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Watch Out for this TSP Tax Trap

TSP Taxes

You may not be aware, but after you leave the military you’ll have the right to move your TSP funds to another retirement account (401(k), 403(b), IRA) via an indirect rollover. You can take the funds out hold them in your very own hands for up to 60 days and as long as you deposit the funds to a qualified account you don't have a tax bill. Why might you want to do that?

Don’t Try this at Home

Here is an example. You’re buying a new home and it will close before you close on the house you’re currently living in and selling. You decide to take the funds out of TSP to make the down payment on the new house and when the old house closes, within the 60-day limit, you redeposit the funds into an IRA (what could go wrong with that scenario?). Completely oblivious to Murphy you go ahead with this plan.

Things Don’t Work Out Exactly Like You Plan

You complete the paperwork to get the $100,000 balance in your TSP. Much to your surprise, you only get $80,000 in cash. Confused, you call the TSP help line and they inform you that they are required to withhold 20% in taxes in case you don’t roll the funds over. Fortunately, you only really need $80,000 and the house transactions go through. You deposit the $80,000 before the 60-day deadline.

The Surprises Aren’t Over

You file your taxes the next year and instead of getting your $20,000 back you only get $13,600. You call the IRS hotline and they explain to you that the $20,000 that was held was a distribution and that they just “held it for you”. Therefore, you had a $20,000 distribution subject to 22% tax (assumed marginal tax rate) plus a 10% penalty. To avoid this scenario, you would have needed to find an additional $20,000 and deposit it to the retirement account for a total of $100,000.

If you do a direct rollover, where the funds go directly from TSP to your retirement account custodian, you don't have to worry about this. That might be a good idea.

Post Military Finances are Complicated

Just like Servicemembers aren’t like civilians. Military retirees and Veterans are different too. So are your finances and taxes. We think you should work with someone who deals with your issues each and every day. If you’d like to chat about how we can help, give us a call.


If you found this article useful, you might like the following blog posts:

I'm About to Retire From the Military. What Should I Do With My TSP?


It's Here! New TSP Withdrawal Options Available


What Military Officers Need to Know About TSP and Estate Planning




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