Q: Mike Miles answered a recent question about Thrift Savings Plan withdrawal by saying that the person making the withdrawal pays the taxes and penalties when filing a tax return, but that the TSP will withhold 20 percent for future liabilities. I’m not sure what that means: If the taxes and penalties are paid when we complete our tax returns, why does TSP withhold 20 percent, and what happens to that money? What could be a future liability? Do we ever get the 20 percent back?
A: The TSP withholding is mandatory; the 20 percent will be deposited with the government and applied against your 2011 tax liability when you file your return. In other words, when you file your return for the year of the withdrawal, the money withheld from your check will appear as a credit against your taxes. The withholding is not actually tax, it is just an advanced payment against whatever your tax turns out to be. If you owe less than you deposited through withholding and/or estimated tax payments during the year, the overpayment will be refunded to you. This is very basic stuff and if it’s a mystery to you, you should seriously consider having a professional prepare your returns!