TSP in Tax Season

Tax time is upon us. The Thrift Savings Plan sent out forms 1099-R (and posted them in the “my account” section of their website) on January 31, 2018. Tax returns are due (unless you request an extension) on April 17, 2018.

Of course, if you are not yet withdrawing funds from the TSP, this is of no interest to you. What interests those of us who are still contributing to the traditional TSP is the fact that we contribute out of pre-tax dollars and our earnings are tax deferred.

What interests those of us who are contributing to the Roth TSP is the fact that, down the road, earnings on qualified distributions are free from federal income tax.

If you’re withdrawing from the TSP, you probably know that withdrawals (save for qualified Roth withdrawals) are taxed as ordinary income. Ordinary income receives no special tax treatment and is taxed based on whichever bracket it falls into.

Presumably brackets will be lower in 2018, though the loss of many deductions/exemptions makes the overall effect of tax reform uncertain. Everything you withdraw from your traditional TSP will be taxable. It also means that, as long as your withdrawals from your Roth TSP balance are qualified, there will be no tax on Roth withdrawals. (Under current rules, all withdrawals from your TSP account must be proportional between your traditional and Roth balances.)

For those of you who are withdrawing from the Roth balance in your TSP, let’s look at what it means for a withdrawal to be qualified. First, you must have had a Roth balance in your TSP account for at least five years. Second, you must be at least age 59 ½. If you do not meet both of these criteria, your Roth withdrawal is not qualified and you will have to pay federal income tax on the portion of your Roth withdrawal that is based on earnings. Of course, Roth contributions have already been taxed.

It is important to note that, although all taxes on TSP withdrawals are at your rate for ordinary income, taxes are withheld at different rates based on the type of withdrawal that you choose. When you begin your withdrawals, you should determine how the rate of withholding compares with the rate at which your withdrawal will be taxed. If you have selected “substantially equal monthly payments,” you will have significantly less withheld than you need for federal taxes and should elect extra withholding.

For additional information, review the TSP publication Tax Information: Payments From Your TSP Account, which has just been updated in January 2018.