Using the CSRS Voluntary Contribution Program to Max-Fund a Roth IRA

Do you make “too much money” to qualify for a Roth IRA? CSRS and CSRS Offset federal employees have a unique benefit that can be used max-fund a Roth IRA.

CSRS and CSRS Offset federal employees have a unique benefit called the CSRS Voluntary Contributions Program (VCP).

The VCP was originally designed to allow CSRS to put more money in and buy an additional annuity at retirement.  But there is another way to use the VCP that can help you max-fund a Roth IRA – even if you thought you made ‘too much money’ to have a Roth.

The VCP to Roth IRA transfer makes the most sense for people who #1) make ‘too much money’ to contribute directly to a Roth IRA, and/or #2) want to put more than $6,000 into a Roth (and have the money).

Roth IRAs & Taxes in Retirement

Roth IRAs allow you to put in after-tax money, and if you let it sit long enough, you can take the money and its earnings out tax-free.

Think about your retirement income for a moment.  Most CSRS will have their CSRS pension, a few might have Social Security from outside work or spousal benefit, and then you have your TSP and other personal investments.

The majority of your CSRS pension will be taxable at ordinary income tax rates. If you receive any Social Security, there’s a good chance that most of that will also be taxed.  And most people have their personal investments in tax-deferred accounts like the TSP and Traditional IRAs.  When you take money out of your TSP or Traditional IRAs, the money will be taxed at ordinary income tax rates.

So almost all of the money you take out in retirement will be taxed at ordinary income tax rates.

The next question is, “Where do you think taxes are going in the future?”
I personally think that taxes are going to increase significantly in the future.

What will happen when income tax rates go up?  If all of your retirement money is taxable – you’ll have no choice but to pay the higher taxes.  Either you’ll have to reduce your lifestyle, or pull more money out of your accounts to pay the higher taxes.

But what if you had a portion of your retirement money in a Roth IRA?  When tax rates increased, you could choose where you took your retirement money from.  In that case, you might choose to pull money out of your Roth IRA for a while and let the money in your TSP or Traditional IRA grow.

Everyone’s situation is unique – but the main point here is that you would have a choice.  You would have control over how much of your retirement income would be taxed – because you could choose which accounts you took money out of.  But in order to do that, you need to plan ahead.

We can’t cover everything there is to know about Roth IRAs in one article – but I think most people can benefit from having money in a Roth IRA.  How much money depends on your personal situation.

Limits on Roth IRAs

If you are eligible to contribute to a Roth, the most you can put in each year is $6,000 a year ($5,000 + $1,000 catch-up if you’re over 50).

But if you make ‘too much money’ – you can’t contribute to a Roth IRA at all.  In 2011, if your Modified Adjusted Gross Income for Married Filing Joint is over $179,000 – you can’t contribute directly to a Roth.

However, even if you make ‘too much money’ – you can still get money into a Roth IRA by transferring it from another qualified account.

In the past, there were income limits restricting who could transfer money into a Roth IRA.  But in 2010, the income restrictions for Roth conversions were removed.  So today (2011), you might make ‘too much money’ to contribute directly to a Roth – but you can still transfer money from a qualified account into a Roth.

What Qualified Accounts can Transfer to a Roth IRA?

The most common qualified accounts for federal employees would be Traditional IRAs or your TSP. These accounts are tax-deferred; which means you’d have to pay taxes on that money when you transfer it to a Roth.

But CSRS and CSRS Offset federal employees also have another option:  the VCP.

The VCP is Different

The VCP is also a “qualified” account, like a Traditional IRA or your TSP.  But it is different in two important ways:  taxes and limits.

First, taxes. The money you put in the VCP is after-tax money.  You will earn a small amount of interest on your VCP contributions.  That interest is tax-deferred.  So your VCP will have a mix of after-tax and tax-deferred money.  This mix is important to understand when you transfer your account.

Second, limits.  While you are limited in how much you can put into the VCP – it’s a much higher limit than how much you can put into other qualified accounts.  For example, if you’re over 50, you’re limited to $6,000 a year for a Roth IRA, or $22,000 a year for your TSP.  Your VCP limit is not by year, but rather is set at 10% of your CSRS basic pay over your entire career.  For many CSRS, their VCP limit is well over $100,000.

Do You Make ‘Too Much Money’ for a Roth IRA?

In the CSRS retirement classes I teach, lots of people are familiar with Roth IRAs.  But many thought they made ‘too much money’ to have a Roth – so they stopped looking any further into Roth IRAs.

Let’s look at an example where you make ‘too much money’ to qualify for a Roth IRA.  And say you have $40,000 of after-tax money that you’d like to put in a Roth IRA if you could – but since your income is too high, you you’re not even allowed to put in the regular $5,000 or $6,000 a year.

While you can’t contribute directly to a Roth IRA, you can transfer money into a Roth.  You can open a CSRS VCP account and transfer in.  You open a VCP account.  Fund it with the $40,000.  Open a Roth (but don’t fund it yet).  File the paperwork to withdraw your VCP and transfer the contributions to your Roth IRA.  While this is not the most common way to fund a Roth – we’re still playing by all of the rules.

There’s more to know, but that’s the basic idea.  It’s not a complicated process, but if you get it wrong it could bring serious (and expensive) tax consequences.

We’ve just covered some basics about Roth IRAs and the VCP.  Before you do anything, please make sure you understand all of your options.  Then and only then can you make the best decision for your personal situation.

I get so many questions about the VCP to Roth transfer that I’ve written a book detailing the entire process:  The Best Kept Secret in CSRS. It’s designed to be an all-in-one resource on the VCP specifically for do-it-yourselfers.

About the Author

Micah Shilanski is a Certified Financial Planner™ professional who specializes in helping federal employees get the most out of their retirement benefits. Micah helps his clients with tax planning, retirement planning, federal retirement planning, estate planning, and investment advice. Plan Your Federal Retirement is a dba of Shilanski & Associates, Inc., an Alaska Registered Investment Advisor, with securities offered through Summit Brokerage Services, Inc., Member FINRA/SIPC.