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Tax Advantages of the TSP

 

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What are the immediate benefits of making tax-deferred contributions to the TSP?

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What are the long-term benefits of tax-deferred contributions?

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What is the Retirement Savings Contributions Credit (Saver’s Tax Credit) and how does it affect the TSP?

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FAQs  
   

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There are two tax benefits to making tax-deferred contributions to the TSP:

What are the immediate benefits of making tax-deferred contributions to the TSP?    Return to Top of this Page

Tax-deferred contributions are "before-tax" contributions.  When you participate in the TSP, you make before-tax contributions.  That means the money you contribute is taken out of your pay before Federal and, in almost all cases, state income taxes are withheld.  Therefore, the amount used to calculate your taxes is smaller and you pay less in taxes now.  Deposits to a regular savings account do not provide such an advantage.

Your TSP contributions are excluded from the taxable income reported on IRS Form W-2, Wage and Tax Statement, that you receive from your agency each year.  Thus, you do not report them on your annual Federal tax return.  This special tax treatment does not affect your salary of record for other Federal benefits — such as the FERS Basic Annuity, the CSRS annuity, or life insurance — nor does it affect Social Security or Medicare taxes or benefits.

By paying less current income tax, you have more take-home pay than if you had saved an equal amount that was not excluded from taxable income.  To give you an idea of the advantage of saving through before-tax contributions to the TSP, let us suppose, for simplicity, that you are a CSRS participant earning basic pay of $30,000 a year.  Let us also assume you are in the 15 percent tax bracket.

If you contribute 5 percent each pay period (or $1,500 per year) to your TSP account, you will owe $225 less (15% (your tax bracket) x $1,500) Federal tax in the current year than if you had not contributed to the TSP.  This is because when you save through the TSP, your contributions are not included in the amount on which your tax is calculated.  The difference in your tax bill will be even greater if the state in which you live permits tax-deferred savings, as most states do.

What are the long-termed benefits of tax-deferred contributions? Return to Top of this Page

By participating in the TSP, you defer (that is, postpone) paying Federal taxes on the money you contribute until you withdraw the funds from your TSP account.  In addition, over the years, the money in your account will accrue earnings.  These earnings are also tax-deferred.  This means that you do not pay income taxes on contributions and earnings in your TSP account until you receive the money — usually after you retire (when your tax bracket may be lower).  Deferring the payment of taxes results in more money staying in your account, working for you.  The longer your money is invested, the greater the benefit of tax-deferred earnings will be. Whether you can also defer state or local income taxes depends on the jurisdiction in which you live, although most states permit such a deferral.

What is the Retirement Savings Contributions Credit and how does it affect the TSP? Return to Top of this Page

The Retirement Savings Contributions Credit (also called the Saver’s Credit) provides an incentive for low- and moderate-income employees to contribute to the TSP (as well as to other retirement savings plans, such as IRAs).  If you meet the income limits, you may be eligible for a tax credit of up to $1,000 ($2,000 if you are married and file jointly) on your Federal income tax return for each year you contribute to the TSP.  This means that you may be able to reduce the tax you owe the Internal Revenue Service (IRS) or increase your refund by the amount of your credit.  However, your credit may be reduced if you receive distributions, including in-service withdrawal payments, paid directly to you from the TSP during the year for which you receive the tax credit.

For tax year 2007, the credit is available to participants with an adjusted gross income of no more than $52,000 if married and filing jointly, $39,000 if head of household, or $26,000 if single or married filing separately.  For the 2008 tax year, the credit is available to participants with an adjusted gross income of no more than $53,000 if married and filing jointly, $39,750 if head of household, and $26,500 if single or married filing separately.  The amount of your credit declines as your income increases.

You can claim the credit by completing IRS Form 8880 and attaching it to your Federal income tax return.  For more information about this tax credit, link to the IRS web site.

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