There will come a time when the money you’ve accumulated in your TSP account will be distributed. It may come before you retire, while you are retired, when you die, or during the life of a beneficiary, but it will eventually happen. If thinking about withdrawing money from your TSP account makes you uncomfortable, it shouldn’t -not if you account for the transaction properly.
Certain things happen, financially, when money is distributed from your TSP account: First, the amount of the distribution is deducted from your account balance. Then, a federal tax deposit may, or may not, be taken from the withdrawn amount and sent to the IRS on your behalf and the remainder is sent to you, or you deposited to your bank account. And finally, an income tax liability is created that will be calculated when your complete your state and federal tax returns for the year in which the distribution is constructively received.
Take $10,000 from your account and you may wind up with $8,000 in your hands after $2,000 in federal tax withholding has been deducted. Then, maybe you’ll owe another $500 in taxes on the distribution when you file your tax returns for the year, making your net, spendable, benefit from the withdrawal $7,500.
At first glance, it looks like you’ve “lost” $2,500 to taxes. But this isn’t the case. You haven’t lost anything. You’ve simply satisfied a $2,500 tax liability that you may have overlooked. This is actually a zero-sum transaction if you’ve accounted for it properly. In other words, you’ll be in the same financial position after the withdrawal as you were before it and your net worth will be the same if you’ve recognized the proper tax liability before the distribution.
In planning for our retirement, it is critical to try to accurately predict and carry the tax liability that exists against your TSP balance. The trick is carrying the correct liability in your planning so that the plusses and minuses offset each other when your tax returns have been filed and all the dust has settled. Ignoring this liability, or underestimating it, will lead to bad decisions, at best, and financial disaster, at worst. If you’ll do this right, taking a withdrawal will be a “non-event”. You’ll move money from one account to another and satisfy a tax liability in the process. After all, $10,000 with a $2,500 tax liability has the same spendable value as $7,500 with no tax liability.
It’s also important to recognize that moving money around within your portfolio and spending money are not the same thing. While withdrawing money from your TSP account should be a zero-sum transaction, spending the proceeds is not.
Written by Mike Miles
For the Federal Times
Publication February 13, 2019