Ben Raikes, CFP®, EA, of Mason & Associates discusses the various methods in which funds can be distributed from the Thrift Savings Plan and the tax consequences of each distribution type.

ℹ️ About the Episode:
• There are three primary distribution methods from TSP:
• Traditional TSP distributions are fully taxable at ordinary income rates.
• Qualified Roth TSP distributions are tax-free.
• Qualified rollover distributions to an IRA or Employer Retirement Plan are tax-free.
• Work with a financial advisor to lessen the tax burden of these distributions!

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TSP Distributions Demystified – Know the Tax Consequences Today!

The Thrift Savings Plan (TSP) is a retirement savings program for federal employees and members of the uniformed services. It offers the opportunity to save for retirement on a tax-deferred basis, meaning that contributions are made with pre-tax dollars and investment earnings are not taxed until they are withdrawn. However, when it comes time to make withdrawals from the TSP, it’s important to understand the tax consequences.

One of the key decisions that TSP participants face is how to take distributions from their accounts. There are several options available, each with its own tax implications. It’s important for TSP participants to fully understand these consequences in order to make informed decisions about their retirement income.

The first option for TSP distributions is a single lump-sum payment. This option allows participants to take their entire TSP account balance as a single payment. However, this can result in a significant tax bill, as the entire amount of the distribution is included in the participant’s taxable income for the year in which it is received. This could potentially push the participant into a higher tax bracket, resulting in a higher overall tax liability.

Another option for TSP distributions is monthly payments. Participants can choose to receive monthly payments from their TSP account, either for a set period of time or for the rest of their lives. These payments can be structured in a way that minimizes the tax impact, as only the amount received each year is included in the participant’s taxable income. This can help to spread out the tax liability over time, potentially reducing the overall tax burden.

Participants also have the option of purchasing a TSP annuity, which provides a guaranteed stream of income for a set period of time or for the rest of the participant’s life. Annuity payments are also included in the participant’s taxable income, but may be offset by a portion of the payment representing the return of the participant’s original contributions to the TSP. This can result in a lower tax liability compared to other distribution options.

To further complicate matters, TSP distributions can also have different tax treatment depending on the type of money in the account. TSP accounts contain both traditional contributions, which are made with pre-tax dollars, and Roth contributions, which are made with after-tax dollars. The tax treatment of distributions from these two types of contributions can be different, so it’s important for participants to understand how the tax rules apply to their specific situation.

In conclusion, TSP distributions can have significant tax consequences, and it’s important for participants to fully understand these implications before making any decisions. Consulting with a tax professional or financial advisor can be helpful in navigating the complex tax rules surrounding TSP distributions. By being informed and making strategic choices, TSP participants can minimize their tax liability and make the most of their retirement savings.