In the third 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 with respect to requesting payments from traditional TSP and Roth TSP accounts.
- Understanding the New Changes to TSP Withdrawal Options – Part 1
- Understanding the New Changes to TSP Withdrawal Options – Part 2
The following table summarizes the “old” rules (pre-Sept. 7, 2019) and the “new” rules (post-Sept. 14, 2019) with respect to making withdrawals from TSP accounts. Note there was a blackout period during the period Sept. 7 through Sept. 14, 2019 in which TSP participants could not request any type of withdrawals from their TSP accounts.
Advantages of the New Rules When Requesting Payments from Traditional TSP and/or Roth TSP Accounts
There are some important advantages to the new TSP rules with regard to requesting payments from traditional TSP and Roth TSP accounts. Before discussing these advantages, it is important to review how the traditional TSP and Roth TSP are funded and grow, which employees are eligible to contribute to the traditional TSP and the Roth TSP, and what happens to the two TSP accounts when an employee retires from federal service.
The traditional TSP is the original TSP and started in 1987. With the traditional TSP, all employee contributions are deducted from an employee’s gross salary. Traditional TSP contributions therefore lower an employee’s taxable salary for federal and in most states, state income tax liabilities. Contributions made to the traditional TSP C, S, I, F and G funds also accrue earnings, in which these earnings are tax-deferred. All full time and part time employees can contribute to the traditional TSP. Those employees who are covered by the Federal Employees Retirement System (FERS) received partial matching on their contributions as well as an automatic one percent of gross pay contribution from their agencies. Both the agency matching contributions and automatic one percent of gross pay contribution are put in the FERS-covered employee’s traditional TSP account. This is true even if the employee contributes entirely to the Roth TSP.
All withdrawals from the traditional TSP are fully taxable. Withdrawals consist of the traditional TSP participant’s contributions accrued earnings, and agency automatic one percent of gross pay and matching contributions. A traditional TSP participant can make penalty-free (no 10 percent early withdrawal penalty) if the traditional TSP participant retires or leaves federal service sometime during or after the year the TSP participant becomes age 55. “Special provision” employees, including federal employees who are law enforcement officials, firefighters or air traffic controllers, can make penalty-free traditional TSP account withdrawals if they retire as special provision employees at age 50 or older.
The Roth TSP started and became available at most federal agencies during 2013. Unlike a Roth IRA in which there are income limitations as far as who is eligible to contribute to a Roth IRA, there are no income limitations for contributing to the Roth TSP. Any full-time or part-time can contribute to the Roth TSP.
With the Roth TSP, contributions come from an employee’s after-taxed salary and do not result in current year tax savings. Contributions are also made to the TSP C, S, I, F and G funds, and accrue earnings through the years. The accrued earnings in an employee’s Roth TSP account will grow at least tax-deferred. But the Roth TSP contributions will be withdrawn tax-free if the following conditions are met: (1) the Roth TSP participant is at least age 59.5; and (2) it has been at least five years since the Roth TSP participant made his or her first Roth TSP contribution.
Both the traditional TSP and the Roth TSP are subject to annual required minimum distributions (RMDs) with the first RMD made by April 1st following the later of the year the TSP participant becomes age 70.5 or retires from federal service. Every subsequent year both a traditional TSP and Roth TSP must be made by December 31.
With this background information, the advantages to the new rules requesting payments from the traditional TSP and Roth TSP accounts are now discussed.
Advantage 1. A TSP participant who retires between age 55 and 59.5 with both a traditional TSP and Roth TSP accounts and requests installment payments will not have to pay tax on the Roth TSP earnings portion of the monthly installment under the new rules. This is simply because the Roth portion of the account does not have to be withdrawn. The following example illustrates:
After 34 years of federal service, Thomas, age 56, retired in early 2019. At the time of his retirement, Thomas had $800,000 in his traditional TSP account and $200,000 in his Roth TSP account (a total of $1,000,000 in Thomas’ TSP accounts). Thomas requests a monthly payment of his TSP account.
Under the old TSP rules (pre-Sept. 6, 2019), Thomas’ $1,000 monthly payment had to come from both his traditional TSP and Roth TSP accounts, “pro-rata”. That is, since Thomas’ TSP traditional account balance of $800,000 is 80 percent ($800,000/$1,000,000) of the total TSP account balance, $800 of the $1,000 monthly payment had to come from his traditional TSP account. The other $200 would come from his Roth TSP account. Pre-Sept. 6, 2019, Thomas had no choice in choosing which TSP account from which to withdraw the $1,000.
In addition, since Thomas is under age 59.5, he had to pay full tax on the $800 traditional TSP portion of the $1,000 payment, with no 10 percent withdrawal penalty, and must pay income tax on the earnings portion of the $200 Roth TSP payment. The TSP will let Thomas know which portion of the $200 monthly payment consists of Roth TSP contributions and which part is Roth TSP earnings. Since Thomas is younger than age 59.5, he must pay full income tax on the earnings portion of the Roth TSP payment.
Under the new (post-Sept. 14, 2019) TSP rules, Thomas can tell the TSP to withdraw the $1,000 entirely from his traditional TSP account and leave the Roth TSP account alone. In so doing, Thomas avoids having to pay unnecessary income tax on the earnings portion of the Roth TSP withdrawal. Most importantly, the Roth TSP account can continue to grow, tax-free.
Advantage 2. With no RMD requirement to start withdrawing one’s Roth TSP account until April 1st of the year following the later of the year the TSP participant becomes age 70.5 or retires from federal service, the Roth TSP account continues to grow, tax-free. Before the year the Roth TSP participant becomes age 70 (if the Roth TSP participant retires before age 70), or the year before the Roth TSP participant retires (if the Roth TSP participant retires after age 70), the Roth TSP participant can transfer all of his or her Roth TSP account to a “rollover” Roth IRA. In so doing, the Roth TSP participant will avoid having to take Roth TSP RMDs because the Roth TSP has been transferred to a Roth IRA. The Roth IRA is not subject to RMDs as long as the Roth IRA owner is alive.
Disadvantages of the New Rules with Regard to Requesting Payments from Traditional and/or Roth TSP Accounts
By keeping both the traditional TSP and Roth TSP accounts in retirement, a TSP participant has more paperwork and two accounts to monitor and track. Both accounts are subject to RMDs.