In the second part of a series of columns discussing the changes to Thrift Savings Plan (TSP) withdrawal options associated with the TSP Modernization Act (PL 115-84), this column discusses the new rules and available options to making partial withdrawals from a TSP account.
The following table summarizes the old rules (pre-Sept. 7, 2019) and new rules (post-Sept. 14, 2019) with respect to making partial withdrawals from a TSP account. Note that there was a blackout period during the period Sept. 7 to 14, 2019 in which TSP participants could not request withdrawals from their TSP accounts.
Advantages to the New Rules Regarding Partial Withdrawals from a TSP Account
With more flexibility to make partial withdrawals from a TSP account – both “age-based” (post-age 59.5) in-service and post-separation from federal service – a TSP participant will be able to better meet his or her financial needs. The following examples illustrate:
Example 1. Jeff, age 60, would like to make some improvements to his house. The improvements will cost about $12,000. Rather than taking out a TSP General Purpose loan, Jeff decides to request an age-based in-service withdrawal of $12,000. He can do so because he is over age 59.5.
Example 2. Same facts as in Example 1 except that three months after Jeff made his $12,000 in-service withdrawal, he needed to buy a new car and needed a down payment of $5,000. Rather than taking out a TSP General Purpose loan, Jeff decides to request another age-based in-service withdrawal of $5,000. He can do so because he is over age 59.5 and this is his second age-based withdrawal in the current year.
Example 3. Emily, age 66, retired from federal service under FERS in Dec. 31, 2018. She is receiving her FERS annuity and has elected to delay starting to receive her Social Security retirement benefits until she reaches age 70. She is doing so in order to receive 32 percent more in Social Security benefits once she starts receiving these benefits at age 70. To help pay her bills, Emily elects to receive her TSP in the form of monthly payments. But less than one year after retiring on Sept. 16, 2019, Emily has to move and incurs some major moving expenses. Emily makes a partial withdrawal from her TSP account even though she is receiving TSP monthly payments. She is eligible to request this partial withdrawal under the new TSP partial withdrawal rules effective Sept. 15, 2019.
It should be noted that a TSP participant who made either an age-based (post-age 59.5) in-service or a post-separation from federal service partial withdrawal before the new TSP withdrawal options became effective on Sept. 15, 2019 is eligible to use the new rules with respect to TSP partial withdrawals.
There is another advantage of a TSP participant being able to request multiple partial withdrawals. The advantage is that a TSP participant can request unlimited number of transfers of his or her traditional TSP account to a traditional IRA or to a Roth IRA. Under the old rules, a TSP participant could request only one one-time age-based post-age 59.5 in-service or a post-separation from federal service transfer to an IRA. Some or all of the traditional TSP account could be directly transferred to a traditional IRA (nontaxable) or directly transferred to a Roth IRA, fully taxable.
The fact that a traditional TSP account owner is able to make a direct transfer to a Roth IRA can benefit many employees and annuitants who cannot contribute to a Roth IRA because their incomes are too large and they are therefore ineligible to contribute directly to a Roth IRA. Roth IRAs can be tremendously advantageous to federal employees in retirement for two reasons, namely:
(1) Withdrawals are tax-free; and
(2) the Roth IRA is the only type of retirement account that is not subject to the required minimum distribution (RMD) rules.
While any employee is eligible to contribute to the Roth TSP, the Roth TSP is subject to RMD requirements. To avoid having the Roth TSP account be subject to RMD requirements, the Roth TSP participant is advised to directly transfer the Roth TSP account to a rollover Roth IRA at the later of the Roth TSP participant’s retirement from federal service or the year before the participant becomes age 70.5.
The same type of direct transfer to a rollover Roth IRA can be made from the traditional TSP with no income restrictions. The problem is that a traditional TSP participant who requests such a transfer has to pay full federal and state income taxes on the amount transferred. Under the old rules regarding TSP withdrawal options, only one such transfer could be made. If the traditional TSP participant wanted to transfer a substantial amount to a rollover Roth IRA, then as a result it is likely that a substantial amount of federal and state income taxes would have to be paid.
Under new rules regarding TSP withdrawal options, the traditional TSP participant can do a series of transfers to “rollover” Roth IRAs over a period of years. Each year, the participant can transfer an amount that will not result in the participant being pushed into a higher marginal tax bracket. For employees and annuitants who are able to make these transfers between now and the end of 2025, they will most likely save in federal income taxes. This is because the Tax Cuts and Jobs Act of 2017 lowered individual tax rates until the end of 2025. Starting in 2026, individual tax rates will revert back to what they were in 2017, inflation adjusted.
Disadvantages to the New Rules Regarding Partial Withdrawals from a TSP Account
With more opportunities to make partial TSP withdrawals, there is the possibility that some TSP participants may treat their TSP accounts as “liquid” savings accounts and withdraw money from their TSP accounts “at will”. Too many partial withdrawals in a particular year from the traditional TSP (fully taxable) can result in a TSP participant being pushed into a higher marginal tax bracket. This means that the participant could pay more in federal and state income taxes compared to the total taxes paid if withdrawals were spread over a period of years.
TSP participants should also try to avoid making partial withdrawals from Roth TSP accounts if they have been contributing to the Roth TSP. Roth TSP participants are encouraged to allow their Roth accounts to grow as long as possible in order to reap the benefit of tax-free growth.
Finally, TSP participants should beware that frequent TSP partial withdrawals can result in higher administrative expenses for the TSP. These higher administrative expenses in turn can directly affect TSP fund investment returns.