Pension Deduction Thrift Savings Plan

You are a Michigan resident with a United States Government Thrift Savings Plan (TSP). You have withdrawn funds in tax year 2023, and plan to continue similar withdrawals in subsequent tax years, for the purpose of rolling these distributions over to a Roth account. You inquire about the income tax treatment of these distributions and specifically whether they are eligible for the retirement and pension benefits subtraction described under MCL 206.30(1)(f). You acknowledge that these distributions are federally taxable distributions with distribution code G on IRS Form 1099-R.

The facts pertinent to your request indicate that you are a Michigan resident retired from federal service who participated in the federal TSP both as a civil service employee and later as a reemployed civil service employee. According to your letter, federal employees who are reemployed after retiring are referred to as offset employees and participate in an Offset Plan of the Civil Service Retirement System. Neither an employee nor an offset employee is required to contribute to either the civil service retirement plan or the offset plan, and any contributions made are not matched by the employer.

According to your letter, you made contributions to both traditional, tax-deferred funds as well as to Roth, post-tax funds. However, the 2023 distribution and all future distributions you inquire about are all withdrawn from or will be withdrawn from a traditional tax-deferred fund and directly rolled over into a Roth IRA, generating a federally taxable distribution. The 2023 distribution was coded with the letter G on IRS Form 1099-R, which according to the 2023 Instructions for Form 1099-R refers to “a direct rollover from a qualified plan, a section 403(b) plan, or a governmental section 457(b) plan to an eligible retirement plan (another qualified plan, a section 403(b) plan, a governmental section 457(b) plan, or an IRA).”

You have asked:

1. Are the subject and future distributions qualifying retirement or pension benefits eligible for the Retirement and Pension Benefits Subtraction described under MCL 206.30(1)(f)?
2. If the subject and future distributions are qualifying retirement or pension benefits eligible for the Retirement and Pension Benefits Subtraction described under MCL 206.30(1)(f), are the subject and future distributions a public or private retirement benefit?

As you note in your analysis, the first step in determining the tax treatment of the distributions at issue is determining whether they are defined as “retirement or pension benefits” under the Michigan Income Tax Act (MITA). MITA defines “retirement or pension benefits” as distributions from the sources described in subsections (8)(a)-(c) of MCL 206.30 and excludes those described in subsection (8)(d). To understand whether your TSP distributions fit within the MITA definition of retirement or pension benefits requires a closer look at your particular TSP contributions and distributions.

There are two types of retirement systems at the federal government. The Civil Service Retirement Act, effective August 1, 1920, established a defined benefit retirement system for certain federal employees, which is when an employer provides a guaranteed income stream for life to eligible employees, when they retire. See 5 USC § 8332. Civilian employees hired before January 1, 1984 are enrolled in the Civil Service Retirement System (CSRS). By law, CSRS covered employees are excluded from Social Security coverage and taxes.

This changed for most new federal hires after 1983 due to a change in Social Security laws, which required Federal Insurance Contributions Act (FICA) coverage for these employees. The Federal Employees Retirement System (FERS) replaced CSRS, and employees hired on or after January 1, 1984 are enrolled in FERS. See 5 USC § 8411. But for any employees who had a break in federal employment and were rehired after 1983, a new subset of CSRS was created called the CSRS Offset program, which resulted in a hybrid type retirement program, incorporating parts of the old system and parts of the new system. Most notably, while a regular CSRS employee does not contribute to social security, a CSRS Offset employee does. These social security contributions reduce (offset) the amount of an employee’s pension.

The TSP is a defined contribution, cash, or deferred arrangement (CODA), similar to a 401(k), which was established by the Federal Employees’ Retirement System Act of 1986. According to Internal Revenue Code (IRC) § 7701(j), the TSP is to be treated as a trust described in § 401(a), exempt from taxation under § 501(a). See also 5 USC § 8440.

The TSP is different for FERS covered employees than for CSRS or CSRS Offset covered employees. For employees covered by FERS, the TSP is one part of a three-part retirement package that also includes the FERS basic annuity and social security benefits. The TSP part of FERS is an account that the government automatically sets up into which it deposits an employer contribution equaling 1% of an employee’s pay each pay period. Employees can also make their own contributions to the TSP account, which will elicit a matching employer contribution up to certain limits. These contributions are tax-deferred. FERS covered employees must meet vesting requirements before being vested in the government’s automatic 1% contribution. However, they are immediately vested in their own contributions and any matching contributions.

For employees covered by CSRS or the CSRS Offset program, the TSP is a supplement to the CSRS annuity. There is no government contribution or match, but employee contributions are tax-deferred. Because there is no match and no automatic contributions by the government, there is no vesting requirement for contributions to the TSP by a CSRS or CSRS Offset covered employee.

MITA uses the terms “retirement” or “pension benefits” to collectively refer to distributions falling into any one of three categories:

(1) pension trusts and annuity plans that qualify under section 401(a) of the IRC (except those included in MCL 206.30(8)(d)), including self-employment plans such as Keogh or HR 10 plans, certain individual retirement accounts where the distribution is a qualified one, 403(b) plans offered by a 501(c)(3) organization or public school system, and 401(k) plans where employee contributions are mandated by the plan or attributable to employer contributions; (see MCL 206.30(8)(a))

(2) certain plans not qualified under the IRC, including plans created by various levels of governments such as the United States, states other than Michigan, and political subdivisions of this state, as well as church plans, and any plan where the distribution is from a pension trust and the plan prescribes the contributions and retirement eligibility; (see MCL 206.30(8)(b)) and

(3) benefits received by a surviving spouse if the benefits qualified for a deduction prior to the decedent’s death. (see MCL 206.30(8)(c)). See also RAB 2023-22.

You assert that because the TSP is treated as a trust described in § 401(a) per IRC § 7701(j), it meets the MITA definition of a retirement or pension benefit under MCL 206.30(8)(a). You acknowledge, however, that subsection 30(8)(a) is subject to the exceptions provided in subsection 30(8)(d), which carves out from the definition of retirement or pension benefits amounts received from a plan that allows the employee to set the amount of compensation to be deferred and does not prescribe retirement age or years of service. Generally, these are distributions from deferred compensation plans like the IRC 457 plans or distributions from a 401(k) plan that were not derived from employee contributions mandated by the plan or from employer contributions. Other carve-outs include premature distributions paid on separation, withdrawal, or discontinuance of a plan prior to the earliest date the recipient could have retired under the provisions of the plan and payments received as an incentive to retire early unless the distributions are from a pension trust.

As relevant here, subsection 30(8)(d) excludes from the definition of retirement or pension benefits any plan that: (1) does not prescribe either retirement age or years of service and (2) allows an employee to set the amount to be deferred. Retirement plans that meet both of the above elements are excluded from the definition of retirement or pension benefits. Thus, each of these elements must be analyzed based on the TSP provisions.

In analyzing whether the TSP prescribes retirement age or years of service, you assert that your CSRS pension plan prescribes retirement age and years of service for receipt of benefits from that plan, and therefore, your TSP is not excluded from the MITA’s definition. However, the terms of your CSRS pension plan do not bear on whether your TSP is defined as a retirement or pension benefit because it is a separate plan. The two plans differ in their structure and benefits. A TSP is a defined contribution retirement savings and investment plan where retirement income is based on contributions and investment returns, and which is not guaranteed by the government; whereas, the CSRS provides a defined benefit contributory pension plan, meaning retirement benefits are calculated based on years of service and average salary, with a fixed monthly payout. While the TSP is essentially a 401(k)-type plan, the CSRS plan provides a lifetime annuity. For employees or retirees under the CSRS, the TSP is supplemental to the CSRS annuity. Each plan has its own separate terms that govern the structure and plan options. Accordingly, the provisions of the CSRS pension plan cannot be applied in considering eligibility of the TSP.

In considering the provisions that govern the TSP, it could be argued that the TSP establishes a retirement age through the application of penalty provisions for early withdrawals. But, while the TSP is generally subject to a penalty for distributions made before the age of 59½ (IRC § 72(t)(2)(A)(i); see also Dollander v IRS, 383 Fed Appx 932, 932–33 (CA 11, 2010)), such a penalty does not constitute a limitation based on “retirement age or years of service.” This conclusion is evident from the surrounding statutory context of Section 30(8)(d). For example, section 30(8)(d)(i) provides specific examples of plans that do not prescribe retirement age or years of service, including 457 plans, 401(k) plans, and 403(b) plans. Each of these plans is subject to the same penalties for early withdrawals as a TSP. The statutory inclusion of 457 plans, 401(k) plans, and 403(b) plans within Section 30(8)(d) suggests that early distribution penalties should not be treated as a limitation based on retirement age or years of service. And, given that a TSP is a CODA like the plans identified in section 30(8)(d)(i)(A)-(C), the department concludes that it, too, is a plan that does not “prescribe retirement age or years of service.”

To be clear, the CSRS defined benefit plan is an example of a plan with a retirement age or years of service requirement. Under the terms of the CSRS, the defined benefits are generally inaccessible until the employee reaches the specific retirement age or service requirement. Such a limitation, however, is different from the penalty for early withdrawals present within any of type of CODA – whether it be a 401(k) or a TSP – which merely creates a disincentive for early withdrawal but does not prevent it. A defined benefit plan is therefore an example of a plan with a retirement age or years of service requirement, but, as noted above, the TSP plan is not such a plan. For these reasons, the TSP does not prescribe retirement age or years of service within the plain meaning of Section 30(8)(d)(i).

A retirement plan is also excluded from MITA’s definition of retirement and pension benefits under Section 30(8)(d) if that plan allows an employee to set the amount of compensation to be deferred. As to this element of section 30(8)(d)(i), you assert that the TSP does not allow an employee to set the amount to be deferred because it is subject to the Internal Revenue Code’s annual limits on elective deferral plans. While you are correct that section 402(g)(1) of the IRC sets an annual limit ($22,500 in 2023) on the maximum amount of elective deferrals that may be excluded from taxable income in the taxable year, the plain language of Section 30(8)(d)(i) does not require that such deferrals be unlimited. Indeed, Section 30(8)(d)(i) only requires that the employee have the authority to set the amount of compensation to be deferred. While the provisions of the IRC may limit the federal tax advantages for such deferrals, employees nonetheless retain discretion under 30(8)(d)(i) to defer compensation within such limits. In other words, Section 30(8)(d)(i) includes retirement plans that give the employee any discretion to set the amount to be deferred, even if the federal tax advantages of such deferral may be subject to separate limitations under the IRC. In this case, because your letter notes that “the participant was not required to make contributions to the TSP,” the TSP therefore gives the employee ultimate discretion to set the deferral amount.

To be sure, one need only look at the plans the Legislature included within section 30(8)(d)(i). All the referenced plans — 457 plans, 401(k) plans, and 403(b) plans —are subject to annual contribution limits, and yet each is identified as an example of a plan that allows an employee to set the amount of compensation to be deferred. Had the legislature intended for the deferral limitations under the IRC to be considered within this context, then it would not have specifically included 457, 401(k), and 403(b) plans within Section 30(8)(d)(i). The TSP is similar to these plans, and therefore its statutory treatment here is the same – the TSP is a plan that “allows the employee to set the amount of compensation to be deferred.”

In conclusion, the MITA definition of “retirement or pension benefits” is structured to exclude distributions from elective salary deferral plans, such as a 457 plan, a 401(k) plan, and a 403(b) plan. It is only where an elective plan meets certain conditions set forth in section 30(8)(d)(i)(A)(C) that the plan distributions will be carved-out from the general rule excluding them from the definition of “retirement or pension benefits.” For instance, for 401(k)s, only those distributions attributable to employee contributions mandated by the plan or attributable to employer contributions are within the definition. While a TSP is a salary deferral plan similar to a 457, 401(k), or a 403(b) plan, it is different in that there is no statutory carve-out in subsection (8)(d)(i) that allows any portion of the TSP be considered an eligible retirement or pension benefit. Because distributions from a TSP satisfy the requisite elements of Section 30(8)(d)(i), they are not a “retirement or pension benefit.”

The distributions from your federal TSP in 2023 and future years are not a “retirement or pension benefit” under the MITA. Given the conclusion that TSP benefits are not retirement or pension benefits under the MITA, they are not eligible for subtraction under MCL 206.30(1)(f). Therefore, this letter ruling does not address whether the distributions from your TSP are from a public or a private source.

May 13, 2025
LR 2025-1
Lance R. Wilkinson
Director, Bureau of Tax Policy