The Treasury Department has declared an interest rate of 3.125% for the Voluntary Contribution Program (VCP) for 2010. While that’s lower than the 2009 rate of 3.875%, the real benefits of the VCP aren’t in the interest rate but in the tax rate.
The Voluntary Contribution Program is a relic; really, a leftover from the days before FERS was even conceived. Originally, it was devised to allow CSRS employees to make additional, after-tax contributions to an account that could be used to add to their pensions. For each $100 in the account at retirement, the retiree added $7 to their annuity.
Making the VCP Viable Again
Once FERS and the TSP were established, however, the VCP was put on the back shelf in the storage room and not thought of again until 2006. With the passage of the Pension Protection Act of 2006, the VCP became viable again. This legislation included a provision that allows participants in the VCP to roll their funds to a Roth IRA upon retirement or leaving the VCP.
The implications of that language are huge. Imagine if you have $25,000 in a mutual fund account. Each year, the mutual fund custodian sends you a 1099, and you pay taxes on the dividends. You might be the lucky recipient of a 1099 even if you had a loss in your account for the year!
You could take that same $25,000, liquidate the account, and put the funds in your VCP. Now it’s growing tax-deferred at 3.125%. The 3.125% may not impress you, but here’s where the attraction comes in.
At retirement, or sooner if you want, you can transfer the funds out of the VCP and convert it to a Roth IRA—paying taxes only on the deferred growth while it was in the account. You can even invest it back in the same mutual funds if you like. From that point forward, you won’t owe taxes on that Roth IRA ever again—and neither will your heirs!
CSRS Employees and a Roth IRA
In the past, many CSRS employees have been excluded from contributing to a Roth due to their income level. The VCP provides a way for CSRS and CSRS-Offset employees to get large sums into a Roth IRA.
As long as they do not owe a deposit or re-deposit and have never participated in the VCP in the past and taken their funds out, they can contribute up to 10% of everything they have ever made as a federal employee (you’ll be surprised to see how much this is!) into an account that can ultimately become tax-free for life.
The Roth IRA is a hot topic today and you have a unique, virtually tax-free opportunity to access the benefits of the Roth.