It’s hard to understate the importance of timing and details when it comes to retirement distributions. Tax efficient distributions can only be done if you understand details of withholding and income taxes.
This can be explained best by sharing a recent interaction I had. A soon-to-be retiree had some plans to take a large distribution from his Thrift Savings Plan. He planned to retire within a month and then move across country to relocate closer to family. His plan was to take a $100,000 distribution from his TSP for a down payment on a new home. The plan was to take this large distribution immediately and the $100,000 wasn’t a specific amount, but more of a round number that he picked.
We spent some time talking about details, discussing his goals, gathering information about income, and talking about details of how his distribution will work.
Taxable income this year and next are expected to be approximately:
- 2021 = $51,000
- 2022 = $31,000
If he were to take his planned distribution of $100,000 from TSP this year, he would pay approximately $19,000 in federal income tax ($30,000 x 12% + %70,000 x 22%). But what if he took some money out this year and some more in January?
Here is a short analysis of what we came up with.
- 2021 Distribution = $30,000
- Federal Income tax = $3,600
- 2022 Distribution = $50,000
- Federal Income tax = $6,000
If he were to take a distribution of $80,000 this year, he would pay $14,600 in 2021 federal income tax.
By simply changing when the distributions are taken, it would allow him to stay in the 12% tax bracket for married filing jointly and save $5,000.
Then you have to learn to navigate TSP distribution withholding!
If he takes the distributions from TSP, they will withhold a mandatory 20%. The Thrift Savings Plan withholds taxes differently than a typical custodian does. They will take 20% out of his distribution in 2021 and 2022. He will eventually recoup the extra 8% when he does his taxes in March 2022 for the 2021 taxes and March 2023 for the 2022 taxes. But that doesn’t help him now. He needs the funds right now and can’t afford to wait until March 2023 to recoup the additional 8%.
Transfer to an IRA
Instead of leaving his money in the TSP and taking distributions from there, he decided to move his money to an IRA where he can adjust the withholding on his distributions. The IRA custodian will allow him to withhold 12% versus the mandatory 20%.
If you keep the TSP in retirement, it is important to understand how it works. Be sure to get your questions answered before making any irreversible decisions.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.