So Many TSP Choices

When most current federal employees retire from government, they will have three different sources of retirement income: the Federal Employees Retirement System basic benefit, a Social Security retirement benefit and assets invested in the Thrift Savings Plan. The first two provide specific lifetime streams of income, while the third provides more flexibility.

Here are your TSP options after you separate from federal employment:

• Withdraw some or all of your money as a taxable lump sum.
• Withdraw some or all of your money in equal monthly payments based on your life expectancy and age at the end of every year.
• Have the TSP purchase a life annuity for you under a contract with MetLife.
• Roll over all or a portion of your balance to an individual retirement account.

Here’s what I’ve learned from financial planners about the various withdrawal options: 

Withdrawing a large lump sum payment from your pre-tax TSP balance may have unfortunate tax consequences. They include paying tax in a higher marginal federal tax bracket than when you were employed. You may also owe state income taxes if you live in one of the 21 states that tax such withdrawals. California, New Jersey and Vermont have the most progressive tax rate structures.

Receiving a monthly payment is an easy and popular way to create a third stream of income in retirement. But it’s not guaranteed to last a lifetime. In addition, the withdrawals will be made on a prorated basis. So if your TSP account is invested 60% in the G Fund and 40% in the C Fund, then a $2,400 monthly payment will be deducted at $1,440  from the G Fund and the remaining $960 from the C Fund.

You can start, stop or change your installment payment at any time. The minimum amount for installment payments is $25. In 2022, the TSP started disbursing payments to about 40,000 accounts, joining close to 3 million ongoing payments. That adds up to a total of close to $4 billion in payments made to separated participants. Monthly payments from your traditional TSP balance are subject to ordinary income tax. 

The annuity option is not as popular as the other TSP choices, due to its permanent nature. Once elected, it cannot be changed or stopped. In 2022, fewer than 1,000 annuities were purchased by TSP participants and in 2022 there were about $100 million in TSP payments to purchasers of life annuities.

The monthly payments of a TSP annuity are affected by your age at the time of purchase (the older you are, the bigger the payment), the interest rate index (it was 4.075% for annuity purchases in May 2023), the features added to a basic annuity (increasing payments, joint annuity options, cash refunds and a 10-year certain payment feature), and the amount of TSP proceeds used to make the purchase. 

Rolling some or all of your TSP into an IRA can provide you with additional options that are not available directly from the TSP. In 2022, the TSP processed more than 320,000 partial withdrawals, totaling around $57 billion. The majority of these withdrawals were rolled over to an IRA or other tax-deferred retirement plan, so the money would not be immediately taxed.

There are multiple tax strategies that can be used with an IRA that are not available through the TSP, which can help with tax, health care and estate planning. For more information, consult a financial planning professional.