The most popular TSP withdrawal choice is substantially equal monthly payments. (The TSP modernization act, when implemented, will allow individuals to choose from monthly, quarterly or annual payments.) You have two choices as to how to receive your monthly payments; either as a fixed dollar amount (that can be changed once per year), or based on the IRS life expectancy table. You make your withdrawal election on form TSP-70 (Request for Full Withdrawal) or on form TSP-77 (Request for Partial Withdrawal When Separated). In this article, we’ll focus on payments that are based on the IRS life expectancy table.
Those who elect payments based on the IRS life expectancy table generally do it for one of two reasons and both reasons have to do with avoiding IRS penalties. Those who separate from federal service prior to the year in which they reach the age of 55 can avoid the 10% early withdrawal penalty by following an age-based withdrawal methodology for the longer of five years or until they reach the age of 59 1/2, and the TSP’s life expectancy choice is a way to meet the requirements of the tax law.
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Those who are withdrawing from the TSP at the age of 70 ½ or older are required to withdraw certain amounts each year or face a 50% penalty for failing to take a required minimum distribution (RMD), and the TSP’s life expectancy choice meets that requirement too.
For those who elect to have their substantially equal monthly payments calculated based on the IRS life expectancy table, the TSP calculates the amount of your payments each year based on the previous year-end balance of your account and your remaining life expectancy. Once you attain the age of 70 ½ this calculation begins to follow the rules for required minimum distributions. The TSP uses only the Uniform Lifetime table to calculate life expectancy based payments.
Below we will take a look at an individual who separates from federal service at the age of 56 with a balance of $375,000 in her TSP account. We will assume that her TSP investments continue to grow at a rate of 5% per year. The TSP’s Retirement Income Calculator was used for these figures.
At age 56, monthly payments begin at $1.088.85.
By age 65 she has reached $1,613.23 per month.
At age 70, just before reaching the age for required minimum distributions it is $1,961.94 per month.
When RMDs kick in at 70 ½, the monthly amount drops to $1245.51. If you were an active 70 ½ year old, you might not like this and might choose to switch to a fixed dollar amount that more closely represents what you would like to spend. In fact, you are allowed to change the payment methodology during the annual open season which runs from October 15th through December 15th (with the changes becoming effective in your January payment). Once you switch from life expectancy based monthly payments to monthly payments of a fixed dollar amount, you will not be able to switch back. Another result we can expect from the implementation of the TSP Modernization Act will be to allow more frequent changes to your monthly (periodic) payments.
Back to our calculations – If the individual in the example above continues to take life expectancy based payments and lives to age 90 she will be receiving $2,601.72 per month and will still have over $325,000 in her TSP.
A note on taxes
You should be aware that all withdrawals from your traditional TSP are subject to federal income tax at your rate for ordinary income. All substantially equal monthly payments will have federal income taxes withheld as if you were married, filing jointly and claiming three dependents. This is a very low rate of withholding and will, almost certainly, result in not enough being withheld for federal income taxes. Someone who is electing monthly payments should choose to have extra money withheld for federal income tax in order to avoid a nasty surprise on April 15th.
Payments based on the IRS life expectancy table are not considered an eligible rollover distribution (they are called periodic payments) and cannot be rolled over into an IRA.