December 31st is the end of the calendar year and the end of the tax year for individuals. This article is directed to those who are already taking money from our traditional Thrift Savings Plan accounts, or are retiring at the end of 2018. Money that is in the traditional balance of your TSP account is fully taxable as ordinary income when it is withdrawn. This means that it doesn’t receive favorable tax treatment like a long term capital gain or a qualified dividend would receive.

There is a big difference, however in how much is withheld from your TSP payments for federal income tax. The amount of taxes withheld on TSP withdrawals varies depending on how you withdraw the money. A tax notice (Tax Information: Payments From Your TSP Account) is updated at least annually and included in the publications section of the TSP website. The tax notice has a detailed table on the last page that describes how each type of withdrawal is treated and what the default withholding rate is.


The two most popular withdrawal methods can leave you holding the bag at tax time because the TSP did not withhold enough money.

If you elect a single withdrawal (the second most popular withdrawal choice), the default withholding rate is 20%. Depending on your tax bracket, this might not be enough to cover the taxes that you will owe. At the time of your withdrawal, you should estimate into which marginal tax bracket the bulk of the withdrawn money will fall and, if necessary, request additional withholding.

The most popular withdrawal choice is substantially equal monthly payments, and if you elect them, federal income taxes will be withheld as if you were married and claiming three dependents. Really? I suspect that very few retired feds claim so many dependents. You would need to be withdrawing over $1,700 per month before the TSP began to withhold for federal income tax. If you take monthly payments and do not request to have more taxes withheld from your distributions, you are asking to be hit by a big tax bill and by the estimated tax penalty. There is one exception to this withholding rate – those whose payments are not expected to last at least ten years will have taxes withheld at a 20% rate.

There is a place on your TSP withdrawal form where you can request additional withholding.

If, at the end of the year, less than 90% of what you owe for taxes has not been withheld for federal income taxes, you will be subject to a 10% estimated tax penalty; 10% of the difference between what should have been withheld and what actually was withheld. While it is better to have money withheld evenly throughout the year, there’s still time to eliminate (or at least mitigate) the penalty by making an estimated tax penalty by January 15, 2019.

If you’re retiring around the end of 2018, make the right withholding choices when you fill out your TSP withdrawal form and you won’t have to worry about penalties for under-withholding.

Not all states have income taxes and, of those that do, many either do not tax retirement income, or have large exemptions for retirees. However, if you live in a state that taxes retirement income, be aware that the TSP does not withhold state income taxes from your payments. You will want to make estimated payments to your state taxing authority if you don’t want to be left holding the bag.