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The Thrift Savings Plan is the third-best benefit that you have as a Federal Employee under FERs. The first, is your Federal Employee Health Benefits followed by your pension when you retire.
What we love about the Thrift Savings Plan (TSP) is that it is easy to use and low cost. There are two types of accounts that you can have with the TSP office,
The contributions that you and your agency make to the Traditional TSP are tax-deferred. Meaning, those funds have never been taxed.
When you retire and make distributions from your TSP, the money that you withdrawal will be subject to US Federal Income Tax. The amount that you are taxed from your TSP withdrawals depends on your income tax rate. Remember, when you make a withdrawal from the TSP that money is added to other forms of income that you have that are subject to income tax for the current year. Other forms of income include the majority of your pension, most of social security, outside employment, etc.
Not understanding how the TSP is taxed in retirement is one of the greater challenges that Federal Employees face when cash flow planning and tax planning.
Here is an example,
You need to carefully plan your distributions from your TSP to supplement your retirement income gap so that you do not bump yourself into a greater tax bracket than you originally anticipated when planning for retirement.
The United States uses a progressive tax system. That means that the more money that you earn, the more taxes that you pay.
This is the number one reason that we discourage most of the Federal Employees that we work with NOT to take money out of their TSP in order to pay off their home. There are several reasons why paying off your mortgage by using your TSP does not make good financial sense.
In our example, we used just one person’s income. However, if you are married make sure that you account for your spouse’s income sources as well.
The Traditional TSP is subjected to Required Minimum Distributions. That means when you reach the qualifying age, you have to make withdrawals from your non-taxed accounts. A good average to assume is about 6% of your entire tax-deferred accounts. This is a mandatory requirement and the fine is pretty steep – 50% penalty for not taking the Required Minimum Distribution when you were supposed to. As an example, if you were required to take $12,000 out of your tax-deferred accounts and did not do so on time, the penalty is $6,000 PLUS you still have to take out the $12,000 – ouch!
Contributions that you made to your ROTH TSP account were taxed at the time that you made them. That allows the contributions and the earnings to grow income tax-free.
This is the power of the ROTH – pay taxes today at the rate you are already familiar with instead of later when you do not know what the tax rate will be.
However, you need to keep in mind that your agency’s contributions are always deposited into the Traditional TSP. Agencies cannot make ROTH contributions.
Keep in mind that to be tax-free you had to have had the ROTH TSP for greater than 5 years and you’re age-qualified to make a distribution.
This is one of the most important questions that we help our Federal Employee clients navigate through as they prepare for retirement.
The reasons that most people have told us that they want to use their TSP to pay off their mortgage are:
Most of the time – the math doesn’t add up. The reasons above are certainly valid but they’re emotional, not financial.
Something that we like to do with our clients is pencil out the math. We look at what withdrawing enough money from their TSP would mean in terms of tax liabilities compared to the mortgage interest on their home.
If cash flow is a concern in retirement, you need to be having these conversations with your Financial Planner now to discuss methods that can help you feel more comfortable about retirement but also not be detrimental to your long-term financial health.
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Hello, first off, I wanted to say I really enjoy your podcasts. I have really learned a lot from you both over the past year or two. I am a
“I stumbled on your podcast and the information is GOLD – thank you! I am 45 and 15 years away from retirement. This year I will maximize my TSP (1/2
Get the most out of your federal retirement benefits by taking advantage of the FERS resources created by Micah Shilanski, CFP®, and the team of independent financial advisors at Shilanski & Associates, Inc. Join the thousands of federal employees who trust us to guide them in their retirement planning journey because of our unique perspective of how your FERS benefits contribute to your comprehensive financial plan.
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