What do you think you know about the Thrift Savings Plan? Do you think you are an expert? Well, there are common misconceptions about the TSP and we’ll look at the major ones in this article.
There are three widely held misconceptions regarding the TSP. Perhaps the most widely held misconception about the TSP is that one will face a 10% early withdrawal penalty on anything they take out of the TSP before they reach the age of 59 ½. This is not true in almost all situations. If you are a regular employee that separates and withdraws money from the TSP in the year in which you reach the age of 55 (or later) there is no early withdrawal penalty. If you are a special category employee e.g., law enforcement officer, firefighter, air traffic controller, etc.), the age is 50. It’s Individual Retirement Arrangements (IRAs) that assess early withdrawal penalties for money taken out before age 59 ½. The TSP (and other employer sponsored plans) do not.
The situation where the TSP will impose an early withdrawal penalty is if an employee separates before the year in which they reach the age of 55 (50 if a special category employee). However, even that penalty can be avoided if the employee follows a life expectancy based withdrawal methodology for the longer of 5 years or until they reach 59 ½.
Another misconception is that those who participate in both the Traditional and Roth TSPs have two separate TSP accounts. Not so; they have two separate balances within their one TSP account. This creates a problem because, if one has both pre-tax (i.e., Traditional) and post-tax (i.e., Roth) money in the same account, withdrawals will be made proportionally unless specified otherwise. This is important for younger retirees because Roth withdrawals are not tax free unless your withdrawal is qualified. In order for a withdrawal to be considered qualified, you must be at least 59 ½ and you must have had a Roth TSP for at least five years. If you don’t meet those requirements, you will be liable for federal income tax on the portion of your Roth withdrawal that is attributable to earnings.
Many feds believe that they are not allowed to contribute to an IRA if they are fully funding the TSP; nothing could be further from the truth. Though the TSP and IRAs are related (they are both devices with which you save for retirement), they are different, as one is an individual plan and the other is an employer sponsored plan. If you haven’t been contributing to an IRA because you have been fully funding the TSP, you have been missing out on an opportunity to set aside another $6,000 ($7,000 in the year you turn 50 and later). Though there are income based restrictions on deducting your contributions to a Traditional IRA and on contributing at all to a Roth IRA, anyone (even Jeff Bezos and Elon Musk) can fund a Traditional Non-Deductible IRA.
With these misconceptions, what you don’t know can hurt you. If you read each edition of FEDweek’s TSP Investor’s Report, you will be kept up-to-date on the rules relating to the Thrift Savings Plan and be better able to take advantage of all it has to order.