Those 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 withholding for the FERS annuity and for Social Security.
Once a FERS employee retires, the FERS annuity is paid monthly, starting the second month after the employee retires and continues 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 of the FERS annuitant’s retirement, these two sources of retirement income will have to be tapped in order to pay expected retirement expenses.
Once a FERS annuitant reaches his or her “required beginning date” (April 1 following the year the annuitant becomes age 72), 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 provides 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 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 withdrawal penalty if the TSP participant is over age 55. 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transfers any of his or her traditional TSP account to a traditional IRA, then the traditional IRA funds can be withdrawn without being subject to a 10 percent early withdrawal penalty.
The transferred TSP funds now inside a traditional IRA can be withdrawn penalty-free only if the IRA owner is over age 59.5.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 an individual becomes age 62. Claiming benefits at age 62 will result in a permanently reduced monthly benefit, as much as 25 to 30 percent, because the 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 to begin 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 2021 earnings (salary or net self-employment income) over $18,960 will result in a takeback of Social Security benefits. In particular, for every $2 earned above $18,960, the Social Security Administration will take back $1 of benefits. There is another less severe Social Security “earnings test’ the year an individual becomes full retirement age. Once an individual reaches their full retirement age, there is no longer an “earnings test”.
Nevertheless, the Social Security earnings test is a reason why many federal annuitants delay their initial receipt of their Social Security benefits until the year and month they become full retirement age. While waiting for the start of their Social Security benefits, many federal annuitants choose to start withdrawing their TSP.
Starting TSP Withdrawals
It is generally 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 may be advantageous.
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.
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 TSP participant becomes age 72. 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 age of 72. The more money that is withdrawn prior to age 72, 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. In so doing, the TSP participant removes the Roth TSP from the total TSP account balance, thus lowering the TSP RMD. 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.
Fewer TSP RMDs not only leads to lower 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. 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 2021 include a 22 percent tax rate on taxable income, up to $172,750 for individuals filing as married filing jointly and 24 percent, up to $329,850 of 2021 taxable income. There is a 22 percent tax rate on taxable income up to $86,375 for individuals filing as single and 24 percent tax rate of 2021 taxable income up to $164,925 for individuals filing as single. It is quite possible that future federal individual tax rates will be much higher. This means that converting tax-deferred account to tax-free accounts may turn out to be a financially astute plan.
One suggestion is to transfer traditional TSP 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, staring 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. Three are perhaps 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.