Unraveling the Mysteries of Roth TSP

By on April 29, 2012 in News

As the rollout date of May 7th approaches, there are still many questions as to the logistics of Roth TSP.  I am going to share with you the most frequent questions that I get during my “Understanding the Roth TSP” workshop. 

Before I get into these frequently asked questions, I wanted to share my opinion about the Roth TSP.  First of all many of you are frustrated about some of the restrictions with the Roth TSP. You are probably already aware that the Thrift Savings Plan is the largest defined contribution plan in the country with approximately 4.5 million participants and 308 billon in assets; it surely is not an easy task to make everyone happy! Be thankful that TSP has added this option. Talk to your friends and families about whether or not their employer offers a Roth 401(k).  You will probably be surprised that the majority of them will not have this benefit.

Tax diversification is such an important component in retirement planning.  Many times I have to remind my clients that their TSP, 401(k), or IRA is not really their money. They have a silent partner, Uncle Sam. The bigger problem is we have no idea how much of that TSP or IRA Uncle Sam owns. 

We are at historical low tax rates. We know that we are struggling in our country with an unprecedented national debt, along with severe liabilities in Social Security, Medicare, Medicaid and the Federal Pension System! 

In the past, our government has had to collect more revenue during difficult times. When the economy is booming, as it was in the 80s and 90s, Congress was able to reduce our income tax, due to the fact that they were getting lots of revenue from a booming economy. Unfortunately, this is not the case today. You may have done a great job saving for retirement, managing your TSP and possibly other investments. Now completely out of your control, your tax rate rises…How will that affect you? 

There are a few things that you can do:

(1) Take more out of your retirement assets so that you will be able to enjoy the same standards of living that you planned for.

(2) Reduce your standard of living, since you are afraid to withdraw a greater amount from you savings since there is a good chance you will spend them down to quickly. 

(3) Decide that you will need to go back to work and find that even the job as a Walmart greeter has a long waiting list, and honestly there may be better looking more vibrant choices for Walmart to choose from.

Now you have the option to pay the tax on your contribution only (not the earnings portion), and not have to worry about where taxes will be in the future.  So let’s get to those questions now.

Q – Can I move any of my TSP to the Roth TSP?

A – No, you cannot convert your TSP to the Roth TSP.  TSP will only accept incoming transfers from a Roth 401(k), A Roth 403(b), or a Roth 457 plan.

Q – If I am going to retire within the next 5 years, does it make sense to contribute to the Roth TSP?
A – This depends on several factors such as when you need to take withdrawals. Tax-free withdrawals go by the 5 year rule which differs from the 5 year rule for Roth IRA’s.

The 5 year rule for Roth TSP:

Tax-free distributions if five years have passed since January 1 of the year you made your first Roth TSP contribution and:

  • you are age 59½ or older
  • permanently disabled
  • deceased

A distribution that is not qualified is subject to the pro-rata rule.  The non-taxable amount of the distribution is determined by dividing your deferrals (basis), by the balance in the Roth TSP account and multiplying the amount distributed by the result. Here is an example of this works:

Roth TSP non-qualified distribution:

Kathy has deferred a total of $30,000 to her Roth TSP and has a total balance in the account of $40,000.  She then takes a distribution of $12,000.  A total of $9,000 of the distribution will be tax-free.

$30,000/$40,000 = .75
$12,000 x .75 = $9,000

Tax-free distributions if five years have passed since January 1 of the year you made your first Roth TSP contribution and:

  • you are age 59½ or older
  • permanently disabled
  • deceased
  • 1st  time homebuyer

There is a different set of rules for a Roth IRA

The 5 year rule for a Roth IRA:

Tax-free distributions if five years have passed since January 1 of the year you made your first Roth TSP contribution and:

  • you are age 59½ or older
  • permanently disabled
  • deceased
  • 1st time homebuyer

Ordering Rules for Roth IRA distributions:

  • Principal contributions
  • Roth IRA conversions
  • Investment earnings

The five-year holding period is never carried over to a Roth IRA. The Roth TSP funds will be governed by the five-year rule applicable to the Roth IRA.  If the Roth has satisfied the five-year period, the Roth TSP funds are deemed to have also met the five-year holding period, even if in the Roth TSP for only one year.

  Roth IRA Roth TSP Traditional TSP
Contribution/Deferral Limits for 2012 $5,000 plus $1,000 if 50 years old or better $17,000 plus $5,500 catch-up if 50 years old or better $17,000 plus $5,500 catch-up if 50 years old or better
Matching Contributions None Up to 5% if the plan allows Up to 5% if the plan allows
Income Limits Yes None None
Tax of Contributions Contributions are after tax Deferrals are after-tax Deferrals are pre-tax
Rollovers Only to other Roth IRAs To Roth IRAs or Roth employer plans To most other retirement plans or converted to Roth IRA
Required Distributions None to Roth IRA owner At age 70 1/2 (unless still working) At ag 70 1/2 (unless still working)
Non-Qualified Distributions Use Roth ordering rules Use pro-rata rule Not applicable
Qualified Distributions 5 years after date Roth IRA was first established and 59 1/2 or death, disability or fist time home buyer 5 years after date Roth TSP was established and 59 1/2 or death or disability Not applicable

So now that you know these rules, how can you use them to take tax efficient distributions?  Let’s look at a couple of examples:

  1. Rollover from Roth TSP to an existing Roth IRA
    Tony opened a Roth IRA in 2004 with $10.00.  He started making contributions to the Roth TSP on May 7, 2012.  He retires in December 2014 at age 60 and rolls his Roth TSP into his Roth IRA.
    The 2004 Roth IRA will trump, and everything can come out of the Roth IRA tax and penalty free.
  2. Rollover from Roth TSP to a new Roth IRA
    Linda also started making contributions to the Roth TSP on May 7, 2012.  She retires in January 2015 at age 62 and rolls her Roth TSP into a new Roth IRA that she establishes at the time of her rollover.  Since the Roth IRA has just been established, the five-year holding period starts in 2015.  Linda loses the 3 years time that she had in the Roth TSP, however now that it is a Roth IRA, she uses ordering rules on the distributions:
    • Principal contributions
    • Roth IRA conversions
    • Investment earnings

Q – When I take distributions from the Roth TSP, can I choose where I want the withdrawal to come from, the traditional TSP or the Roth TSP?
A – No, they will come out proportionately.  If you had $150,000 in TSP and $50,000 in Roth TSP upon taking a withdrawal of $1,000, $750 would come from TSP and $250 from the Roth TSP.

Q – I am a CSRS and have a VCP.  Can I roll the after-tax portion of my VCP into the Roth TSP?
A – No, There is a complicated answer to this simple question.  The TSP can accept rollovers or transfers of the earnings attributable to the VCP, but only if they are going to a traditional TSP balance.  OPM’s publications about the VCP make it clear that this is permissible.

However, the TSP is statutorily prohibited from accepting transfers from VCP accounts into a Roth TSP balance.  Both the Federal Employees’ Retirement System Act (FERSA) and the Internal Revenue Code prohibit the TSP from accepting certain transfers and rollovers from the VCP.

These rules can be complicated and you may want to discuss them with a financial advisor that has extensive knowledge of federal benefits.

© 2016 Carol Schmidlin. All rights reserved. This article may not be reproduced without express written consent from Carol Schmidlin.

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About the Author

Carol Schmidlin is the President of Franklin Planning and has been advising clients on how to grow and preserve their wealth for 20 years. In addition to her financial planning practice, she is the founder of FedSavvy® Educational Solutions, which provides Financial and Retirement Literacy Programs for Federal Employees. Follow FedSavvy® Educational Solutions on Facebook for the most up to date information. Contact Carol at (856) 401-1101 or visit FranklinPlanning.com.

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  1. Sailor Jerry says:

    I’m coming back into the military after a break of 5+ years. TSP was new to the military when I was getting close to separating, so I never contributed. -I had made my own maximum Roth IRA contributions every year while I was on active duty ( < $4500/year). After just familiarizing myself over the last day with the new Roth TSP option, I can’t believe how good of a deal it is. This is the path to having millions of dollars at retirement age, if done right. The annual $17,500 TSP Roth cap + $5,500 Roth IRA cap allows a frugal and wise military member to accumulate a massive amount of retirement savings protected from the tax-man if they can afford the contributions.

    The $50,000 annual TSP Roth cap for personnel serving in a combat zone is an awesome incentive. If a 25 year old in the military fully-funded that $50,000 TSP Roth just one year during deployment and never touched it again, at age 65 the Roth alone would become worth over $4.5 million in untaxable retirement benefits over the course of the past 40 years considering an average annualized 12% return rate or better.

  2. rick20112 says:

    Regarding the 5-year rule – Does this rule start with the time you make any Roth IRA or Roth 401K deposit, or more specifically to any deposit within an investment vehicle (e.g. TSP)?

  3. USPS Letter Carrier says:

    There is at least one less than ideal downside to the new Roth TSP option. Your Roth money is invested proportionally based on the percentage of regular non taxed income and Roth income. If you own more than one fund you can’t invest all of your Roth income to say the C fund. Some of the Roth income has to go to all the other funds you’re in.

    For simplicity let’s assume you have $50k of regular income and $50k of Roth income in your TSP account, your asset allocation is 50% G fund, 50% C fund, and you’d prefer your Roth income go the C fund. But TSP requires your Roth be split 50-50 or $25k each in the G and C funds.

    Now suppose the G fund rises from $50k to $60k and the C fund rises from $50k to $100k. You now have of ($30k G + $50k C =) $80k of Roth income that you can withdraw at retirement tax free. You’d also have $80k of taxable TSP income. However if TSP allowed you invest your initial $50k of Roth income in the C fund, you’d have $100k of Roth at retirement and only $60k of taxable TSP income.
    With the scheme TSP devised, you’re on the hook for the tax on $20,000. Ouch.

  4. CirclingHawk says:

    Until the rules permit choosing which pot you want to take money out of upon retirement (Roth or tax-deferred), I don’t see much sense to putting money in the Roth TSP except for brand-new participants. Why bother when the withdrawals are proportional? So much for tax planning in retirement.

  5. USPS Letter Carrier says:

    “Kathy has deferred a total of $30,000 to her Roth TSP and has a total balance in the account of $40,000.  She then takes a distribution of $12,000.  A total of $9,000 of the distribution will be tax-free.”

    Isn’t “deferred” here incorrect? That is income to a traditional TSP is (tax) deferred but Roth money is not deferred.

    I know the hypothetical here is illustrative to show how much is lost to tax, but wouldn’t the smart thing here is to leave the Roth TSP alone and instead take a distribution from the traditional TSP?
      

    • grannybunny says:

      That’s not an option; see the Q&A above:  the distribution will be allocated proportionately.

      • USPS Letter Carrier says:

        It would be an option as follows:  As per Ed Z. at FederalDaily you can move your Roth TSP and leave the t-TSP intact. Then you would take a distribution as I had suggested and avoid the problem with getting double taxed with a Roth TSP.

        Ed Z:  “After you retire … you will be able to move your entire Roth TSP account to a “rollover” Roth IRA with Vanguard. You will be able to leave your traditional TSP account in the TSP. If you leave all of your money in the TSP (both your traditional and Roth TSP accounts), you will be able to make separate withdrawals (designate which account the withdrawals will come from).” 

        • Ringokate says:

          If you roll over your Roth TSP account to an IRA, are you saying it MUST be with Vanguard?  You don’t have the ability to choose where you want your rollover account to be, ie Fidelity, USAA, etc?

          • USPS Letter Carrier says:

            You may roll over to a custodian of your choice. The person (SlapShot) asking Ed Z. was considering Vanguard and Ed Z just repeated the name Vanguard in his Apr 12 reply on that website.

  6. USPS Letter Carrier says:

    “Q – When I take distributions from the Roth TSP, can I choose where I want the withdrawal to come from, the traditional TSP or the Roth TSP?A – No, they will come out proportionately.”

    C.S. is taking a distribution the same thing as asking to roll over the Roth TPS portion into a Roth IRA? Or can one ask to roll over the Roth TSP portion into a Roth IRA and leave the traditional TSP account alone?

  7. gov guest says:

    it is not fair that current retirees are not allowed to roll some of their traditional TSP into a Roth (after paying taxes on it of course)…especially since current retirees were not allowed to contribute to a Roth when they were employees!!!  I suggest that retirees write their congressional representatives and Senators and ask that a rollover Roth in TSP be allowed for those who have already retired!!!

    • USPS Letter Carrier says:

      Fair? Current employees may not roll their traditional TSP into a Roth TSP either, so both groups are treated the same. If you are gung ho on a Roth why not roll your TSP into a traditional IRA and then into a Roth IRA and pay the tax?

    • ready to retire says:

      Here is something I received on the same question. 

      Quote from TSP Withdrawal handbook:

      ‘If you choose to have the TSP transfer your Monthly payments to an IRA or an eligible employer plan, the TSP can only transfer monthly payments that are expected to last less than 10 years and are not based on the IRS life expectancy table. Thus, if you choose a dollar amount for your monthly payments, the TSP will determine whether your payments are expected to last less than 10 years. We will do this by dividing the part of your account balance that ou chose to be paid in monthly payments by the dollar amount that your chose for our montly payment. If hte result is less than 120, your payments will be eligible to be transferred.”

      • Donbeth says:

         What really bugs me is that any interfund transfer request will apply in equal proportion to your Roth TSP and Traditional TSP.  I’d like to use this Roth TSP feature– but I do not think I will due to the overly restrictive rules that apply to it

  8. LibLady says:

    This is a question on a Roth IRA for someone in their 30’s. If someone puts in several thousand a year and then wants to take out $1000 of the contributions after 1 year, can they do that? I thought you could take out your contributions (not income) on a penalty free basis at any time.

    • FERSretired says:

      I believe you are confusing “penalty” and “taxes”.   You can always withdraw your principal contributions tax free because you paid the tax on it when you contributed to your ROTH IRA.  You may, however, bump into the 10% early distribution penalty if you tap your Roth IRA before you’re age 59 1/2. Here are the exceptions to that penalty:
      You’re disabled You’re an IRA beneficiary You’re a first-time homeowner and need to cover certain expenses You have significant unreimbursed medical expenses You’re paying for medical premiums after losing a job You have qualified higher-education expenses IRS levy of a qualified plan You’re taking substantially equal periodic payments (same rules as under traditional IRA)

  9. guest fed says:

    I could have done without the chatty polical background in the beginning. I’m like Joe Friday of Dragnet,  “just the facts ma’am.” The chart and the FAQs were helpful.

  10. msgrowan says:

    The chart above includes information on how matching contributions will be treated insofar as a Roth TSP account is involved, which appears to indicate that government matching contributions will be credited to a FERS-covered employee’s Roth TSP account.  However, other articles on this topic have said that government matching contributions will NOT be credited to an employee’s Roth TSP account, but rather to his/her traditional tax deferred TSP option.  Who’s right?

  11. Fed Peasant says:

    A very good article!!

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