Page 53 - The Informed Fed--Hearn (edited 10.29.20)
P. 53

The TSP also has a lot of the same pitfalls of the 401k. First, it was
               originally designed as a tax shelter, but has never been as effective as
               intended.  In  a  401k,  taxes  are  deferred  on  contributions  while  an
               employee is working and are assessed as income when the funds are
               withdrawn during retirement. The theory was that this would be at a
               lower tax rate, thereby creating a tax shelter on both the contributions
               and the earnings. The tax savings have been minimal from the beginning.
               The cost of living has steadily increased, as has the standard of living.
               Inflation doesn’t stop at retirement. While pensions and Social Security
               checks are significantly  less than  the  employee’s paycheck while  they
               were  working,  adding  a  spouse’s  retirement  income  and  taking
               withdrawals  from  savings  will  frequently  result  in  an  end-of-year  tax
               bracket that is similar to pre-retirement rates, and those rates continue
               to climb. In fact, most 401k funds that are withdrawn in retirement are
               assessed at an equal or higher tax rate than they would have been when
               they were deposited. Many retirees experience no tax savings through
               401k income, and will see as much as one-third of their funds lost to
               taxes.
                   Until  an  employee  reaches  the  age  of  59½,  401k  funds  are
               inaccessible without penalty or interest. The IRS is your silent partner
               who will demand their part during distributions. In fact, they will demand
               their portion when you turn 72 years old. This is known as Required
               Minimum  Distribution.  Because  taxes  have  not  been  paid,  the  IRS
               regulates  those  funds  very  carefully  and  has  a  vested  interest  in  the
               account. If you withdraw funds prior to age 59½, you must pay a 10%
               penalty plus count the withdrawal as income for the year and pay taxes
               accordingly. The exception to this rule is that if you leave service at age
               55  or  older,  you  can  take  distribution  without  incurring  the  10%
               premature distribution penalty. You will still be required to report this as
               income in the year you take the distribution. This is unique to the TSP
               program.  To  our  knowledge,  there  are  no  other  qualified  plans  that
               provide this special IRS provision.



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