In part 2 of 4 of Ed’s in-depth overview of TSP Withdrawals, he examines withdrawing options for “separated” and “Beneficiary” TSP Participants
Edward A. Zurndorfer
This is the second of four FEDZONE columns discussing the various withdrawal options available to separated Thrift Savings Plan (TSP) participants and beneficiary TSP participants. In these columns, a “separated” TSP participant refers to a civilian federal employee or a member of the uniformed services who has separated from either one of those employments. A “beneficiary” TSP participant refers to a spouse beneficiary of a deceased civilian or a deceased uniformed services TSP participant who has established a TSP account in his or her name.
This column discusses two withdrawal options, namely: (1) single withdrawals and (2) transfers to qualified retirement accounts and to IRAs.
A separated TSP participant or a beneficiary TSP participant can withdraw an amount of at least $1,000 from his or her account in a single payment. This is referred to as a single (partial) withdrawal. There is no limit on the number of single withdrawals that a separated or beneficiary TSP participant can make during his or her lifetime. However, the TSP will not process more than one single payment withdrawal request in any 30-day period. Also, single payment withdrawal requests can be requested even if the separated or beneficiary TSP participant is simultaneously receiving TSP installment payments (TSP installment payments were discussed in the previous FEDZONE column).
Which TSP Account – Traditional, Roth, or Both Accounts – Will the TSP Single Payment Come from?
Separated and beneficiary TSP participants who have money in both the traditional TSP and Roth TSP accounts have the option of specifying that a single withdrawal come solely from their traditional TSP account or come solely from their Roth TSP account. If the separated beneficiary participant does not specify which account, then the withdrawal will be made from both accounts pro-rata, meaning the single withdrawal will have the same percentage of traditional and Roth as are in their account. The following example illustrates:
Jim’s total TSP account balance is $500,000, of which $400,000 (80 percent) is in the traditional TSP and $100,000 (20 percent) is in the Roth TSP. Jim requests a partial withdrawal of $20,000. Jim does not specify whether the $20,000 withdrawal will come from his traditional TSP account or from his Roth TSP account. Jim’s TSP withdrawal will consist of $16,000 (80 percent of $20,000) of traditional TSP money and $4,000 (20 percent of $20,000) of Roth TSP money.
What Are the Tax Consequences of Single TSP Withdrawals?
Traditional TSP withdrawals are subject to federal (and state, if the separated or beneficiary TSP participant is a resident of a state with an income tax). A separated or beneficiary TSP participant can make penalty-free (no 10 percent early withdrawal penalty) if the separated or beneficiary TSP participant is age 55 or older.
Roth TSP withdrawals are federal and state income tax-free if the following conditions are met: (1) the separated or beneficiary TSP participant is over age 59.5; and (2) at the time of the withdrawal, it has been at least five years since January of the year the separated TSP participant made his or her first Roth TSP contribution. If the separated or beneficiary TSP participant withdraws from the Roth TSP before age 59.5, a 10 percent early withdrawal penalty will be imposed on the earnings portion of the Roth TSP withdrawal, in addition to the earnings portion being subject to both federal and state income taxes.
Transferring TSP Withdrawals
A separated or a beneficiary TSP participant is allowed to transfer part or all of a single withdrawal from the traditional TSP to a traditional IRA or to an eligible employer-sponsored retirement plan. An eligible sponsored retirement plan includes a traditional 401(k) plan, traditional 403(b) plan, traditional 457 plan, SEP-IRA plan, and SIMPLE IRA plan. The separated or beneficiary TSP participant should check with the IRA provider or the employer-sponsored retirement plan administration to find out whether the IRA provider or the plan administrator accepts TSP transfers.
A direct transfer (“trustee to trustee”) of a separated or a beneficiary TSP participant’s traditional TSP to a traditional IRA or to a qualified employer-sponsored retirement plan is not immediately taxable. The TSP will not withhold any federal income taxes from the participant’s requested traditional TSP account amount that is requested to be directly transferred. On the other hand, if a separated or beneficiary TSP participant requests a rollover of the participant’s traditional TSP account that is to be transferred to a traditional IRA or employer-sponsored retirement plan, then the TSP: (1) will issue a check payable to the separated or beneficiary TSP participant for the requested rollover amount; and (2) withhold 20 percent in federal income taxes from the rollover amount. Once the participant receives the rollover check, the participant has 60 days to deposit the full amount of the requested rollover amount into the TSP, including the 20 percent withheld in federal income taxes. If the full amount is not deposited within 60 days, then the rollover is considered a failed rollover, resulting in the full amount of rollover amount being subject to federal and state income taxes. The following example illustrates:
Pamela, age 63, retired from federal services on Dec. 31, 2020. On March 1, 2021, Pamela requested a $100,000 rollover of her traditional TSP account. On March 3, 2021, Pamela receives a check from the TSP made out to her for $80,000. Twenty percent of the $100,000 rollover request, or $20,000, was withheld in federal income tax. Pamela must deposit a check of $100,000 to her IRA custodian no later than May 2, 2021, 60 days from March 3, 2021. If she fails to deposit the full $100,000 by May 2, 2021, the $100,000 will be considered a TSP withdrawal, fully taxable and added to Pamela’s other taxable income for 2021. There is no 10 percent early withdrawal penalty because Pamela is over age 55.
A separated TSP participant or beneficiary TSP participant can also request a transfer of their traditional TSP account to a Roth IRA. This transfer is entirely taxable and subject to federal and state income taxes. The amount transferred is subject to federal and state income taxes in the year of transfer. However, the TSP does not withhold any federal income taxes when the TSP makes a traditional TSP to Roth IRA transfer. The participant is fully responsible for paying the federal and state income taxes due. These tax payments are usually best accomplished through federal and state estimated tax payments. A separated or beneficiary TSP participant who desires to make traditional TSP to Roth IRA transfers is strongly encouraged to work with a knowledgeable tax accountant when they transfer their traditional TSP account to a Roth IRA.
A separated TSP participant and beneficiary TSP participant is permitted to request a transfer of their Roth TSP account to a Roth IRA. This transfer is always a direct transfer, and therefore there are no tax consequences as a result of the direct transfer.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those, Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.