You Have TSP Questions; We Have Answers
Why you should do a dry run of your taxes before pulling the plug on work, and other tips.
One of my favorite things to do is to answer questions from federal employees and retirees. Last week's column generated a lot of questions and commentary from readers about general retirement processing, Thrift Savings Plan issues and other considerations that affect your retirement funds. So this week I thought I’d provide some additional reference material for those who want to continue the dialogue.
One reader pointed out that you will need to include a copy of your marriage certificate (if married) and the W-4P withholding certificate (federal tax withholding election) for pension or annuity payments with your retirement application. Also, if you have been divorced and your ex was awarded a portion of your retirement or survivor benefits, a copy of the divorce decree will also need to accompany your retirement application.
It’s a good idea to do a dry run of your tax return before you retire so that you get a better idea of the taxes you will pay on your income from FERS or CSRS, Social Security, and distributions from your TSP. You can use available software or a professional tax preparer can provide this service as well. Many federal employees underestimate the amount of taxes they will owe after they are retired. You no longer will have to pay the FICA and Medicare taxes after retirement, but you will be obligated to pay federal income tax. Here is a guide to state income taxes for retirees.
And don’t take it for granted that you’ll see a cost of living increase in retirement pay. One reader who retired Dec. 31, 2014, was surprised to not receive a COLA on Jan. 1, 2015. That’s because they were not retired during the rating period for 2014. They will also not receive a COLA on Jan. 1, 2016, because there will be no COLA for CSRS, FERS, Social Security or military retirees due to the lack of increase to the Consumer Price Index upon which the COLA is based.
Turning 50 and TSP
One reader lost $2,000 in matching TSP funds because they got tripped up by the “catch-up” option available when employees turn 50. Here is the most important thing to remember about Catch-Up contributions: For FERS employees especially, these contributions should be made concurrently with your regular TSP contributions. You will have two allotments from your paycheck: one for the regular contributions that are matched, and a second for catch-up contributions, which are not matched.
Here more information you need to know about making catch-up contributions to your TSP account.
You can begin making catch-up contributions at any time beginning in the year you turn 50. To be eligible, you must expect to contribute the maximum amount allowed to the TSP or to an equivalent tax-deferred employer plan, such as a private sector 401(k) or nonprofit 403(b) employer plan.
Be aware that if you are a FERS participant, you will not receive matching on any catch-up contributions.
It’s also important to know that the ROTH TSP has a 5-year rule for tax-free distributions. Here is more information sent to every separated federal employee who has a TSP account.
If you have a Roth TSP account, you have already paid taxes on those contributions. You will not owe taxes when you receive a payment (distribution) from your account. The earnings in your Roth balance become qualified, and are therefore paid tax-free, when the following two conditions have been met: 1) Five years have passed since Jan. 1 of the calendar year in which you made your first Roth contribution, and 2) You have reached age 59½ or have a permanent disability or death. (Note: If you are a beneficiary participant, the Roth earnings in your account become qualified when 5 years have passed since Jan. 1 of the calendar year in which the deceased TSP participant first made a Roth contribution.)
If the payment from your Roth balance is not a qualified distribution and you do not transfer or roll over the payment to a Roth IRA or Roth account maintained by an eligible employer plan, you will be taxed on the earnings. If you are under age 59½, you will incur a 10 percent early withdrawal penalty tax on early distributions (unless an exception applies). However, if you transfer or roll over the payment, you will not have to pay taxes currently on the earnings and you will not have to pay taxes on payments that later become qualified distributions.
In summary, if the payment from your TSP Roth balance is a qualified distribution, you will not be taxed on any part of the payment even if you do not transfer or roll over the payment. If the payment from your TSP account is a nonqualified distribution and you transfer or roll over the payment, you will not be taxed on the amount you transfer or roll over. Any earnings on the amount you transfer or roll over will not be taxed if paid later in a qualified distribution.
The maximum TSP contributions for 2016 remain as they are in 2015: $18,000 (regular contributions) and $6,000 (catch-up contribution limit after you turn 50). Your payroll office will generally include a reminder on your leave and earnings statement near the end of the year to let you know about contribution limits for the upcoming year. There is also a helpful fact sheet on elective deferral limits to help compute the maximum contribution to your TSP.
Don't miss your TSP government match for the 27th payday this year. This is a rare year with 27 Paydays (normal pay day for the pay period ending Dec 26 is Jan. 1, 2016, but this year it will be paid Thursday, Dec. 31). To get the government match for this 27th payday, you have to spread out contributions so that you contribute at least 5 percent of your biweekly gross pay during that final pay period without hitting the maximum allowed contribution ($18,000). For those who contribute the maximum regular TSP contributions and have been contributing at a rate to exactly hit the max in the 26th pay period, you won't get a government match in the 27th unless you adjust now.
Death Benefits and TSP
One reader requested more info about TSP beneficiary participant accounts: Specifically when I die my husband gets the account but when he passes the kids inherit that account. Do they have to take those monies out in a lump sum or can they transfer the money out of TSP into a retirement account of their own, avoiding a large tax bill?
This is a great question. Beneficiaries cannot roll over this money to an inherited IRA. They must receive it as a taxable distribution. I wrote about this situation earlier this year.
The Internal Revenue Code allows non-spouse beneficiaries, including trusts (but not estates), of civilian and uniformed services TSP accounts to transfer all or part of a death benefit payment to an “inherited” IRA. An inherited IRA is an IRA established specifically for the purpose of transferring money inherited from a plan such as the TSP. They may provide significant tax benefits since the required distribution for the IRA can generally be spread across the lifetime of the beneficiary. However, the rules governing inherited IRAs are complicated, and there are restrictions. So before you make a decision to transfer money from the TSP to such an IRA, we strongly recommend that you discuss the details of your transfer with a qualified tax advisor or your IRA provider.
You may not roll over a TSP death benefit paid directly to you. If you choose to have the TSP transfer all or part of the payment to an inherited IRA:
• Your transfer will not be taxed in the current year, and no income tax will be withheld.
• The taxable portion of your payment will be taxed when you withdraw it from the inherited IRA.
• The tax treatment and plan rules for withdrawals from the inherited IRA to which you transfer the distribution may be different from those of the TSP.
Note: Death benefits paid from a beneficiary participant account cannot be transferred into an inherited IRA. Instead the payment will be made directly to the beneficiary of the beneficiary participant account.