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Tax Strategies for TSP · Federal Retirement Advisors | FedLegacy

• William Smith: How many of you all ever been asked the question, how much is in your TSP? That's a question you probably get asked often if you're getting ready for retirement and you're talking to financial planners and things like that. Or you ask that question from friends and you just let you go. First thing you do, you pull up your statement and you look at the number on the screen. ⁓ dang, I'm aging myself. You don't pull up your statement anymore. You log into the app. You go into the website and you look and you look up what that number is. But here's the thing. That number might say 300,000, 400,000, whatever it is, a million, whatever your TSP balance is, 100,000. But the truth of the matter is all of that money isn't yours because what's baked into that balance is a portion that has to go to the IRS. And what better day to talk about that than April 15th? I wrote, I had to write a check to the IRS yesterday and I had been putting it off. knew I had to write it since, February. And I told my sister, I was like, we're not sending it off until the day before. And so you can't avoid it. And no matter how much money was in my account and how much money, you know, is there, knew that all of that wasn't mine because the IRS has a deadline, April 15th, that you have to send that money up to the IRS and there's nothing you can do about it. I you can, you can try to avoid it all you want to. There's consequences of that. They'll add interest to it, et cetera, et cetera, et cetera. But the thing you can do is you can absolutely reduce what you send to the IRS. I a situation with the IRS where I was, you know, just because I run a business, certain things, we get certain different deductions and things like that. And I spotted a deduction that we should have got that we didn't, and it reduced our tax bill by lot, right? And so this minor things, I couldn't avoid paying taxes, ⁓ you absolutely alter the amount of money you pay paying taxes by having a strategy that ⁓ What we're going to talk about tonight is we're going to talk about a tax strategy that we help the client work through. And this this quarter, we're going to do more workshop driven, not just all slides. We're actually going to show you strategies that work to help you save money when it comes to the TSP and your money growing into retirement, different tax strategies that are involved in that. so the person we're going to talk to today is Dr. she works for NASA out in Ohio. And so again, your taxes are an invisible liability that you just cannot avoid. So Dr. Rochelle Sample was her last name, ⁓ worked at NASA. a computer engineer. ⁓ And when she with us in December, 2024, the first thing she said, I'm afraid of taxes that will take away, take away all my money now. All of it. Big exaggeration. But that's what she said right now. Her retirement date is January next year. At the time that we talked, she had 278,544 thousand TSP and. And she had done everything right. She had paid off her house in Ohio. Her vehicles were paid off and she was just getting ready for retirement. And then we, when we did the, the, the analysis of her income or projected income and her expenses, she was positive $1,600. So she's thinking everything is great. However, she knew that the thing that she hadn't done, the one thing she hadn't done and she just didn't have the expertise in it was, okay, I have all this stuff paid off, Mr. Smith, but what I don't have is a tax strategy. So we meet with folk, what we do is we take you through our retirement readiness checklist. We talk about, how are you feeling when it comes to the longevity of your money? Her situation, she was okay because she knew her bills weren't high. We talked, the next thing we asked you about, How secure are you in the safety of the way in which your investments are invested? Me and her had some conversations about that, but she was still kind of good there. The next thing we talked about was healthcare and that she was good there because she had a long-term care policy. The next thing we talked about was taxes and that was the area that she had the most fear in, right? And so she knew that because her money was in the TSP was a hundred percent traditional TSP. She knew that as her money continued to grow, she was at some point going to have a tax situation. And so. As you know, when you retire and some people don't know this, and people ask us all the time, they're like, well, what happens to my TSP when I retire? The thing that happens to your TSP when you retire, unless you're using it for income, it's gonna keep growing. It doesn't just stop, it just keeps growing. I think, you know, that's something that you have to understand. Like sometimes me with folk and they're like, well, I wanna make sure that I have a million before I retire. Well, I wanna make sure I have at least 500,000 before I retire. I always say like, what difference is it going to make? Your money's going to continue to grow anyway. And then when they see that, they're like, oh, wow. But in Dr. Rochelle's situation, yes, her money was going to continue to grow. But at the same time, so does that tax liability. So you go from 200,000, and this is a projection of what her hers is going to look like. But if you look at 278 by Tom, she's 85. That 278 is going to be a 726,000. Now, in this, like I mentioned. baked into this is the IRS's portion, right? And so as their portion grows, they're excited about it. One of the things that happened with the Secure Act was the RMDH got pushed back. And most people think, well, great, the RMDH got put back. I got more time to pay the IRS. No, the IRS is just as happy because you know why? Because if you're 72, you have 500,000 in your TSP, but then at 74 now, mean, yeah, 74 now, 75 now. You have 600,000 in your TSP. Guess what? The IRS got more money. I was talking to a friend today and we were just talking about, you know, paying the taxes and making sure you, you know, do our tax and things like that. And he said, well, I just, I just extended it. It doesn't matter. I just deal with it in October. I'm like, man, you know, by extending your taxes, it's not that you don't not owe the money anymore. The IRS has charged you interest. And so he looked it up right there. He's like, what? They charged me interest. And so I'm like, yeah, nevermind. I used to do that all the time, not knowing. But when I showed him that, when he looked it up and saw it himself, he was like, oh, well, it's only like 3 % or 4 % or whatever the amount was that it will equal out to for him. But do you think the IRS is happy when you extend your taxes? Because it's not like they're not charging you. They just make more money at end of the day. It might seem small to you, but you're giving away money just because you want to extend your taxes. And so it's the same thing with your TSP and your RMDs. They pushed the years back. If you have a bunch of money in traditional TSP, there's more, there's more than you owe the IRS. And so it's not that the TSP it all is a bad investment. It's a great investment. But the thing you have to do is you have to have a tax strategy when it comes to your TSP. And as a federal employee, the reason why tax strategy is very, very important to you is because you're stacking three possible income streams that are all being taxed. Right? So your first pension, that's a hundred percent taxed. 100 % of your taxes. So for her, her first pension average is, mean, average, her first pension estimate is going to be 58, 51. 100 % of that is tax when she retires, 100%, right? 100%, well, not, let me not say 100 % tax. She owes taxes on 100 % of it. Whereas with the social security, you owe taxes on 85 % of it, right? That's what I mean, right? Not saying the whole thing is a tax, but it's all taxable, I should say. Whereas with social security, 85 % of that is tax. So our social security is going to be at 2351. Her TSP withdrawals, because she has 100 % in traditional TSP, 100 % of that is tax. Her tax bracket when she retires is at the 24 % tax bracket. Now, if she were to go above that, because she's a single woman, she can go into the higher tax brackets, and that's what happens over time. And so you want to make sure you have attack strategy because the more you take out, the more you owe the IRS, which they like. So. If a legacy, we always talk about the financial house, which is your foundation. Again, the most important part of your financial plan. The reason why it's the most important is because what most people do when they get into a situation in retirement, they get emotional and the way the two things that trigger emotion is not enough income, not knowing where your money's coming from in an emergency. ⁓ some type of stock crash or something like that. And you're panicking and making moves that you shouldn't make because you're not prepared for those things. And those things can be very, very costly. Right. So you want to make sure your foundation is tight, tight. You want to make sure you're getting the right amount of income to cover your bills and things like that. And if you're not going to make sure you have an income strategy that's going to continue to come in no matter what the market does. So you want to have that foundation. The next we talk about is the walls. She didn't have that set up. She didn't have a tax strategy. She didn't have an inflation strategy. And so when you don't have those things, you end up having to pay a lot more taxes down the line. The next thing we have, and the walls in our system takes care of taxes and it takes care of inflation, because inflation is another thing that can catch you off guard. If you think about it, we talk about this all the time, is that ⁓ healthcare... When we go in and we sometimes we do a retirement plan for people three, four years before they retire. So we take in their expected income, we take in their expenses and they give us the health insurance cost of their paying right at that time. We'll go in there two years later and health insurance is 200, sometimes $300 more than what it was two years prior. That becomes an issue when you retire and your cost of living is not increasing at that rate. I can't tell you how many times we talk to people and they're like, no, my income is fine. Then they retire and we're doing our annual reviews and they're like, well, Mrs. Smith, think I need another 1500. I know I said I didn't need it, but I need this extra 1500. The reason being is because inflation. So you want to make sure you have an inflation strategy. The next piece is we call the roof and that's to make sure that your money is still growing so that, and you're not just parking it in the G fund like a lot of folks do. You want to make sure that you have the right strategy when it comes to how you grow your money. You don't want to have it all in the C-fund and things like that, but you want to have some so that you're making sure that you catch the waves when the market is going up. getting back to taxes, there's a taxable account and there's a tax free account, but you got to get your money moved over. And so in her case, what the strategy that we created for her, I'm going show you in a second. We said, okay, you got a hundred percent of your money in this, in the traditional TSP, which is fine. when she started in the government, like many of you all, all you had was traditional TSP. So what we did, we looked at her different tax brackets and we said, okay, we want it. We're going to do $25,000 a year keeps you in a decent tax range. And we're going to make sure we move all that money over to a tax free bucket with the Roth IRA. So that money can grow in time. And so when you pass on, if you need long-term care and things like that, your money is sitting in a, in a tax free bucket, which is the Roth TSP. And so Roth IRA. Okay. And so same money, same woman, two different legacies. So in this case, we're looking at age 95, right? We project her money out to age 95. And in this case, when you look at it, she's at 692,000 in after tax money when she, when she retires, when at age 90, sorry, when we do the tax free strategy, she's at 907,000 tax free because the taxes are taken out. Now that's a $214,000 difference that it makes by having a Roth conversion strategy that helps you avoid that tax drag because that tax drag can hurt you in the long run, not only you, but your kids. So ⁓ what we do here We really like to make this a process where we build this out for you and we help you build out different scenarios. In this situation, we just have two, but for most clients, we build out more. And so what we do is we first collect all your information. We collect all her information, her income, when she's retiring, the plan date, get her social security income in there, get her first pension number in there. get her TSP in there, put that in there, how much she's putting in TSP, all traditional TSP. Then what we do is we look at our tax bracket. the thing we do is we look at, okay, the year you retire, what is your tax bracket? And so for her, she's in the 22 % tax bracket, okay? And so, okay, 22 % tax bracket, not super bad, but this is where you are. Now, as we mentioned before, when she retires, her money is going to continue to grow, which it does. And as we look at these, if we look at this scenario here, let's just take age 80, 85, I should say. And we look here, we see that now she has 549,000 in her TSP. 168 has had to come out because of RMDs, requirement of distribution. Right? This is where the government starts to force you to take that money out. That money continues to grow, continues to grow. Age 95, she has 770, 73,000 in there. 383 now is still in the traditional TSP, but she's had to take this money out because she had to pay taxes on that money, right? And so when we look at it, the system already calculates how much she would have in after tax ⁓ wealth at age 95, right? 692,000. Now, what do we do next? We created the TSP tax strategy for her. Again, same income. What we did though, was we modeled a raw thyroid. So we could see, taught her how to do the tax, the TSP tax strategy, right? And then what we did is again, we go and we look at the tax bracket, see where she is. She was in the 22 % tax bracket. Then what we did is if you see here, these numbers are much lower in the 22 % bracket because what we did is we wanted to max it out. And so what we did was, We started transferring 25,000 in her case to the Roth IRA. every year. And because we did that. It allowed us. model her putting more and more money in a tax free strategy. So now when you look here, you see one account 396,000. This is all Roth money. This money now is a hundred percent tax free. Now, when you look at this after tax legacy, the amount is much higher, all of it tax free. And what does that mean though? That means when she passes, her kids don't have a tax issue because now that money goes directly to them in the way in which they want it. All the taxes are already extracted out. The old way, especially because of the Secure Act, there's a 10 year rule now where the kids would have to pay taxes on the money. within a 10 year period, which can be very problematic, right? Imagine you, your parents passed, you were in your highest earning years, you were preparing for retirement. Now you're getting inheritance, which is not a bad deal, but now you're dealing with the IRS and making sure you're taking those income withdrawals, which puts you in a higher tax bracket on your personal income and the money that you're inheriting. Who wins in that situation? The IRS. And most times, especially if you have a high TSP balance, and I'll show you when you look at these tax brackets. When you look at federal plus the state, most folk, when you're taking that inherited tax. you know, it's putting you into the higher 30 % tax brackets. Plus you still got taste state taxes on top of that. So you're almost at 40 % just in the money that somebody inherited. So imagine you inherit a million dollars, 400,000 going to the IRS. You inherit, you know, a hundred thousand, 40,000 of that going to the IRS and the state. What you want to do is you want to avoid that at all costs. When you have the Roth account set up, It eliminates that tax drag. You just want to make sure you do it in a systematic way. And so this is one of the things that we take a lot of time in doing, right? And this is the reason why we also have a CPA on staff because we want to make sure that that money that's supposed to, that you, that you, ⁓ that you leave your kids, that you, that you're, that you have for long-term care when you need it in the long run, you want to make sure the taxes are already taken out of that because The IRS has set this thing up, especially with the Secure Act and the 10 year rule and even the pushback RMDs where, you know, is there that they're trying to win, right? And so you want to make sure you have a strategy in place. And so we take time to build these these out for you. And there's a lot of layers to this, but I don't want to go a mile deeper to this. You book a call with us. We'll go through a one on one with you and build out a similar tax strategy like we did for Dr. Rochelle.