Last week, we explored the topic of required minimum distributions from the Thrift Savings Plan and other retirement savings accounts. This week, let’s look at the specific issue of how TSP distributions can affect your decision about the date on which to retire.
I recently received this email about a new retiree’s experience with RMDs:
I am over age 70 ½ and I recently retired, effective close of business Dec. 31, 2018, with my first day of retirement Jan. 1, 2019. On Feb. 6, I received correspondence from the TSP stating that the RMD and associated taxes are due to be withdrawn from my account for both 2018 and 2019. Since I worked through all of 2018, it seems to me that there shouldn’t be a 2018 RMD. I was told by the TSP that the 2018 RMD was because my payroll office reported that my date of separation was Dec. 31. I assume (maybe incorrectly) that this situation stems from the TSP interpreting Dec. 31, 2018 as my first day retired, and so I was not employed for the entire year. This TSP distribution creates an unwarranted tax obligation, lowers my TSP balance and raises my 2019 income, which may affect my Medicare Part B premium.
According to IRA expert Ed Slott, with respect to the still-working exception to RMD rules, one issue that routinely surprises both financial advisers and their clients is the requirement that an employee be employed throughout the entire year to qualify for the exception and delay RMDs past the year in which they turn 70 ½.
The confusion in the emailer’s case revolves around a single day: Dec. 31. I’ve heard similar stories in the past. I learned that the TSP is required to pay the first RMD for an employee who is over age 70 ½ in the year of retirement and who retires in that year. That’s true even if the retirement is effective on Dec. 31. The payments must be made by April 1 of the year following the year of separation from service—in this case by April 1, 2019.
Would retiring on Jan. 1 avoid this dilemma? Yes, but it might create other problems. Remember that under the Federal Employees Retirement System, your retirement commences the first day of the month following your date of retirement. By retiring on Dec. 31, your retirement would begin on Jan. 1, with the first benefit payment due on Feb. 1 (for the month of January).
By retiring on Jan. 1, your retirement would start on Feb. 1, with the first payment due on March 1 for the month of February. No benefit would be payable for Jan. 2- 31. This would cause the loss of a full month of retired pay. On the other hand, if you retired on Jan. 31, you would forfeit any excess annual leave hours above the carryover limit. (Although due to the furlough this year, many employees had their excess leave restored for 2019.)
By retiring in 2019 instead of 2018, you would have more breathing room, instead of having to make a withdrawal decision post-haste. Employees who are over 70 ½ in their year of retirement and who want to cash in annual leave above the carryover limit (typically 240 hours) must make a choice ahead of time.
By the way, here’s a note for those of you who are over 70 ½ who are retired and taking monthly payments from your TSP: If your withdrawal election does not meet the RMD threshold for 2019 (say, for instance, you are receiving monthly payments of $25, the minimum monthly payment amount), the TSP will issue a supplemental lump sum payment in December 2019 that ensures you will satisfy the 2019 RMD. This avoids the IRS penalty for failing to take the required amount of RMDs, which is a 50 percent excise tax on the amount not distributed as required.