Those federal employees covered by the Federal Employees Retirement System (FERS) save for their retirement through elective contributions to the Thrift Savings Plan (TSP) and mandatory payroll deduction to the FERS Retirement and Disability Fund and deduction for Social Security payroll (FICA) taxes. Once a FERS employee retires, the FERS annuity is paid monthly, starting the second month after the employee retires and continuing for the rest of the FERS annuitant’s life.
It is entirely up to the FERS annuitant to decide when to start receiving Social Security retirement benefits and when to start making TSP withdrawals. At some point during the FERS annuitant’s retirement, these two sources of retirement income will have to be tapped in order to pay expected retirement expenses.
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Once a retired TSP participant reaches his or her “required beginning date” (April 1 following the year the annuitant becomes age 73 for TSP participants born between January 1, 1951 and December 31,1959; age 75 for TSP participants born after December 31,1959), then TSP required minimum distributions (RMDs) begin.
It is important to coordinate TSP withdrawals and the receipt of Social Security retirement benefits. Specific plans to optimize this coordination will vary from individual to individual. This column presents some general guidelines.
Options for FERS Employees Who Retire Between Their MRA and Age 62
FERS employees can retire at their minimum retirement age (MRA) (age 55 to 57 depending on which year they were born) with a minimum of 30 years of federal service. They could retire at age 60 with a minimum of 20 years of federal service. In either case, a retired FERS employee will immediately start receiving their FERS annuity. They will also receive the FERS annuity supplement until they are age 62. However, the FERS annuity and the FERS annuity supplement may prove to be insufficient to pay the annuitant’s monthly expenses.
Traditional TSP accounts can be tapped without being subject to a 10 percent early withdrawal penalty if the TSP participant is age 55 or older. If the traditional TSP account owner has retired under FERS and directly transfers any of his or her traditional TSP account to a traditional IRA, then the traditional IRA funds can be withdrawn without being subject to a 10 percent early withdrawal penalty. The transferred TSP funds now inside a traditional IRA can be withdrawn penalty-free only if the IRA owner is over age 59.5. An exception to the 10 percent early withdrawal penalty for a pre-age 59.5 traditional IRA distribution is possible, including withdrawals from a traditional IRA to pay qualified higher education expenses or to purchase an individual’s first principal residence.
Social Security retirement benefits can be claimed as early as when a “fully insured” individual becomes age 62. But claiming benefits at age 62 will result in a permanently reduced monthly benefit (as much as 25 to 30 percent) because the retirement benefits started before the individual reached his or her full retirement age (FRA) (age 65 to 67, depending on which year the individual was born).
Retired FERS Annuitants Who Choose to Continue Working
If there is no need to start withdrawing TSP or receiving Social Security benefits, it makes sense to delay the withdrawal of each. When choosing which retirement benefit to begin withdrawing first, one factor is whether the FERS annuitant is working post-federal retirement and doing more than “token” work for pay.
Those FERS annuitants who reach age 62 are eligible to start receiving their Social Security retirement benefits. But if they are working and receiving Social Security retirement benefits, then the Social Security “earnings test” could trigger a loss of Social Security benefits. The “earnings test” applies to any individual who is between age 62 and the year the individual becomes full retirement age. During 2024 earnings (salary or net self-employment income) over $22,320 will result in a take-back of Social Security benefits. In particular, for every $2 earned above $22,320, the Social Security Administration will take back $1 of benefits. There is another less severe Social Security “earnings test’ the year an individual reaches full retirement age. Once an individual reaches the month of their full retirement age, there is no longer an “earnings test.”
The Social Security earnings test is an important reason many federal annuitants delay their initial receipt of their Social Security benefits until the year and month they reach full retirement age. While waiting for the start of their Social Security benefits, many federal annuitants choose to start withdrawing their TSP, either because they want to (for example, to reinvest into a different investment) or they have to (for example, to help pay their monthly expenses or to make a major purchase such as a vacation home).
Starting TSP Withdrawals
It is preferable for a federal annuitant to start withdrawals from the TSP before filing for Social Security. There are two reasons that delaying the start of one’s Social Security retirement benefits is advantageous to the federal annuitant.
The first reason is that from age 62 (the earliest age to start Social Security monthly benefits) to age 70, (the latest age to request Social Security benefits in order to increase benefits) waiting effectively increases the monthly benefit by more than 75 percent. That is the equivalent of getting a return of as much as eight percent per year guaranteed by the federal government. Moreover, Social Security benefits are indexed to inflation, which can help to keep the mandated payout increases being eroded by increases in the cost of living during retirement.
The second reason that waiting as long as possible to start receiving Social Security benefits is that for a married individual, delaying the receipt of Social Security benefits will also potentially provide a higher benefit for a surviving spouse. After one spouse of a married couple dies, only one check will be paid to the surviving spouse – namely, the higher of the two date-of-death monthly benefit amounts (that is, the higher of the deceased spouse’s monthly Social Security benefit or the surviving spouse’s monthly survivor benefit).
Reducing TSP RMDs
Another reason for starting TSP withdrawals before receiving Social Security retirement benefits is that TSP required minimum distributions (RMDs) must start when the retired TSP participant has reached his or her required beginning date (April 1 following the year the TSP participant reaches age 72, 73 or 75 depending in which year the TSP participant was born). The way in which TSP RMDs are calculated is that the larger the balance of the TSP account (includes the balance in both the traditional and the Roth TSP), the larger will be the TSP RMD. Since the traditional TSP is fully taxable, the larger the TSP account balance the more federal (and in most cases, state) income taxes have to be paid.
In short, it makes sense to start TSP distributions earlier than the required beginning date. The more money that is withdrawn prior to the TSP participant’s required beginning date, the less growth will occur resulting in a lower TSP account balance used to determine the TSP RMD. A TSP participant who has a Roth TSP account is allowed to directly transfer the Roth TSP account to a Roth IRA. The fact that the Roth TSP is transferred to a Roth IRA does not change the nature of the Roth TSP. All qualified withdrawals from a Roth IRA are income tax-free-plus there is no RMD requirement for the Roth IRA. But if the TSP participant does not transfer his or her Roth TSP balance to a Roth IRA before his or her required beginning date, then there is good news resulting from the passage of SECURE 2.0. Effective January 1,2024, the Roth TSP account balance will not be used in the calculation of the TSP RMD.
Smaller TSP RMDs not only leads to lower federal and state income taxes, they also can hold down various stealth taxes such as the Income-Related Monthly Adjustment Amount (IRMAA) of premiums of Medicare Part B and exposure to the Net Investment Income Tax (NIIT). Federal annuitants are strongly encouraged to enroll in Medicare Part B when they are first eligible (age 65, if at that time they are retired from federal service). There is a monthly premium cost for Medicare Pat B. The monthly premium depends on an individual’s income each yar. The higher their income the more the individual pays in Part B premiums the following year.
Current federal marginal brackets during 2024 include a 22 percent tax rate on taxable income up to $201,050 and 24 percent tax rate on up to $383,900 taxable income for individuals who file as married filing jointly. There is a 22 percent tax rate on taxable income up to $100,525 and 24 percent tax rate on taxable income up to $191,950 for individuals filing as single. It is quite possible that federal individual tax rates will increase starting January 1,2026 when the Tax Cut and Jobs Act of 2017 expires. This means that converting tax-deferred accounts to tax-free accounts may turn out to be a financially astute plan.
One suggestion is to convert traditional IRA money to Roth IRAs each year, making sure to avoid steep marginal income brackets. Once a TSP participant becomes age 63, the IRMAA brackets should also be monitored because there is a two-year lag between reported income and the higher premiums owed by some Medicare Part B enrollees, starting when they are age 65.
Taking Social Security Benefits First
There are some situations that could lead to filing for Social Security early, before full retirement age, and deferring TSP distributions. There are some TSP participants who are confident their marginal tax bracket will never be higher than it is now, and that TSP beneficiaries never will have to pay higher taxes than they are now on the bequeathed distributions.
Individuals in poor health with no survivor benefits to consider may want to claim Social Security as soon as possible in order to start the cash flowing.
In summary, there is no single answer to the question of which should be withdrawn first – Social Security or TSP. Considering the moving parts – from one’s health status to family situations to future tax rates, both federal and state – will hopefully lead to a plan that increases the chances of being able to enjoy a financially secure retirement.