The Thrift Savings Plan withholds taxes at different rates for different types of payments. Image: RomanR/Shutterstock.com
By: John GrobeIt’s not too early to start thinking about your 2025 federal income taxes; especially if you are planning on retiring at or near the end of 2024.
Retirement income from your FERS annuity, Social Security, and the Thrift Savings Plan is taxed as ordinary income – just like your salary is today. However, there are differences in how taxes are withheld which can sometimes result in surprises.
Recently retired feds often have a surprise of the nasty variety when they see the bottom line on their first federal income tax return after retiring because of these withholding differences. You want to pay attention to withholding rates in order to avoid being one of those who ends up owing a lot of federal income taxes at filing time. Ideally, you want to pay your taxes bit by bit over the course of the tax year.
While you’re still working you simply file a W-4 and taxes are withheld from your paycheck. You “set it and forget it”. It’s different when you retire.
Regarding your federal annuity (CSRS or FERS), you likely filled out a W-4P with your retirement papers and now taxes are being withheld from your monthly payments. You probably based this withholding on the last W-4 you filed while still an employee and it will most likely cover all taxes due from your CSRS or FERS annuity. OPM will also, upon request, withhold state income taxes if you happen to live in a state that taxes retirement income.
Where it gets problematic is when we get to your Social Security and TSP withholding. It is quite likely that 85% of your Social Security will be subject to federal income tax at your rate for ordinary income, though some retirees will find that a lesser portion is considered taxable; the higher your income the higher the percentage of your Social Security benefit that is subject to federal income tax. But Social Security does not withhold one red cent from your benefits for taxes unless you ask them to!
The key to avoiding a tax surprise (particularly in your first year of retirement) is to pay the income tax on your Social Security as you go.
To that end you can:
• Ask Social Security to withhold from your monthly payments. You can do this when you apply (if you’re applying online, you do it in the “remarks” section of the form) or you can file a form W-4V after you have applied.
• Make quarterly estimated tax payments. These payments which are due on April 15, June 15, September 15 and January 15 (or a few days later depending on the day of the week the 15th falls on) require you to remember to set aside the money for the payment and remember to actually send it in. I don’t trust my memory (or my ability to keep my hands off money that I have set aside) so, when I filed for Social Security, I requested that they withhold 25% of my benefit for federal income taxes. If I don’t see it, I won’t miss it.
The Thrift Savings Plan withholds taxes at different rates for different types of payments. They have a booklet available on their website, tspbk26.pdf that contains a detailed table describing the withholding on each different type of withdrawal.
According to TSP statistics, the most common withdrawal is installment payments and that that type of withdrawal (if the payments are like to continue for 10 years or more) is withheld as if you were single and claiming no exemptions. This level of withholding is likely to cover your federal income tax liability.
The TSP, however, does not withhold for state income taxes. You would want to consider making quarterly estimated tax payments, or having extra money withheld from other sources of income (e.g., FERS, Social Security, etc.).
Most other types of payment from the TSP withhold at a 20% rate, which may (or may not) be sufficient to cover your federal income taxes.
Most of us don’t like to pay taxes – but we have to. What we don’t have to do is pay penalties that result from our underpaying taxes due to the fact that we do not understand how taxes are withheld from retirement income. Forewarned is forearmed. Plan now for next year’s taxes.
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