Unraveling the Mysteries of Roth TSP

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By on April 29, 2012 in Pay & Benefits with 0 Comments

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.

© 2020 Carol Schmidlin. All rights reserved. This article may not be reproduced without express written consent from Carol Schmidlin.


About the Author

Carol Schmidlin, Certified Financial Fiduciary®, MRFC® is the President of Franklin Planning and has been advising clients on how to grow and preserve their wealth for 25 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. She is passionate about helping families with all phases of Wealth Management and is a member of Ed Slott’s Master Elite IRA Advisor Group. Her practice maintains a home office in Sewell, NJ along with a satellite office in Washington, DC. Carol can be reached at (856) 401-1101.