I will be retiring in a couple years from civil service and I'm trying to figure out the best way to use my TSP (which is the federal government's version of a 401K). My initial plan when I retire was to use my TSP to pay off our mortgage. However, I saw my financial advisor a couple weeks ago and he advised against that. He said it's better to keep my mortgage and just take monthly distributions from my TSP and use that to pay off the mortgage. He said the tax liability for taking out a large lump sum to pay off a mortgage would be very high, he said probably something like 33%. So let's say I set up a monthly distribution for the amount of my mortgage payment (+ escrow), how would the tax rate on that amount be determined? Are distributions from pensions taxed at a specific rates, or does it just become part of your annual income and the tax rate is simply based on how much I make a year? Can I have taxes withheld from my distributions when they're sent out? Another thing I don't understand about the TSP is at age 70 1/2, I have to start pulling money out. Does that still apply if I'm already taking a monthly distribution?
Pensions and taxes
- Thread starter grampi
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Withdrawing a big amount is a bad idea and puts you in a high tax bracket.
If you are taking a distribution every month then you are OK.
That 70.5 age rule is for people not touching their retirement funds and Uncle Sam wants taxes on that money before they kick the bucket. My mom has an $8000 RMD this year, she doesn't need the money but will be penalized 50% of RMD ($4000) if she doesn't have the necessary distribution.
The government wants their money.I cash my RMD minimum every year to avoid the large penalty. Ed
Your TSP distribution is taxed as regular income at whatever tax bracket (rate) you are in. If you withdraw say a lump sum of $300,000 it will kick you into the highest tax bracket and you will be taxed at that rate on the $300,000. If you take a $12,000 yearly distribution you will be taxed at a lower rate on $12,000. In addition, if you itemize your deductions, you will be able to deduct your mortgage interest expense if you do not pay off the mortgage.
The short answer, don't take a lump sum withdrawal to pay off your mortgage.
Grampi, congratulations on your retirement. 
Recent articles say people feel less stressful in retirement with a paid off mortgage. But that may be some, not all.
Hopefully your financial planner figured in your social security. For some on the edge of a SS tax bracket, earn $1 more and more of your SS will get taxed.
Make sure your TSP is in a low fee index fund. Some financial planners suggest to give the $$ to them for them to invest and collect huge fees.
Then there is what state you live in. Some states are more retirement friendly than others. NY is retirement unfriendly.
Originally Posted By: grampi
RMD?
I would land somewhere in the middle of those 2 options.
Let's say u are in a 25% tax bracket with monthly withdrawals .
I would take out a smaller lump sum each year and put towards mortgage but make sure it is small enough not to push you to the next higher bracket
But I'm curious if you plug numbers into a mortgage calculator, pay monthly mortgage payment what is the total interest paid vs taking out total lump sum ,
If interest paid is higher, why not take it all out?
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Not sure if Ohio is the same as Michigan but here the Feds require the fund to withold 20% of any distribution for taxes and the state tax witholding is optional. The amount withdrawn is tacked on to your income for that year. As an example, say you have $30,000 in income and also withdraw $12,000, your yearly income would be $42,000. Your total witholding on both sources would be reflected in your W2 as well as the 1099 you will get from the fund administrator.
Watch that RMD. I worked in local government and maxed out my 457 plan, plus IRA's--switching to a Roth IRA as soon as they were available. Also have a good pension.
Since hitting 70.5, my taxes have almost tripled since my last year of work. Had I thought it through, I probably should have taken my 457 only up to the employer match and just invested the rest-- capital gains would have been less painful, but no one wants to pay if they don't have to.
Now, my 457 has been placed in my regular IRA (far fewer hidden costs) and I have this big hunk of money which has to RMD'd (is that a verb?).. about my only course to lessen real pain in the out years is to move additional money from my regular IRA to my Roth once the RMD has been paid. Social security and Medicare have some real hard points which go up quickly once money starts becoming taxable. A couple of years ago I missed a hard AGI target by a little over $100 and it cost me ten times that much with additional Medicare and Social Security losses. People who complain about being in a higher tax bracket usually don't realize that it's only applied to money over the limit. Not so when you hit these RMD bright lines. My non-professional, non-guaranteed advice would be to switch money into a Roth as much as possible before you're 70.5. You'll pay the taxes anyway, but will get gigged less on Medicare.
OP, the answers to your questions depend on the amounts involved. I am going to assume that the financial advisor has the full picture and is competent.
Below is a tax calculator that can help you get a sense of what is going on.
Also, some institutions can withhold the income tax portion from the distributions, you will have to talk to them about your account. Otherwise, you will need to make quarterly payments to the IRS in order to avoid penalties.
https://www.taxact.com/tools/tax-bracket-calculator
Originally Posted By: Brybo86
I would land somewhere in the middle of those 2 options.
Let's say u are in a 25% tax bracket with monthly withdrawals .
I would take out a smaller lump sum each year and put towards mortgage but make sure it is small enough not to push you to the next higher bracket
But I'm curious if you plug numbers into a mortgage calculator, pay monthly mortgage payment what is the total interest paid vs taking out total lump sum ,
If interest paid is higher, why not take it all out?
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Grampi, you don't state your age. If you will be 59.5 years or older when you retire, there's no worries. Figure out your monthly withdrawal amount, and that annual total will count as regular income. At age 70.5 years, the IRS will require you to withdraw a minimum required distribution each year, as set by IRS based on life expectancy.
You must be a FERS employee. I am a CSRS/FERS retiree, having worked 21 years under CSRS and 8 years under FERS. What worked for me was doing a direct transfer from TSP to a brokerage account. That way you have more flexibility, more choices (many of them no cost) and you can use an advisor at that firm or continue to use your own.
One mistake retirees make is underestimating the cost of health care in retirement. Even with your Federal group health insurance, instead of an average COLA of 1-3%, you should figure an 8-10% annual inflation rate for health care expenses.
Good luck with your retirement.
Originally Posted By: NormanBuntz
Grampi, you don't state your age. If you will be 59.5 years or older when you retire, there's no worries. Figure out your monthly withdrawal amount, and that annual total will count as regular income. At age 70.5 years, the IRS will require you to withdraw a minimum required distribution each year, as set by IRS based on life expectancy.
You must be a FERS employee. I am a CSRS/FERS retiree, having worked 21 years under CSRS and 8 years under FERS. What worked for me was doing a direct transfer from TSP to a brokerage account. That way you have more flexibility, more choices (many of them no cost) and you can use an advisor at that firm or continue to use your own.
Good luck with your retirement.
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Congrats on retirement, you've earned it.
Big mistake your mortgage should be paid off when you retire as well as all those fancy toys!
Originally Posted By: grampi
Originally Posted By: NormanBuntz
Grampi, you don't state your age. If you will be 59.5 years or older when you retire, there's no worries. Figure out your monthly withdrawal amount, and that annual total will count as regular income. At age 70.5 years, the IRS will require you to withdraw a minimum required distribution each year, as set by IRS based on life expectancy.
You must be a FERS employee. I am a CSRS/FERS retiree, having worked 21 years under CSRS and 8 years under FERS. What worked for me was doing a direct transfer from TSP to a brokerage account. That way you have more flexibility, more choices (many of them no cost) and you can use an advisor at that firm or continue to use your own.
Good luck with your retirement.
Originally Posted By: NormanBuntz
Originally Posted By: grampi
Originally Posted By: NormanBuntz
Grampi, you don't state your age. If you will be 59.5 years or older when you retire, there's no worries. Figure out your monthly withdrawal amount, and that annual total will count as regular income. At age 70.5 years, the IRS will require you to withdraw a minimum required distribution each year, as set by IRS based on life expectancy.
You must be a FERS employee. I am a CSRS/FERS retiree, having worked 21 years under CSRS and 8 years under FERS. What worked for me was doing a direct transfer from TSP to a brokerage account. That way you have more flexibility, more choices (many of them no cost) and you can use an advisor at that firm or continue to use your own.
Good luck with your retirement.
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