Marcus retired from a federal agency at 62 and decided to use TSP money to replace his roof. The contractor quoted $30,000, so he requested a $30,000 withdrawal. A week later, $24,000 landed in his checking account. He called the TSP, convinced something had gone wrong.

Nothing had. The other $6,000 went straight to the IRS as mandatory federal income tax withholding. Marcus was short on the roof, and he had no idea whether that $6,000 was a fair estimate of what he owed or a wild guess. (It was closer to the second one.)

What the 20% actually is

When you take a single payment from the TSP and have it paid to you instead of rolling it over, the TSP must withhold 20% of the taxable portion for federal income tax. You can't lower that amount or waive it. You can ask for more withholding, but not less.

The key word is withholding. It is a down payment on your tax bill, not the bill itself. Your real tax on that withdrawal depends on everything else in your year: pension, Social Security, spouse's income, deductions, and which brackets the extra income pushes you into.

That's why the 20% can be wrong in either direction.

  • If the withdrawal lands mostly in the 12% bracket, you'll likely get some of it back at filing time.
  • If it pushes you into the 24% or 32% bracket, you could owe more in April.
  • If you're under 59½ and don't qualify for an exception, there's a 10% early withdrawal penalty that the 20% doesn't cover at all.

Which withdrawals trigger it

The mandatory 20% applies to what the IRS calls eligible rollover distributions. In TSP terms, that generally means:

  • Single (lump sum) payments paid to you
  • Partial withdrawals paid to you
  • Monthly payments set to last fewer than 10 years

It generally does not apply to monthly payments based on life expectancy or scheduled for 10 years or more, or to required minimum distributions. Those follow different withholding rules, where you have more say in the amount. Check the current TSP withdrawal booklets at tsp.gov for the exact treatment, since the details matter here.

It also applies only to the taxable part. If you're taking money from a Roth balance, a qualified withdrawal (generally five years since your first Roth contribution and age 59½ or older, disabled, or deceased) is tax-free. A nonqualified Roth payment is taxed only on the earnings portion.

The way around it: a direct rollover

If you don't need the cash, ask the TSP to send the money directly to a traditional IRA or another eligible plan. A direct rollover has no mandatory withholding and no current tax. The money stays tax-deferred until you take it out of the IRA.

You can also split the payment. Say you want $30,000 in hand and $70,000 moved to an IRA. The TSP withholds 20% only on the portion paid to you. The rolled amount goes over whole.

Be careful with the alternative, the indirect rollover, where the check comes to you first. You have 60 days to deposit it into an IRA. But the TSP will have withheld 20%, and to roll over the full amount you'd need to make up that missing 20% from your own savings. Skip that and the withheld portion counts as a taxable distribution. You get the withholding back at tax time, but you've fronted the money for months. It rarely makes sense.

Planning around the withholding

Gross up the request

If you need a specific dollar amount, divide by 0.80. Marcus needed $30,000 net, so he should have requested $37,500. After 20% withholding of $7,500, he'd have received $30,000.

But grossing up means a larger taxable withdrawal, which may be more income than you want to report in one year. Which brings up the better question.

Check your bracket before you pull the trigger

Say Marcus and his wife have $68,000 of taxable income from his pension and her part-time job. A $37,500 withdrawal brings them to $105,500. For a married couple filing jointly, that crosses from the 12% bracket into the 22% bracket. His real tax on the withdrawal might land somewhere around 18% to 20% on average, so the 20% withholding is a decent match. Bracket thresholds change every year, so look at the current tables at irs.gov rather than trusting any number I quote.

Now picture a different couple with $40,000 of taxable income. The same withdrawal might be taxed mostly at 12%, and the withholding would overshoot by a few thousand dollars. They'd have lent the IRS money for a year.

And a couple with $180,000 of income could see much of the withdrawal taxed at 24% or higher. They'd write a check in April.

Consider spreading it out

A large single-year withdrawal can push you into higher brackets and affect other things, like the taxation of Social Security benefits and Medicare IRMAA surcharges, which look back at your income from two years earlier. Splitting a withdrawal across two tax years, say December and January, can sometimes keep both years in a lower bracket. That's not always possible when the roof is leaking, but it's worth asking.

Mind the early withdrawal penalty

If you separate from service in or after the year you turn 55 (age 50 for certain public safety employees), the 10% additional tax doesn't apply to TSP withdrawals. If you separated earlier and you're under 59½, the penalty can apply, and nothing in the 20% withholding covers it. Someone who takes $30,000 at age 52 could face $3,000 in penalty on top of regular income tax. Talk to a tax professional before making that move.

Don't forget state tax

Federal withholding is only half the story. Some states require or allow state income tax withholding on retirement distributions, and the rules vary widely. A few states don't tax retirement income at all. Check your state's rules, and look at how the TSP handles state withholding on its current forms.

Fixing a withholding miss

If you've already taken a withdrawal and the 20% turned out wrong:

  1. Withheld too much. You'll get the overage back as a refund when you file. Nothing else to do.
  2. Withheld too little. Consider making an estimated tax payment (Form 1040-ES) so you don't get hit with an underpayment penalty. Or increase withholding from your pension or other sources for the rest of the year.
  3. Used the money for something and regret it. If you did an indirect rollover and are still inside the 60-day window, you can deposit funds into an IRA to undo the taxable event. After 60 days, the IRS rarely forgives.

The short version

The 20% is not a tax rate, it's a placeholder. Before any TSP withdrawal, work out roughly what your tax bill for the year will look like, decide whether you need the cash or can roll it, and size the request accordingly. Ten minutes with last year's return and a calculator usually answers it.

Marcus ended up borrowing $6,000 from a savings account to pay the roofer. When he filed his return the next spring, he got $1,100 back. It was a cheap lesson, but only because he happened to be in a bracket that forgave him.

For current withholding rules and forms, see tsp.gov. For bracket thresholds and penalty rules, see irs.gov.