I absolutely loved the episode on what you cannot do in the TSP. Naturally, it brought up other questions in my mind. Before I got smart in 2019 and started funneling all of my TSP contributions to Roth, I had designated contributions into Traditional TSP. What is a good strategy when I start withdrawing? Ideally, I’d like to withdraw traditional contributions first, then Roth contributions at a later time (so the Roth balance can continue to grow tax-free). But I don’t believe I will have that option when I start withdrawing. What can I do? – Charlie
Savings for retirement and spending in retirement are two separate and specific tasks. For these tasks, there are specific tools available to help you save and help you spend. There are also common tools. Let’s take a closer look at some of the tools.
Let’s start on the tool classification level, you are probably familiar with a screwdriver, wrench, and hammer. But if you have used a screwdriver, wrench, and hammer, you know there are different types of screwdrivers, wrenches and hammers and using the proper specific type will help you be more efficient and successful in your project.
The same is true for your retirement savings and retirement spending.
The two most common types of tools for Federal Employee savings and spending in retirement are the Traditional TSP and Roth TSP.
The Thrift Savings Plan (TSP) is a retirement savings program for federal employees and members of the uniformed services. It functions similarly to a 401(k), offering both traditional (pre-tax) and Roth (after-tax) contributions. While the TSP is a valuable tool for retirement savings, understanding its withdrawal rules and limitations is crucial for making informed financial decisions during retirement.
Key TSP Withdrawal Rules
1. Traditional vs. Roth TSP Withdrawals
Federal employees often contribute to both traditional and Roth accounts within the TSP. Each account type has unique tax implications:
- Traditional TSP:
- Contributions are made with pre-tax dollars.
- Withdrawals are taxed as ordinary income.
- Roth TSP:
- Contributions are made with after-tax dollars.
- Qualified withdrawals are tax-free (must be age 59½ and have held the account for at least five years).
These are fantastic retirement savings tools for Federal employees and there are specific options available for those with specific needs and goals.
For retirement spending (withdrawals), participants can choose whether to withdraw from their traditional or Roth accounts, providing tax planning flexibility.
2. Proportional Withdrawals and Market Impact
When you are in retirement spending mode, there might be a need for other types of tools that give you specific options to overcome some of the possible shortfalls in the TSP withdrawals.
TSP withdrawals are taken proportionally from all investments within the account. This means that when you withdraw funds, the money is deducted evenly across your investment allocations.
Example:
If your TSP is invested as follows:
- 25% in the C Fund (Common Stock)
- 25% in the S Fund (Small Cap Stock)
- 25% in the I Fund (International Stock)
- 25% in the G Fund (Government Securities)
A $1,000 withdrawal would result in $250 being sold from each fund. This proportional approach can lead to selling investments during market downturns, potentially reducing long-term growth.
3. Using an IRA for More Flexibility
One of the options available for greater control over withdrawals (retirement spending), participants may transfer their TSP funds into an Individual Retirement Account (IRA).
Benefits of this strategy:
- Ability to select specific investments to sell.
- Adjust investment strategies based on market conditions.
- Continue tax-free growth in a Roth IRA.
It’s important to complete this transfer as a direct rollover to avoid tax penalties.
4. Planning Your Withdrawals
When deciding how to withdraw from your TSP, consider the following factors:
- Taxes:
- Traditional TSP withdrawals are taxable.
- Qualified Roth TSP withdrawals are tax-free.
- Market Conditions:
- Avoid withdrawing during market downturns to preserve account value.
- Other Income Sources:
- Consider how Social Security benefits, pensions, and other savings fit into your overall strategy.
Speaking with a financial advisor can help create a withdrawal plan tailored to your retirement goals.
Conclusion
The Thrift Savings Plan (TSP) is a powerful tool for building retirement savings, but understanding its withdrawal rules is key to being more efficient when you are in retirement spending mode. By knowing how withdrawals work and exploring options like IRAs for added flexibility, federal employees can develop a strategy that aligns with their financial goals.
ABOUT THE AUTHOR
Micah Shilanski, CFP®, is a distinguished financial planner known for his deep commitment to providing exceptional advisory services to his clients. As the founder of Plan Your Federal Retirement, Micah has dedicated his career to helping federal employees understand and optimize their benefits to ensure a secure and prosperous retirement. His expertise is widely recognized in the industry, making him a sought-after speaker and educator on financial planning and retirement strategies.
Micah’s approach is client-centered, focusing on creating personalized strategies that address each individual’s unique needs. His work emphasizes the importance of comprehensive planning, incorporating aspects of tax strategy, investment management, and risk assessment to guide clients toward achieving their financial goals.