooses to have the TSP perform a direct rollover or transfer all or part of the traditional TSP account, then no Federal income tax will be withheld from any part of the rollover or transfer.
- If a traditional TSP account owner chooses to have an eligible rollover distribution paid directly to the account owner, then the TSP must withhold 20 percent in Federal income taxes even if the account owner plans to rollover the distribution to another qualified retirement plan or to a traditional IRA. However, the full amount is treated as distributed to the account owner even though only 80 percent of the original amount was received. The account owner must include in income any part – including the 20 percent in Federal income taxes withheld – not rolled over to another qualified retirement plan or to a traditional IRA within 60 days. Note the 60 day period begins on the day the TSP account owner receives the distribution. Weekends and holidays are included in the 60 day rollover period.
Direct Transfer of a Traditional TSP Account to a Roth IRA
If a traditional TSP account owner requests that any part of the account be directly transferred to a Roth IRA, then the amount transferred will be taxed in the year it is transferred. The TSP will not withhold Federal income taxes in such a transfer unless the account owner requests Federal income tax withholding.
Direct Transfer of a Roth TSP Account to a Roth IRA
A direct transfer of a qualified Roth TSP account to a Roth IRA is not a taxable event. The TSP will not withhold any Federal income taxes in such a direct transfer.
If a traditional TSP account owner asks the TSP to buy an annuity from Metropolitan Life Insurance Company using some or all of the account owner’s account, the annuity payments are taxed when the TSP account owner receives the monthly annuity payments. The payments are not subject to the additional 10 percent tax on early distributions even if the account owner is under age 55 when they begin. But there is no tax due at the time the TSP purchases the annuity on behalf of the traditional TSP account owner.
Any funds withdrawn from the traditional TSP account and paid directly to the account owner (or directly deposited into the account owner’s bank account) are generally taxed as ordinary income. Withdrawals include contributions, automatic one percent of salary and matching contributions (FERS employees), and accrued earnings.
Withdrawals are taxable for Federal and, in states that have state and local income taxes, for state income tax purposes. The TSP does not withhold any state and local income taxes. The traditional TSP account owner is responsible for paying state and local income taxes due on traditional TSP withdrawals.
Any money paid to a traditional TSP account owner before the owner reaches age 59.5 may be subject to an additional 10 percent tax on early distributions. But this additional tax does not apply in certain situations, including any of the following:
- The account owner receives the distribution and had separated from government service during or after the calendar year in which he or she reached age 55;
- The account owner left or retired from Federal service before age 55 and has chosen to receive monthly payments based on life expectancy (that must continue for the later of five years or age 59.5), or through a TSP annuity; or
- The account owner is totally and permanently disabled.
- Under the Defending Public Safety Employees’ Retirement Act that was signed into law June 29, 2015, specified Federal law enforcement officers, customs and border protection officers, Federal firefighters and air traffic controllers who separate from service at age 50 or later can make withdrawals from the TSP without incurring a 10 percent early withdrawal penalty. The effective date of this bill was Dec. 31, 2015, meaning that starting Jan. 1, 2016, specified federal law enforcement officers, custom and border protection officers, federal firefighters and air traffic controllers who retire between ages 50 and 55 are allowed to make penalty-free (no 10 percent penalty) TSP withdrawals.