A Guide To Taxes In Retirement (Annuity, Supplement, TSP)
Two things up front:
You REALLY should get a CPA the first year in retirement. Taxes are tricky and you don’t want to be one of the people that call me at tax time, wondering why they owe $10k. “I mean, doesn’t OPM know how much to withhold, Chris???”
None of this is tax advice. At all. This is education so that you can have a more intelligent conversation with your CPA. And depending on when you read this, the laws could have changed.
Also, a third thing: Fair warning. This article is going to be longer than a CVS receipt. But it’s what you guys wanted to know. So here goes.
As I have said before, “simple” and “tax code” don’t go together. But I’ll do my best to break this down into simplified sections and the various taxes you’ll have to pay on your multiple sources of income when you retire from Uncle Sam’s Cubicle Army.
We’ll break it down into the following sections:
How Annuity and Supplement are taxed (And the withholdings)
How TSP is taxed (And the withholdings)
What you do at tax time, and
How taxes work, in general, in the United States, to give you a better understanding
ANNUITY AND SUPPLEMENT
FERS ANNUITY — FEDERAL TAXES
The monthly annuity is the permanent part of your check. You’ll get this for the rest of your life. (Assuming the government continues to pay its debts.) This is not conditional like the Supplement—you can’t lose the annuity. In fact it goes up each January, in the form of a Cost of Living Adjustment (COLA), which is tied to inflation. SCE’s will be eligible for COLA’s immediately upon retirement at any age, Regular FERS have to be 62 to be eligible for a COLA, though.
You actually paid for part of your annuity. Yes, that comes as a shock to some people, I realize. But the annuity isn’t free. Depending upon when you were hired and whether you’re an SCE or a Regular FERS, you paid .8%, 1.3%, 3.1%, 3.6%, 4.4% or 4.9% every pay period toward your pension. This was paid with after-tax dollars. Meaning, you got your net income each pay period, and then they took out your annuity cost.
Why is this important? Because you’ve already paid taxes on part of your annuity—the money you paid into it. Which means when you start to get a check in retirement, some of the money you get each month is really just your own money coming back to you. You’re being “repaid” in essence. So you don’t have to pay taxes on money you already paid taxes on. The end result is that part of your FERS annuity check is tax-free since it’s really just a repayment of your own money back to you.
How much? Depends. But for most of you, you won’t have to worry about it. When you receive your 1099-R from OPM in January, it will show the previous year’s taxable amount and non-taxable amount. Or at least it should. If it doesn’t, I’ll show you how to deal with it in a second.
Don’t expect a huge tax break on this income though. I received around $75k last year from OPM. About $74k of it was taxable. Not much of a break at all. To some people it might not even be worth learning about this nontaxable portion. But we are trying to be as precise as possible so it’s best to explain everything.
What if the 1099-R doesn’t split the two out?
Sometimes the 1099-R from OPM will not specifically note how much is nontaxable. Then you’ll have to figure it up yourself. Or rather, your CPA will. Right? Right? Fortunately for us, the IRS publishes a guide specifically for federal employees to help them with their benefits. IRS Publication 721 explains how to figure the nontaxable portion of your FERS annuity.
FERS ANNUITY PSO DEDUCTION
If you are a retired Public Safety Officer, or if your spouse is a retired Public Safety Officer, you will want to make a note of this section. What is a PSO? It’s a state, local, or federal: police, fire or medic. So you federal agents out there. Or you federal firefighters. If you are a retired PSO, you can actually reduce your taxable income that you report on your federal tax return by $3,000 a year. ($6,000 a year if you are both PSOs). Why? Because PSO’s can deduct this amount to help offset their FEHB (healthcare) premiums.
This is not as widely known as it should be. And many retirees are paying more taxes than they should. Please share this with others you know qualify.
Here is an article that explains it in great detail. Send it to your CPA.
FERS ANNUITY - STATE TAXES
Some states don’t have any state income tax: Florida, Texas, Tennessee, South Dakota, Nevada, and others. Some states have state income tax but do not tax federal pensions: New York, Pennsylvania, Illinois, and others. Some tax your pension partly. Some tax your pension initially, but then give you a break when you reach a certain age. Some don’t tax your pension if you are retired law enforcement. And some states tax your pension completely no matter who you are. (Come on, Indiana!).
It is absolutely impossible for me to keep up with the laws in every state. Impossible. They are constantly changing, and they have qualifiers for different ages and categories. Again, this is why the CPA is so handy. They will make sure that you aren’t paying any more than you should.
People often ask me which state is best for retirement. They generally mean from a tax standpoint. This is also a terribly difficult question to answer. I mean, seriously, if Florida is the best for taxes, but you’d hate living there, is it still the best place to retire?
Realize most states are going to get you one way or the other. Texans have no state income tax, but they always complain to me about the high property tax. Homeowner insurance in Florida has become almost like a separate tax as the premiums have skyrocketed. New York and Illinois are traditionally high tax states, but they don’t tax federal pensions, so is that good enough? South Dakota has no state income tax whatsoever, but that might not make up for January and February’s weather. The same for Nevada, but you may not exactly embrace the local climate in July.
In other words, there is no perfect spot to retire to. Move where you love. No sense being miserable just to save $3k a year in taxes. All states have to be funded. You’re paying one way or the other.
RETIREE ANNUITY SUPPLMENT (RAS) — FEDERAL TAXES
Please, please, PLEASE stop calling this the Social Security Supplement. That is not the name of it. Nowhere in any FERS literature is it called this. It is paid by OPM, not the Social Security Administration. It in NO WAY affects your future Social Security payments. Why am I so picky about this distinction? One word: confusion. Because as soon as you start associating the RAS with SSA, then you start thinking it operates like SSA benefits. Meaning you think it is taxed like SSA benefits, which are partly tax-free. It is NOT. It is FULLY TAXABLE. There is no tax break whatsoever at the federal level for your RAS. It is 100% taxable. There is no part of it that is not taxable. All of it is taxed. As ordinary income. No break whatsoever. Not like the FERS annuity, where part of it is your money coming back to you. That doesn’t apply here. No break whatsoever.
If I didn’t mention it earlier, it is 100% fully taxable at the federal level. 100%.
Clear enough? You’ll see articles online explaining precisely how it is taxed like SSA and how part of it is tax free. These articles are precisely incorrect. Oh, and 100% of it is taxable as ordinary income.
To reiterate, it is 100% taxable as ordinary income.
In summary, 100% of it is taxable as ordinary income.
Seriously.
RETIREE ANNUITY SUPPLEMENT (RAS) — STATE TAXES
The RAS is considered part of your pension, aka your retirement, so the states will treat this part of your check as they do the FERS annuity. Meaning you pay no taxes on it in NY, IL, PA, and other places that do not tax your pension. Or, of course, that do not have state income tax.
ANNUITY/SUPPLEMENT WITHHOLDINGS — FEDERAL TAXES
Withholdings are those taxes that are taken out each time you get a check. You have that now while you’re working. You’ll have them in retirement as well. For example, let’s say your monthly check from OPM is $4,000. Perhaps $800 will be withheld by OPM and sent to the IRS on your behalf. That is the withholding. You’ve experienced this your entire life. This should not be new. Your employers have been withholding taxes from your check since you were flipping burgers at the Golden Arches 40 years ago, saving up money for those Jordache jeans, and Saturdays at the arcade.
How does OPM come up with this withholding amount? And why do some people have $100 coming out for taxes, while another person has $1,500 coming out for taxes? Simple. The dreaded W-4P form. As part of your retirement process, on the retirement application (SF 3107), it will ask you if you want federal taxes withheld. Most people would want this. Well, actually no one wants taxes to come out. So maybe that’s a bad choice of words. But most people choose this rather than owing thousands at tax time. Maybe that’s worded better. Anyway, most people fill out a new W-4P form that helps OPM determine the amount of money they should withhold for federal taxes.
All of us are familiar with the federal tax withholdings system of the last few decades. You know—you pick Married with 2. Or Single with 2. Or Married w/3, etc. We are all used to that. What most of us don’t know though, is that that system no longer exists. That went away a few years ago. The new W-4 forms don’t allow you to choose that. You have to do them completely different. And it is FAR more confusing, judging by the number of calls I get on the W-4P. I get more questions on this than anything else. Hence the article I wrote on the subject. Please see that.
The bottom line is this. DO NOT….UNDER ANY CIRCUMSTANCE….Assume that the amount of money OPM is withholding for your federal taxes is correct. Please do not do this. This is risky. You may be like one of those people who end up calling me, shocked and angry that they owe $10k this year in taxes. Fill that form out the best you can. But, here is the best practice: Midway through your first year of retirement, sit down with your CPA. Show him your retirement check, and how much money is being withheld for taxes.
The CPA will be able to calculate if you are on track to owe a lot more (in which case you can up your withholdings for the remainder of the year), or if you’re planning on getting a lot of money back. In which case, you could reduce your withholdings if you wanted to. The CPA may need to see all of your income for the year—like if you or your spouse are working other jobs—-but they should be able to give you a projection that will be fairly accurate. And will prevent any serious shock come next April.
Refuse to verify that OPM is taking out the appropriate amount of taxes, and you might not be happy with what your tax return bottom line is.
ANNUITY/SUPPLEMENT WITHHOLDINGS — STATE TAXES
If you live in a state where your annuity and supplement are taxed, you’ll have to make arrangements for withholdings on your monthly check. OPM will withhold state income tax, but it works totally differently. First of all, there is no state form that OPM will accept. IN ANY STATE. If you try to send in say, the Virginia equivalent of a W-4P, OPM won’t even look at it.
OPM will withhold Virginia tax (or any other state you want), but you have to tell OPM exactly the dollar amount you want withheld. For example, I retired in Indiana. I told OPM I want them to withhold $400 for Indiana state income tax. I did this on my self-service opm.gov account. They withhold $400 and send it to Indiana Department of Revenue every month for me. You’ll have to do the same.
“But, Chris, how do I know what amount to tell them? Should I do $100, $250, $400, or what?” It’s a tough question, isn’t it? If you haven’t discovered yet, taxes in retirement are more complicated than when you’re working. There is more of a responsibility on you to figure them out. You know how you figure this amount out? You dump the problem on your handy dandy CPA. Let him run his numbers and give you the amount. Then you provide that amount to OPM. And midway through the year, you two revisit the amount and make sure it’s tracking to be an outcome you are happy with.
LIVING OVERSEAS
Sometimes people retire and move overseas. It’s pretty common, actually. You will REALLY want to get a CPA that has experience in this. There may be some countries that work with the US tax system to give you credit in the country you’re in. But the bottom line is your retirement check is from the U.S. and you will have to pay federal tax on it to the U.S. Moving to Belize or Portugal doesn’t mean that your annuity is no longer taxed by the U.S.
You may or may not owe state taxes, depending upon if you have a residence there. That gets complicated. Please check with your internationally competent CPA.
DISABILITY RETIREMENT
If you retire on a disability and you are receiving a disability retirement benefit, that is NOT tax free. I think a lot of people believe this. That is not the case. It is an annuity, and taxable until the person reaches MRA. This is directly from OPM:
”If you retired under a disability provision, then the disability annuity you receive from CSRS or FERS is taxable as wages until you reach minimum retirement age.”
THRIFT SAVINGS PLAN
TRADITIONAL THRIFT SAVINGS PLAN - FEDERAL TAXES
Each of you have a traditional TSP, even if you put 100% of your contributions in the Roth. Because (at least for now) all matching from the government goes into the traditional side.
Remember that the money you have contributed to the traditional TSP and the matching has NEVER been taxed before. It was contributed with pre-tax dollars. So therefore, all of it is subject to federal income tax when you withdraw it. Withdraw $50,000 from your TSP and that is $50,000 of taxable income.
What rate is it taxed at?
Whatever income tax bracket that income puts you in.
For example, let’s say you are in the 24% tax bracket and you withdraw $10,000 of traditional TSP. That will be taxed at the federal level at 24%. Or in this case, $2,400 in federal tax ($10,000 x 24%). Let’s say you are $8,000 from going into the 32% tax bracket. Then the first $8,000 will be taxed at 24% and the remaining $2,000 will be taxed at 32%. Meaning a total tax liability of $2,560. ($8,000 x 24% and $2,000 x 32%).
(If you have no idea how tax brackets work, it might be wise at this time to pause and look at the end of this article to see how taxes work in this country.)
As you can see from this simple example, the more you withdraw from your TSP, the more taxes you owe. This is why you probably don’t want to withdraw $400,000 in one year to pay off your mortgage. That will jump you up at least a couple of tax brackets and now you are paying taxes on the withdrawal at a higher rate. Maybe 35% instead of 22%, as an example.
TSP WITHHOLDING —FEDERAL TAXES
For most traditional TSP withdrawals, they will withhold 20% automatically for taxes. For example, request $10,000 traditional TSP withdrawal and you will receive $8,000. The other $2,000 will be withheld by TSP.
TSP takes that money and sends it into the IRS on your behalf. That MAY be enough. Or it MAY NOT be enough. If you are in the 24% bracket and they withhold 20%, then they didn’t withhold enough. Come tax time, you’ll owe an additional 4% on that withdrawal. If you are in the 12% bracket and they withheld 20%, then they withheld too much and you’ll get a refund when you do your taxes. This works similar to your paycheck now. So this should not be a difficult concept to understand. Have too much taken out for taxes and you get a refund. Have too little taken out and you owe. The same works with your traditional TSP withdrawals as well.
You do have the ability to alter the TSP withholdings. For example, if you know that you are in the 24% bracket in retirement, you can have TSP withhold extra money so that you don’t owe in April. In some cases you can have them withhold less. See the TSP booklet (TSPBK26 1/2024) HERE about taxes on withdrawals.
TSP WITHHOLDING — STATE TAXES
This is easy. TSP will NEVER….EVER….EVER….withhold state income taxes. If you live in a state that will tax your TSP, you need to make your own arrangements for setting that money aside. But first you need to know if your state taxes TSP withdrawals. Obviously if there is no state income tax where you live (FL, TX, TN) then you will not owe state income tax on your TSP withdrawal. Some states that have income tax will sometimes consider your TSP to be part of your pension and therefore not subject to state income tax. New York is one example of this. NY does not tax your TSP withdrawals.
So you need to do your homework. Again, this is something your CPA can assist you with. No sense going this alone. If you do live somewhere that taxes your traditional TSP, then you’ll need to set some money aside and send in quarterly payments to the state. That might be best. Or you can just pay it all at the end of the year when you file your taxes. Be careful with this approach though. In some places, there is a penalty if you owe too much at the end of the year. So you might not want to do this. Your CPA can help you with this problem.
TRADITIONAL THRIFT SAVINGS PLAN EARLY WITHDRAWAL PENALTY—10% EXTRA TAX
Many of you are aware of this concept but let’s explain it so we are all on the same page. Generally speaking, for most retirement accounts (IRA’s, 401k’s, TSP, etc.), a person has to have reached 59 1/2 years of age in order to make withdrawals from their retirement account. If they are younger than that at the time of withdrawal, there is a 10% additional tax levied on the withdrawal. For example, withdraw $5,000 and you’ll have to pay an additional $500 in the early withdrawal penalty in addition to any other taxes you have to pay.
However…
The TSP has a couple of exceptions for employees. Again, we are breaking it down between Special Category Employees and Regular Employees. SCE’s have to work at least one day in the year they turn 50, or they have to have 25 years in the plan before they separate. In other words, if an SCE retires on a regular retirement, they are eligible to make TSP withdrawals without the extra 10% penalty. The 25 year rule is new. Everyone used to have to work until they turned 50. Now, SCE’s can retire at say, 48 and make penalty-free withdrawals as long as they did 25 years in the plan.
Regular FERS have to work at least one day in the year they turn 55. Since their MRA is AT LEAST 55, if they retire on a regular retirement, they will be eligible to make withdrawals without the 10% penalty either.
So, meet your retirement eligibility threshold and you won’t have to pay the 10% additional tax. If you don’t meet your threshold listed here, then you’ll owe an additional 10% tax for any withdrawals taken prior to 59 1/2. (There is a way around this, but it is complicated and you 100% NEED to hire a CPA to take advantage of the 72t loopholes. Beyond the scope of this article.)
ROTH THRIFT SAVINGS PLAN — FEDERAL TAXES
Many of you have Roth TSPs now. They are funded with after tax money. You do not get a tax break when you contribute to your Roth TSP. The benefit comes years later when you make your withdrawals. Assuming you meet the criteria, you do not have to pay any taxes on the withdrawal. This includes both your contributions and the earnings on those contributions. Pull out $1m from your Roth TSP and you don’t owe a single dime in federal tax. $0. Unlike the traditional TSP, where you would be in the highest tax bracket (37%) and owe a LOT of federal tax. That is the benefit of the Roth TSP.
So what are the criteria?
You have to be 59 1/2. Yes. 59 1/2. There is no special exception like we talked about under the Early Withdrawal Tax above. SCE’s and Regular employees both have to be 59 1/2 in order for the entire withdrawal to be tax free. Make a withdrawal from your Roth TSP prior to 59 1/2 and some of it will be subject to federal income tax. So, you have to be 59 1/2….AND….
You have to have the Roth TSP opened (funded) for at least 5 years. If you started a Roth TSP at 57, retired at 60, then you are still not eligible to make a completely tax-free withdrawal from your Roth TSP, even though you are older than 59 1/2. Because you have to satisfy both prongs of this test. Be 59 1/2 and have your Roth TSP for at least 5 years.
This comes as a surprise to a lot of people.
The financial press does a fantastic job of making you think you’re an idiot if you don’t do a Roth. That is not necessarily correct. If you are late in your career and at a higher income tax bracket currently than you will be in retirement, the Roth TSP is not necessarily the most attractive option. Given just this little bit of information, the traditional TSP is probably the better choice. But a person has to analyze their entire financial situation to determine which is best. What is certainly true is the following statement: The Roth is not the best option 100% of the time. So if you are coming to the end of your career and don’t have a Roth TSP, don’t stress. It might be something to look at, but you might find there’s no good reason for you to get one at this point.
ROTH THRIFT SAVINGS PLAN — STATE TAXES
Most states do not fully tax Roth withdrawals. However, some preliminary research shows that some states may tax Roth withdrawals at the state level? Arkansas, Alabama, California (of course, California has to be California-ing!) and maybe a few more seem to tax Roth withdrawals? Again, I cannot keep up with all 50 states’ rules, nor do I even try to. But that would certainly be something to consider when pondering Roth TSP contributions and future withdrawals. If you know if your state taxes Roth withdrawals, let everyone know in the comments below.
TSP ROLLOVERS
A rollover is when you transfer (careful—this is different than a withdrawal. A withdrawal, the money comes to you) money from one retirement account to another retirement account. For example, you retire and transfer $500,000 from your TSP to your broker to manage over at Charles Schwab.
Rollovers are non-taxable events, assuming they are done directly—directly from the TSP, directly to Schwab. Like, you aren’t involved in it. The money doesn’t come to you first and then you turn around and send it to Schwab. As long as you transfer it directly from one retirement custodian (TSP) to another retirement custodian (Schwab), that transaction is not taxable. When you finally withdraw that money from Schwab, it may be taxable if it was the traditional TSP, and you may even owe a 10% penalty if you withdraw it from your Schwab IRA before 59 1/2, but the actual movement of money from TSP to Schwab is not taxable.
Whether or not you should transfer money and those questions are for another article, but for taxes, the direct transfer is not a taxable event. I’m sure you will consult with your financial planner if you are considering a rollover.
ROTH CONVERSIONS
This is when you take some money that is in a traditional retirement account (like the TSP or an IRA or whatever) and you transfer it to a Roth account. When someone does this, they owe taxes on the conversion. It is considered a taxable event. It is very much like a withdrawal. Remember Roth accounts are after tax accounts. So you are, in effect, converting pre-tax money to after-tax money. The only way to do that is to make that money after-tax, i.e., pay the taxes on it at the time of the conversion.
Here’s the thing though: The TSP does not allow you to do this. You cannot convert your traditional TSP, or any part of it, to your Roth TSP. It’s just not allowed. It is allowed in some companies’ retirement plans. It is not allowed in the TSP. So any Roth conversions you want to do, you will have to do outside of the TSP. Like transfer your traditional TSP to a traditional IRA at Fidelity, Vanguard, Raymond James, etc., and THEN do the conversion to a Roth IRA.
Should you do this? I don’t know. In some cases, they might be beneficial, depending upon what you’re trying to accomplish. In other cases, not so much. In all cases, however, I would hope you would have a financial advisor walking you through these so that you don’t make a mistake, and so that you know it’s worth paying all those taxes during that year.
As a general rule, Roth conversions are not as beneficial for federal employees as those in the private sector. And the reason is simple—the pension. In the private sector if you quit working, you don’t have any income coming in. Government retirees will always have AT LEAST their annuity coming in. We can never get our incomes down to zero (and that’s a good thing!). Private sector retirees can get their incomes down to zero. So they can do Roth conversions at little to no tax consequences in many cases. Because they are in the lowest income tax bracket. Not so with the federal employees. Some retired Fersonians are in the 22% bracket just from their pensions alone! So Roth conversions START at 22% and move up from there. That’s starting to get pretty pricey.
But, your CPA and your financial planner can help you decide if it’s best for you.
TAX TIME
WHAT EXACLTLY HAPPENS AT TAX TIME EACH YEAR?
Annuity/Supplement Documentation
OPM will send each retiree a 1099-R. This should come in the mail. But it is also available for download from your OPM self-service account once OPM has uploaded it. Generally January or February. This 1099-R will have your income that you received as part of your annuity and supplement (assuming you are getting the supplement). IT WILL NOT have any TSP withdrawals on it. It WILL NOT have your lump sum annual leave check on it either, if you retired last year. That annual leave check is included in the W-2 you will receive, reporting your earnings as an employee. Remember W-2’s are for employees. 1099’s are for non-employees. Like contractors, retirees, etc. So a W-2 for your last year of wages—including the annual leave payout—, and a 1099-R for your retirement income.
You will report this 1099-R income (minus the nontaxable part that is listed) on your 1040 tax return for the year. Pretty simple.
TSP Withdrawal Documentation
Assuming you had TSP withdrawals, TSP will also send you a 1099-R for the previous year.
So if you retired and got a pension and took TSP withdrawals, you will get two 1099-R’s. One from TSP and one from OPM.
You’ll report this amount of income on your 1040 as well. Also pretty simple.
One potential issue. In Box 7 of your 1099-R from TSP is a “Distribution Code”. This is basically a categorization of your TSP withdrawal. There are a LOT of different codes that could be listed. But if the wrong code is listed, it might indicate to the IRS that you owe a 10% penalty, even if you know for a fact you don’t owe one, because it’s not an early withdrawal. Please understand that TSP makes mistakes in this block from time to time. Rather than retype everything here, please see the other article that I wrote regarding if TSP makes a mistake on your 1099-R. There are different ways to fix it, and it’s frankly not that big of a deal. But it is something to pay attention to. You don’t ever want to pay more taxes than you are legally required to. At least, I’m assuming you don’t…
MISCELLANEOUS
HOW INCOME TAXES WORK IN THE UNITED STATES
Not sure what a “bracket” is? Not sure if it’s worth it to make more money because you’ll just have to pay more taxes? Let’s look at these things.
In the U.S., we have what is generally referred to as a progressive tax structure. Meaning, the taxes get progressively higher as you work through the brackets. In other words, the more you make, the higher percentage of taxes you owe.
Currently there are 7 income tax brackets. Doesn’t matter if you are single or married, there are still 7 tax brackets. Those brackets are the percentage of taxes you pay if you earn that amount of money. The brackets are: 10%, 12%, 22%, 24%, 32% and 37%. There is nothing currently above 37%. (At one point in this country after WWII, the highest tax bracket was in the 90% range!!!)
Here’s a pic of the 2024 tax brackets and the income that puts you into those brackets.
Some people erroneously think that if they make $150,000 and they are married that they pay 22% on everything they earn. (Look above and you’ll see that $150k puts you in the 22% range for Married). That’s not true at all. Let’s do an example to see how taxes work.
Fact #1. A married couple
Fact #2. They make $150,000 together.
This is how the taxes would be figured.
On the first $23,200 of taxable income, they would pay 10%. For a total of $2,320 ($23,200 x 10%)
From $23,201 to $94,300 of taxable income, they would pay 12%. For a total of $8,531 ($94,300 - $23,201 = $71,099 x 12% = $8,352)
From $94,301 to $150,000 of taxable income, they would pay 22%. For a total of $12,254 ($150,000-$94,301 = $55,699 x 22% = $12,254)
Add all of that up and you would get: $23,105 ($2,320 + $8,531 + $12,254). As you can see, they didn’t pay 22% on everything. They only paid 22% on the income that is in the 22% bracket.
In fact, if you do the math, and you divide $23,105 by their taxable income of $150,000, you’ll see that their effective tax rate is about 15% when you combine everything. ($23,105 divided by $150,000). So not 22%. But rather 15%.
Now, what if they took out an additional $100,000 in traditional TSP withdrawals for the year? Well, then they would have a total of $250,000 of taxable income. But the 22% bracket only goes up to $201,050. What happens then? After that, the 24% bracket starts. So if they pulled out $100k of TSP, and that brought them up to $250k of taxable income, then about $49,000 of their money would be taxed at the 24% rate. ($250,000 - $201,050). You can see why it would be painful to take out a huge chunk of TSP in one year! It makes them pay more and more taxes on the withdrawal, the more they take out. Probably better to spread the taxes out over multiple years rather than all in one year.
A few things to learn from this:
Earning more money puts you into a higher tax bracket but it doesn’t mean all of your money is taxed at the highest rate, only the portion of earnings in that particular bracket
It’s always better to earn more money. Because even though the government’s share of your earnings goes up, you ALWAYS get more than the government gets. At least as the tax brackets stand now.
Tax brackets are an important thing to know. You want to know how close you are to the next tax bracket so you know how much traditional TSP you can pull out. Or how much of a Roth conversion you can do before you hit the next bracket.
Tax brackets determine in large part if you should do the traditional TSP or the Roth TSP. If higher bracket now than in the future, you might want to go with traditional. If lower bracket now than in the future, that leans towards Roth.
This is a GREATLY simplified example of how taxes work. We left out tons of information here for time’s sake. Standard vs Itemized deductions for one. State taxes for another. But it is enough to give you a solid foundation for discussing potential tax moves with your CPA.
SUMMARY
Taxes are more complicated in retirement than while working
FERS Annuity and FERS Supplement are taxed as ordinary income at the federal level, but a tiny portion of the Annuity is tax-free
FERS Annuity and FERS Supplement MAY be taxed in your particular state—they are all different. Do your homework
Traditional TSP withdrawals are taxed at the federal level and may be taxed at the state level
Roth TSP withdrawals are not taxed at the federal level, assuming you are 59 1/2 and have held the account for 5 years
TSP withholds 20% for federal taxes (generally) and 0% for state taxes. So you will have to handle the state taxes on your own
GET A CPA WHEN YOU RETIRE!