Once you retire, many financial planners will encourage you to roll your TSP funds into a tax deferred option that they will be happy to sell you. It may be an IRA, a deferred annuity or some other type of investment. You may not know that you can roll money into your TSP from certain accounts. Both current employees and retirees may roll money into the TSP.
Money can be rolled into the TSP from a traditional IRA, SIMPLE IRA and/or an eligible employer plan. Rollovers are not allowed from Roth IRAs or Roth 401(k)s. I expect that once the TSP introduces the Roth TSP (currently planned for April 2012), that the Roth TSP will accept rollovers from Roth IRAs and 401(k)s.
Form TSP-60 (which is available on the TSP website in the forms and publications section) is used to effect the rollover.
The money must be an “eligible rollover distribution” and the TSP encourages individuals to check with their financial advisor or the plan administrator to ensure that the money qualifies for rollover. The money must also be before tax money. With regard to IRAs, this means that a traditional deductible IRA, and the earnings portion of a traditional non-deductible IRA would be eligible to be transferred to the TSP, but the contributions to a traditional non-deductible IRA would not (as they were made from already taxed dollars).
Any money that is transferred into the TSP will not count against the annual contribution limit ($16,500 for 2011).
Additional information on rolling or transferring money into the TSP can be found on page 7 of the Summary of the Thrift Savings Plan, which can be found in the forms and publications section of the TSP website.
You may have noticed that I have used the words “transfer” and “rollover” up to this point. There is a difference between rolling money over and transferring money, and if you do not understand that difference, you may end up paying taxes that you could have avoided. Avoiding taxes is perfectly legal; it’s when you evade taxes that you get into trouble.
There are specific tax rules about taking money from a qualified account and moving it into the TSP. Going all the way back to the inception of the IRA, individuals have been allowed 60 days to roll their money from one tax advantaged account into another without being liable for federal income taxes on the money. Until the mid-1990s that was all anyone needed to know. If an investor withdrew money from an IRA, there was no tax withheld unless they requested it. If, within 60 days, that money was put in another tax advantaged plan, no tax was due.
Unfortunately, many people took the money out and didn’t roll it over. That resulted in tax problems for those who had managed to spend the entire rollover and had no money left to pay the tax that was due. It also created extra work for the Internal Revenue Service. This resulted in a change to the tax law. Individuals still had the 60 day tax-free period but, if they didn’t directly transfer the money, 20% of the amount was withheld for federal income taxes. If the distribution from my tax advantaged account is sent to me (or my checking account) rather than being transferred to the TSP, the 20% will be withheld.
If I had $100,000 in my traditional deductible IRA and requested that it be transferred directly to the TSP, all $100,000 would be transferred to that account.
If, for some reason I had the $100,000 sent to my checking account, only $80,000 would be sent to the TSP. $20,000 would have been withheld for federal income tax. In the event I had an extra $20,000 somewhere, I could add it to the $80,000 and roll over a full $100,000 within 60 days. If I did that, I would receive a $20,000 refund when I filed my tax return.
What if I didn’t have $20,000 to add to the $80,000 received from my IRA? I would roll over the $80,000 into the TSP within 60 days. However, I would not be able to roll over the $20,000 that had been withheld. At tax time, that $20,000 would be treated as a withdrawal (even if I hadn’t been able to get my hands on it as it had been withheld). I would have to pay tax on the $20,000. If I were in the 25% tax bracket, that would result in an additional $5,000 of federal income tax. Instead of a $20,000 refund at tax time, I would receive $15,000.
The words direct transfer are very important to remember, whether you are rolling money into the TSP or out of the TSP.