Upon leaving or retiring from federal service, Thrift Savings Plan (TSP) participants can request installment payments from their traditional TSP account. The TSP participant has the option to choose a fixed-dollar payment with a minimum payment of $25, or to have the TSP calculate a monthly payment based on life expectancy.
Installment payments based on life expectancy and fixed-dollar payments expected to last 10 years or more fall into one category, while fixed-dollar payments expected to last less than ten years fall into another tax category. The TSP determines the expected duration of a TSP participant’s duration of installment payments using the TSP participant’s account balance, the payment amount the TSP participant chooses, and an assumed earnings rate.
SEE ALSO: Understanding TSP Withdrawals: Installment Payments
Note that it is assumed throughout this column that a TSP participant is requesting installment payments from the participant’s traditional TSP account only, and nothing from the participant’s Roth TSP account.
Installment Payments to Last 10 Years or More, or Based on Life Expectancy
TSP participants should note the following about this type of installment payment:
1. The IRS categorizes these payments as periodic payments.
2. All installment payments based on life expectancy are included in this category, regardless of the TSP participant’s age.
3. The TSP participant is not allowed to rollover any part of these payments to a traditional IRA or to an eligible retirement plan.
4. The TSP is required to withhold federal income taxes from any traditional TSP payment amount as if the TSP participant is single with zero exemptions unless the TSP participant elects a different option for federal income tax withholding. This means a different percentage would be withheld or that no federal income taxes would be withheld, and
5. Any installment payment of this type, and any portion of such installment that goes toward satisfying a TSP required minimum distribution (RMD) is subject to the rules described here. This is an exception to the usual RMD withholding rules.
Installment Payments to Last Less Than 10 Years
TSP participants should note the following about this type of installment payment:
1. The IRS categorizes these as eligible rollover distributions.
2. A TSP participant is allowed to rollover all or part of these installment payments to a traditional IRA or to an eligible employer-sponsored retirement plan. The TSP is not required to withhold federal income taxes from money that the TSP participant requests to be directly rolled over to a traditional IRA or to an eligible employer-sponsored retirement plan.
3. The TSP is required to withhold at least 20 percent of any taxable portion of an installment payment that is not directly rolled over to a traditional IRA or to a traditional qualified retirement plan. In case a TSP participant requests a rollover of a portion of his or her traditional TSP, then the participant has 60 days after receiving payment to implement the rollover. However, the participant must use other funds to make up the 20 percent of federal income taxes withheld.
4. A TSP participant can instruct the TSP to withhold a percentage that is greater than 20 percent but the participant cannot request a percentage less than 20 percent, and
5. Any type of installment payment, fixed or based on life expectancy, that goes toward satisfying a required minimum distribution (RMD) is subject to a different set of tax rules, namely: (1) The IRS categorizes these payments as non-periodic payments; (2) A TSP participant is not allowed to rollover an RMD to a traditional IRA or to an eligible employer-sponsored retirement plan; and (3) The TSP is required to withhold 10 percent of any distribution for federal income taxes unless the TSP traditional participant requests a different percentage between zero and 100 percent.
Life Expectancy Installment Payments and the Early Withdrawal Tax Penalty
Installments based on life expectancy are an exception to the early withdrawal penalty tax. However, the penalty can be applied retroactively if a TSP participant receiving payments based on life expectancy does any of the following within five years of beginning installment payments or before reaching age 59.5:
• Requests to stop life expectancy-based payments.
• Requests to switch life expectancy payments to fixed dollar installment payments, or
• Takes a distribution from his or her traditional TSP account in addition to the life-expectancy-based installment payments.
If any of those actions occur during the time a TSP participant is receiving life-expectancy-based payments, then the TSP participant will be liable for the 10 percent penalty tax on the installment payments previously received.
The following chart summarizes the federal tax treatment on traditional TSP payments:
Tax Treatment for Traditional TSP Participant Payments
