For those of you who are withdrawing money from your TSP, there will be a change coming on September 15, 2019 that can have an effect on the taxability of your 2019 income.
Along with the implementation of the TSP Modernization Act on that date, the TSP will allow those who have both traditional and Roth balances in their TSP to specify from which balance they want their distributions taken. Up until the change is enacted, withdrawals from the TSP must be taken proportionally. If you had 75% of your TSP in your traditional balance and 25% in your Roth balance, each withdrawal would come 75% from the traditional side and 25% from the Roth side. If you found it advantageous to take out more from the Roth side because you wanted to avoid going into a higher marginal tax bracket, or avoid crossing a threshold for one of the “stealth taxes” (e.g., avoiding income related monthly adjustments to your Medicare Part B premiums) you would be out of luck.
The ability to specify the balance from which your withdrawals come will help those who are under 59 ½ avoid paying taxes on the earnings portion of their Roth TSP withdrawal. In order for withdrawals from the Roth portion of your TSP to be tax free, not only must the Roth balance have been in place for five years, you must be at least 59 ½ years old. Someone who retired at, say, 57 and began withdrawing from a TSP account that had both traditional and Roth balances would be paying federal income taxes on the portion of their withdrawal that was attributable to the earnings on the Roth balance at their rate for ordinary income for 2 ½ years! The upcoming change will allow many TSP participants to avoid the so-called “Roth Tax Trap” that has haunted the TSP since the introduction of the Roth TSP back in 2012.
As we get closer to September 15th, we will have more articles explaining the new flexibility in withdrawals that we will have once the TSP Modernization Act in implemented. Have a question? Post it to ask.FEDweek.com.