Last week, we talked about income taxes in retirement. Unfortunately, some things never change! So you most likely still pay some taxes after you retire, although your tax bracket and/or the amount you pay might change somewhat.
We already focused on how your pension is likely to be taxed, so this week we’re shifting gears to discuss taxes on your Thrift Savings Plan (TSP). Years ago, when you first began your employment with the federal government, you were offered a choice regarding your TSP contributions. Now that choice will affect the income taxes you pay (or don’t pay) in retirement.
If you chose the Traditional contribution option… You made contributions to your TSP on a before-tax basis. Throughout your career, this option allowed you to lower your overall taxable income each year, while also preparing for retirement. Those contributions also grew free of taxes for many years.
Now, when you retire, your TSP withdrawals will be taxable as regular income according to your tax bracket each year.
If you chose the Roth contribution option… You made contributions on an after-tax basis. These contributions don’t help to lower your taxable income each year, so you didn’t enjoy that benefit throughout the decades, but once you reach retirement you will enjoy withdrawals that are non-taxable. That’s because you already paid taxes on that money throughout your career.
Do remember that this rule only applies to “qualified” withdrawals. Qualified withdrawals are those made after age 59 ½, on money that has been in the account for at least five years.
The point we’re making is that taxes on this part of your retirement benefits will depend upon decisions you already made, years ago. Before you retire, let’s meet up and evaluate your potential income tax situation in retirement, so that you know what to expect. We can help you establish a budget, avoid any surprises, and keep you updated on any other rules or opportunities that might affect your benefits or income taxes in retirement.
