The funds in a participant’s traditional Thrift Savings Plan (TSP) account are taxed as ordinary income in any year that the TSP funds are withdrawn. This is because the participant’s contributions to the traditional TSP account, automatic agency 1 percent of gross pay contribution, agency matching contributions (FERS employees) and accrued earnings in the participant’s traditional TSP account have not been previously included in the traditional TSP participant’s income. As discussed below, the way a traditional TSP participant withdraws his or her traditional TSP account balance determines when Federal and (and in states with income taxes) state income taxes are levied.
Starting in 2012, the TSP offered to Federal employees and to Uniformed Service members a Roth TSP option, in which after-taxed salary contributions are made to the Roth TSP account. This means that Roth TSP contributions are included in the employee’s income in the year the contributions are made and will not be included in income when withdrawn. Agency contributions (automatic 1 percent and matching contributions) (FERS employees only) are always deposited into a FERS employee’s traditional TSP account. This is the case even if the TSP participant contributes the maximum possible in annual elective deferrals ($18,500 during 2018) to the Roth TSP.
Qualified distributions from a Roth TSP account are not included in income. This applies to the accrued investment income (interest, dividends, capital gains) in the Roth TSP participant’s account. A qualified distribution from a Roth TSP account is defined as a distribution that is:
Example. Joan started contributing to her Roth TSP account on July 1, 2013 when she was age 56. As of Jan. 1, 2018 when Joan was age 60, she was able to request a qualified distribution from her Roth TSP account.
Those TSP account owners who have a Uniformed Services traditional TSP account that includes contributions made from combat zone pay should be aware that the distributions attributable to those contributions are tax-exempt. This is because the combat zone pay was nontaxable. Any earnings on those contributions are subject to Federal income tax, however, when they are distributed. When such an account is distributed, the statement that is sent to the combat zone participant will separately state the total amount of the distribution and the taxable portion for the year it was distributed. Since the nontaxable portion and the taxable portion of the account are separated, combat zone participants with a Uniformed Service traditional TSP account and who also have a civilian traditional TSP account are advised not to merge their civilian and Uniformed Services traditional TSP accounts. If they do, then all cash withdrawals from the merged traditional TSP account will be fully taxable.
If a traditional TSP account owner asks the TSP to directly rollover or transfer any part of his or her account to a traditional IRA or to another qualified retirement plan such as a 401(k) retirement plan, then any tax due that part of the traditional TSP account is deferred until the account owner makes withdrawals from the traditional IRA or qualified retirement plan.
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Some rules on direct rollovers and transfers:
If a traditional TSP account owner requests that any part of the account be directly transferred to a Roth IRA, then the amount transferred will be taxed in the year it is transferred. The TSP will not withhold Federal income taxes in such a transfer unless the account owner requests Federal income tax withholding.
A direct transfer of a qualified Roth TSP account to a Roth IRA is not a taxable event. The TSP will not withhold any Federal income taxes in such a direct transfer.
If a traditional TSP account owner asks the TSP to buy an annuity from Metropolitan Life Insurance Company using some or all of the account owner’s account, the annuity payments are taxed when the TSP account owner receives the monthly annuity payments. The payments are not subject to the additional 10 percent tax on early distributions even if the account owner is under age 55 when they begin. But there is no tax due at the time the TSP purchases the annuity on behalf of the traditional TSP account owner.
Any funds withdrawn from the traditional TSP account and paid directly to the account owner (or directly deposited into the account owner’s bank account) are generally taxed as ordinary income. Withdrawals include contributions, automatic one percent of salary and matching contributions (FERS employees), and accrued earnings.
Withdrawals are taxable for Federal and, in states that have state and local income taxes, for state income tax purposes. The TSP does not withhold any state and local income taxes. The traditional TSP account owner is responsible for paying state and local income taxes due on traditional TSP withdrawals.
Any money paid to a traditional TSP account owner before the owner reaches age 59.5 may be subject to an additional 10 percent tax on early distributions. But this additional tax does not apply in certain situations, including any of the following:
