In September of 2019, the Thrift Savings Plan (TSP) made it easier for participants to make a TSP withdrawal. While the laws changing or loosening the rules surrounding TSP withdrawals were approved in 2017 with the passage of the TSP Modernization Act of 2017, the actual changes allowing for few restrictions for a TSP withdrawal didn’t go into effect until two (2) years later in 2019. More information about the updates and changes under the TSP Modernization Act of 2017 can be found here: (https://www.joneswealthmgmt.com/new-tsp-withdrawal-options).
For the regular or traditional TSP, because contributions were made on a pre-tax basis, one of the most important considerations of a TSP withdrawal is income taxes. The TSP is required to withhold 20% from any TSP withdrawal or distribution, but that may not be that only amount of taxes owed. In many instances, the 20% required withholding is just a “down payment” on your ultimate tax bill for the withdrawal.
The total amount of taxes owed for a TSP withdrawal is ultimately determined when you file your income taxes for the year in which the TSP withdrawal was made. In other words, how much you’ll own for a 2021 withdrawal will fully be determined when you file your taxes in 2022.
If someone made a TSP withdrawal for $100,000 in 2021, the TSP was required to withhold 20% or $20,000 and a distribution was made forleaving $80,000 as the net distribution amount. However, and the total amount of the withdrawal, ($100,000), is included with your other sources of taxable income and once that total is determinedto arrive at the total taxable income for the year.
Below is a tax table reflecting the tax rates for 2021 (source: irs.gov):
You’ll notice that there is not a 20% tax bracket; there is a 12% or a 22% bracket. If a TSP participant that’s a single filer and has annual income of $75,000 and makes a $100,000 TSP withdrawal, their total income for that year would be $175,000. At $75,000, they’d be in the 22% tax bracket, but adding an additional $100,000 from the TSP withdrawal for a total of $175,000 of income would push them into the 32% tax bracket.
From income of $75,000 there likely would have been deductions for taxes throughout the year, but for this hypothetical explanation, taxes on $75,000 would be $16,500 ($75,000 x 22%). Adding $16,500 to With the $20,000 in taxes withheld from the $100,000 TSP withdrawal, of $100,000, $20,000 was withheld automatically, so total taxes paid would be $36,500.
However, at $175,000 total income, a single filer would now fall into the 32% tax bracket and 32% of $175,000 is $56,000 ($175,000 x 32%). It was stated previously that total taxes previously paid was $36,500, but at an total income level of $175,000, taxes owed would be $56,000, meaning that in this hypothetical explanation, an additional $19,500 in income taxes would be owed in this hypothetical explanation.
This explanation does not include an early withdrawal penalty of 10% that applies to withdrawals made before age 59½. The 10% early withdrawal penalty would apply to the $100,000 TSP withdrawal and would be an additional $10,000, bringing the total taxes owed of $66,000, with only $36,500 having previously paid.
It should be noted that the 10% early withdrawal penalty does not apply to payments made after you separate from service during or after the year you reach age 55 (or the year you reach age 50 if you are a public safety employee as defined in section 72(t)(10)(B)(ii) of the Internal Revenue Code).
A TSP withdrawal is when the payment is made directly to the participant and a withdrawal is subject to the mandatory 20% tax withholding. A TSP rollover or TSP transfer is a payment made to an IRA (individual retirement account) at a financial institution on behalf of the participant and is not subject to the mandatory 20% tax withholding.
The Jones Wealth Management Group does not provide tax advice and you should consult with a tax professional as it pertains to your situation. The purpose of this information is to provide an explanation of the considerations of a TSP withdrawal.
Martavius Jones of the Jones Wealth Management Group is a Chartered Federal Employee Benefits Consultant (ChFEBC) and has been a financial advisor since 1994. He works with federal government employees across the country and has shown them strategies that provide monthly income potential that doesn’t involve drawing down from principal, but is derived from EARNINGS only. Click here to contact him or dial 901-312-9166 to schedule a no-cost consultation.