Thrift Savings Plan (TSP) Withdrawal Strategies: Know Your Options

This blog has been updated with new information from its original version, published on August 20, 2020.

As a federal employee, you can save in a Thrift Savings Plan (TSP), the government’s version of a 401(k). For the most part, a TSP follows many of the same rules as a 401(k), up until the TSP withdrawal stage. 

The federal government automatically contributes 1% of your salary and matches up to 4% if you contribute 5%. When it comes time to create retirement income, you are offered a wide array of options. 

TSP Modernization Act

Thanks to changes made under the TSP Modernization Act, participants have more flexible withdrawal options than before. Some of the highlights include:

  • Employed participants age 59.5 or older are eligible to take four in-service withdrawals each calendar year.

  • Ability to change the payment amount as desired rather than once a year.

  • Expanded withdrawal options to include a quarterly or annual basis in addition to monthly payments.

  • Flexibility to choose withdrawals between a Roth or traditional balance, or both. 

  • Participants are no longer limited to one partial withdrawal post-separation with the second requiring a choice be made on the remaining balance (i.e., rollover or withdrawal).

Withdrawal Strategy

After leaving federal service as a TSP participant, you are presented with several withdrawal options:

  • Lump sum withdrawals

  • Installment payments 

  • Purchase of a life annuity

You can combine choices, and you will want to review each withdrawal option in conjunction with your other assets and income streams, such as a pension or Social Security.

Lump Sum Withdrawals

Lump sum distributions allow you to withdraw up to your entire TSP account balance in a single payment. This can be as a direct payment, a rollover to an IRA/Roth IRA, qualified retirement plan [e.g., 401(k)], or a combination. 

Taking funds directly gives immediate access to expenses such as paying down debt, buying a car, or purchasing a vacation home—but can lead to a hefty income tax bill. On the other hand, a rollover keeps the preferential tax status and typically offers a wider array of investment options and increased withdrawal options. 

One drawback is the inability to specify which TSP funds to withdraw from. Unlike IRAs or some 401(k)s, the TSP does not allow selective withdrawals from specific funds—withdrawals are taken proportionally from each fund in which you’re invested. Ideally, during market downturns, it’s more advantageous to lean heavier on lower-risk investments (bonds) and less on aggressive investments (equities).

Installment Payments 

This option was previously called “substantially equal payments.” It can provide automatic payments to you as the account holder. Like a lump sum withdrawal, this option can be paid directly to you or rolled over with the following stipulations: 

  • Payments can be made on a quarterly or annual basis in addition to monthly.

  • Payment amounts can be changed at any time rather than just once a calendar year.

  • Installment payments can be stopped at any time, and you can elect a life annuity with the remaining balance.

Similar to the life annuity option (below), this option provides a stream of payments in the form of a fixed dollar amount, a fixed number of payments, or a life expectancy payout. 

Depending on the withdrawal method, the amount or duration of payments may change based on account performance. Each has different tax ramifications and should be reviewed regularly. The IRS requires participants to take RMDs starting at various ages, depending on what year they were born.

Purchase of a Life Annuity

You can allocate a portion or all of your TSP proceeds toward a life annuity, which in many regards is similar to a FERS pension. The three most common options are: 

  • Single Life: This option pays the highest benefit amount but also bears the largest risk, as payments cease upon your passing.

  • 100% Survivor Benefit: This pays a benefit less than the single life option, but your designated beneficiary receives the same amount over their lifetime upon your passing.

  • 50% Survivor Benefit: The payment amount is between that of single life and 100% survivor where the designated beneficiary receives 50% over their lifetime upon your passing.

It is important to note that if you hold traditional and Roth balances, separate annuities must be purchased. The primary advantages are a lifetime guaranteed stream of income and the elimination of market volatility. However, the annuity removes the potential for market gains and access to liquidity, and may leave little to nothing to your beneficiaries. 

Creating an income-generating roadmap is a vital piece of any retirement plan, government employee or otherwise. While there are many moving pieces and unknowns of what the future holds, understanding your Thrift Savings Plan withdrawal options and the tax implications is of the utmost importance.

Discuss your situation with a fee-only financial advisor.

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